Flexible Budgets and Variance Analysis

1
Introduction to Management Accounting
2
Introduction to Management Accounting
Chapter 8
Flexible Budgets and Variance Analysis
3
Favorable and Unfavorable Variances
Favorable variances arise when
actual results exceed budgeted.
Unfavorable variances arise when
actual results fall below budgeted.
Favorable (F) versus Unfavorable (U) Variances
Profit Revenue Costs Actual gt Expected
F F U Actual lt Expected U
U F
4
Static and Flexible Budgets
Learning Objective 1
A static budget is prepared for only one level of
a given type of activity. Differences between
actual results and the static budget for level
of output achieved are static-budget variances.
A flexible budget (variable budget) adjusts for
different levels of activities. Differences
between actual results and the flexible budget
are flexible-budget variances.
5
Flexible Budget Formulas
Learning Objective 2
To develop a flexible budget, managers determine
revenue and cost behavior (within the relevant
range) with respect to cost drivers.
Note that the static budget is just the flexible
budget for a single assumed level of activity.
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Activity-Based Flexible Budget
Learning Objective 3
An activity-based flexible budget is based on
budgeted costs for each activity and related cost
driver.
For each activity, costs depend on an different
cost driver.
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Evaluation of Financial Performance
Learning Objective 4
Actual results may differ from the master budget
because...
1) sales and other cost-driver activities
were not the same as originally forecasted, or
2) revenue or variable costs per unit of activity
and fixed costs per period were not as expected.
8
Evaluation of Financial Performance
Flexible budget for actual sales activity (3)
Actual results at actual activity level (1)
Sales-Activity Variance (4) (3)(5)
Flexible-budget variances (2) (1)-(3)
Static Budget (5)
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Isolating the Causes of Variances
Managers use comparisons among actual results,
master budgets, and flexible budgets to
evaluate organizational performance.
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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.
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Flexible-Budget Variances
Learning Objective 5
Total flexible-budget variance Total actual
results Total flexible-budget planned results
5,970 Unfavorable
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Sales-Activity Variances
Total sales - activity variance
Actual sales unit Master budgeted sales units

Budgeted contribution margin per unit

Flexible budget
(7,000 9,000) 9.20
Master budget

18,400 Unfavorable
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Setting Standards
A standard cost is a carefully developed cost per
unit that should be attained.
An expected cost is the cost that is most likely
to be attained.
Perfection (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.
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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.
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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.
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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.
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Comparison with Prior Periods
Some organizations compare the most recent budget
periods actual results with last years results
for the same period.
These comparisons are not as useful as
comparisons of actual outcomes with planned
results.
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Flexible-Budget Variance in Detail
Standard per unit of output
Std. inputs Flexible
expected Budget Amount Direct
Material 5 pounds 2 /pound 10 Direct
Labor ½ hour 16/hour
8
Std. price expected
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Variances from Material and Labor Standards
Actual results for 7,000 units produced
Direct material Pounds purchased and used
36,800 Price/pound 1.90 Total actual
cost 69,920
Direct labor Hours used 3,750 Actual price
(rate) 16.40 Total actual cost 61,500
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Variances from Material and Labor Standards
Flexible Budget or Total Standard Cost Allowed

Units of good output achieved

Input allowed per unit of output

Standard unit price of input
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Variances from Material and Labor Standards
Standard Direct-Materials Cost Allowed
7,000 units X 5 pounds X 2.00 per pound
70,000
Standard Direct-Labor Cost Allowed
7,000 units X 1/2 hour X 16 per hour 56,000
(1) (2) (3) Flex
ible Actual Flexible Budget
Costs Budget Variance Direct Materials
69,920 70,000 80 F Direct
Labor 61,500 56,000 5,500 U
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Price and Quantity Variances
Learning Objective 6
Price variance (Applied to labor is called a
rate variance)
(Actual price Standard Price) Actual quantity
used
Quantity variance (Often called usage or
efficiency variance)
(Actual quantity used standard quantity
allowed for actual output) Standard price
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Price Variance Computations
Direct materials price variance
(1.90 2.00) per pound 36,800 pounds
3,680 F
Direct labor price (rate) variance
(16.40 16.00) per hour 3,750 hours 1,500
U
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Quantity (Usage) Variance Computations
Direct-materials quantity variance
36,800 (7,000 5) pounds 2 per pound
3,600 U
Direct-labor quantity variance
3,750 (7,000 ½) hours 16 per hour
4,000 U
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Favorable or Unfavorable Variance?
To determine whether a variance is Favorable or
unfavorable, use logic rather than memorizing a
formula.
A quantity variance is favorable if the actual
quantity used is less than the standard quantity
allowed.
A price variance is favorable is the actual price
is less than the standard.
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Direct Materials Flexible Budget Variance
Direct-Materials Flexible-budget variance
3,680 favorable 3,600 unfavorable 80
favorable
Direct-Labor Flexible-budget variance
1,500 unfavorable 4,000 unfavorable
5,500 unfavorable
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Interpretation of Price and Usage Variances
Price and usage variances are helpful because
they provide feedback to those responsible for
managing inputs.
Managers should not use these variances alone for
decision making, control, or evaluation.
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Variable-Overhead Spending and Efficiency
Variances
Learning Objective 7
A variable-overhead efficiency variance occurs
when actual cost-driver activity differs from the
standard amount allowed for the actual output
achieved.
A variable-overhead spending variance occurs
when the difference between the actual variable
overhead and the amount of variable overhead
budgeted for the actual level of cost-driver
activity.
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Variable-Overhead Variances
variable- actual standard
standard overhead cost-driver
cost-driver variable-overhead
efficiency activity activity
rate per variance allowed
cost-driver unit
-

X
variable- actual
standard actual overhead
variable variable-overhead
cost-driver spending overhead rate per
unit activity variance of cost-driver
used
-

X
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Fixed Overhead Spending Variance
Learning Objective 8
The difference between actual fixed overhead and
budgeted fixed overhead Is the fixed overhead
spending variance.
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The End
End of Chapter 8