Flexible Budgets and Variance Analysis

Chapter 8
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 8-1

Static Budgets
A static budget is prepared for only one level of a given type of activity. All actual results are compared with the original budgeted amounts, even if sales volume is more or less than originally planned.

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8-2

Master Budget Variance: Sales

The variances of actual results from the master budget are called master (static) budget variances.

Actual $217,000

Budget $279,000

Variance $62,000 U

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8-3

Master Budget Variance: Expenses

Actual expenses that exceed budgeted expenses result in unfavorable (U) expense variances. Actual expenses that are less than budgeted expenses result in favorable (F) expense variances.

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8-4

Static Budget
McDonalds

Budgeted Actual
Purchase (100,000 buns @ RM1 per bun) Purchase (90,000 buns @ RM1 per bun) 100,000 90,000

Variance

10,000

Purchase (100,000 buns @ RM1.10 per bun) Purchase (90,000 buns @ RM1.10 per bun)

110,000
99,000

(10,000)
1,000

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8-5

Flexible Budget
A flexible budget (variable budget) is a budget that adjusts for changes in sales volume and other cost-driver activities.

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8-6

Flexible Budget Formulas

To develop a flexible budget, managers determine revenue and cost behaviour (within the relevant range) with respect to cost drivers.

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8-7

Activity-Based Flexible Budget

An activity-based flexible budget is based on budgeted costs for each activity and related cost driver. Within each activity centre, costs depend on an appropriate cost driver.

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8-8

Evaluation of Financial Performance

Flexible-budget variances

Activity-level variances

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 11

Evaluation of Financial Performance

Actual results at actual activity level Flexible budget for actual sales activity

Flexiblebudget variances

Units 7,000 Sales $217,000 Variable costs 158,200 Contribution margin $ 58,730 Fixed costs 70,300 Operating income $ (11,570)

7,000 $217,000 152,600 $ 64,400 70,000 $ (5,600)

5,670 U $5,670 U 300 U $5,970 U

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 12

Evaluation of Financial Performance

Flexible budget for actual sales activity Master budget

Salesactivity variances

Units 7,000 Sales $217,000 Variable costs 152,600 Contribution margin $ 64,400 Fixed costs 70,000 Operating income $ (5,600)

9,000 $279,000 196,200 $ 82,800 70,000 $ 12,800

2,000 U $62,000 U 43,600 F $18,400 U $18,400 U

Total master budget variances = $5,970 + $18,400 = $24,370

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 8 - 13

Isolating the Causes of Variances

Managers use comparisons among actual results, master budgets, and flexible budgets to evaluate organizational performance.

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 14

Isolating the Causes of Variances

Effectiveness is the degree to which a goal, objective, or target is met. Efficiency is the degree to which inputs are used in relation to a given level of outputs. Performance may be effective, efficient, both, or neither.
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 8 - 15

Flexible-Budget Variances
Total flexible-budget variance = Total actual results Total flexible-budget planned results Actual results $(11,570) Flexible budget $(5,600)

$5,970 Unfavorable
Flexible-budget variances
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 8 - 16

Sales-Activity Variances
Total sales-activity variance = Actual sales unit Master budgeted sales units

Budgeted contribution margin per unit

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 17

Sales-Activity Variances

Flexible budget $18,400 Unfavorable Activity-level variances

Master budget

(9,000 7,000) $9.20

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 18

Setting Standards
An expected cost is the cost that is most likely to be attained.

A standard cost is a carefully developed cost per unit that should be attained.

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 19

Perfection Standards...
or ideal standards, are expressions of the most efficient performance possible under the best conceivable conditions, using existing specifications and equipment.

No provision is made for waste, spoilage, machine breakdowns, and the like.

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 20

Currently Attainable Standards...

are levels of performance that managers can achieve by realistic levels of effort. They make allowances for normal defects, spoilage, waste, and nonproductive time.

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 21

Trade-Offs Among Variances

Improvements in one area could lead to improvements in others and vice versa.

Likewise, substandard performance in one area may be balanced by superior performance in others.

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 22

When to Investigate Variances

When should management investigate a variance? Many organizations have developed such rules of thumb as investigate all variances exceeding $5,000 or 25% of expected cost, whichever is lower.

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 23

Comparison with Prior Periods

Some organizations compare the most recent budget periods actual results with last years results for the same period.

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 24

Flexible-Budget Variance in Detail

Standard per unit of output: Direct Material 5 kg $ 2 $10 Direct Labour hour $16 $ 8

Std. inputs expected Std. price expected Std. cost expected

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 25

Variances from Material and Labour Standards

Actual results for 7,000 units produced: Direct material Kgs purchased and used: 36,800 Price/kg: $1.90 Total actual cost: $69,920

Direct labour Hours used: 3,750 Actual price (rate): $16.40 Total actual cost: $61,500
8 - 26

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

Variances from Material and Labour Standards

Standard Direct-Materials Cost Allowed: Units of good output achieved: 7,000

Input allowed per unit of output: 5 kgs

Standard unit price of input: $2/kg = Flexible budget or total standard cost allowed: $70,000
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 8 - 27

Variances from Material and Labour Standards

Actual cost $69,920 $80 Favourable Direct material flexible-budget variance Flexible budget $70,000

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 28

Variances from Material and Labour Standards

Standard Direct-Labour Cost Allowed: Units of good output achieved: 7,000

Input allowed per unit of output: hour

Standard unit price of input: $16/hour = Flexible budget or total standard cost allowed: $56,000
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 8 - 29

Variances from Material and Labour Standards

Actual cost $61,500 $5,500 Unfavorable Direct labour flexible-budget variance Flexible budget $56,000

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 30

Price and Usage Variances

(Actual price Standard Price) Actual quantity

(Actual quantity Standard quantity) Standard price

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 8 - 31

Price Variance Computations

($1.90 actual $2.00 standard) per kg 36,800 kg actual = $3,680 F

($16.40 actual $16.00 standard) per hour 3,750 hours actual = $1,500 U
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 8 - 32

Usage Variance Computations

[36,800 actual (7,000 5 standard)] kg $2 per kg standard = $3,600 U

[3,750 actual (7,000 standard)] hours $16 per hour standard = $4,000 U
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 8 - 33

Favourable or Unfavourable Variance?

To determine whether a variance is favourable or unfavourable, use logic rather than memorizing a formula.

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 34

Direct Materials Flexible Budget Variance

Actual cost $69,920
$3,680 F
(Price variance)

AQ SP = $73,600
$3,600 U
(Usage variance)

Flexible budget $70,000

Direct material flexible-budget variance

$80 F

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 35

Direct Labour Flexible Budget Variance

Actual cost $61,500 $1,500 U
(Price variance)

AH SP = $60,000 $4,000 U
(Usage variance)

Flexible budget $56,000

Direct labour flexible-budget variance $5,500 U

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton

8 - 36

Interpretation of Price and Usage Variances

Price and usage variances are helpful because they provide feedback to those responsible for inputs. Managers should not use these variances alone for decision making, control, or evaluation possibility of trade-offs
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 8 - 37