Budgeting and Variances

1
Budgeting and Variances

• Uses of budgets
• Production variances

2
Agenda

• Discussion of budgeting
• Discussion of variances
• Materials
• Labor
• Overhead
• Demonstration problems
• Group work

3
Master Budget

• Budget quantitative expression of a firms
  strategic plan of action
• Master budget prepared before the accounting
  period begins
• Also static budget
• Standard costs

4
Preparing the budget

• Project sales
• Plan production activity level
• Sales prediction
• Current finished goods inventory
• Desired ending finished goods inventory
• Plan purchases, employment
• Estimate fixed costs
• Prepare estimated income statements and balance
  sheets

5
Uses of budgets

• Planning
• Operational plans (short-term)
• Capital budgets (long-term)
• Company strategy
• Performance evaluation
• Variances
• Responsibility centers
• Control

6
Behavioral aspects of budgeting

• Participative budgeting
• Better information
• Better cooperation
• Budgetary slack
• Dysfunctional responses
• Compulsion to spend all discretionary funds
• Short-run emphasis on budget only
• Questionable actions designed only to balance
  the budget

7
Flexible budget

• Flexible budget the master budget you would
  have prepared if you had known before the
  accounting period started how much you would
  actually produce during the period.
• Flexible budget standard cost allowed for good
  output achieved

8
Flexible budgets and performance evaluation
9
Variances

• unfavorable variance NI is reduced from the
  budgeted expectation
• favorable variance NI is increased from
  budgeted expectation
• Note Do not interpret directly as bad or
  good behavior on the part of management.

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Variances
11
Variable cost variances

• Direct materials
• price variance usage price variance
• purchase price variance
• (actual price - std. price) x actual usage
• (actual price - std. price) x actual purchases
• quantity variance based on usage
• (actual usage - std. usage) x std. price
• actual usage total actual materials used
• standard usage std. allowed per unit x actual
  units

12
Variable cost variances

• Direct labor
• rate variance (actual price - std. price) x
  actual usage
• efficiency variance
• (actual usage - std. usage) x std. price
• actual usage total actual labor hrs. used
• standard usage std. allowed per unit x
  actual units

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Example Chemical, Inc.
Chemical, Inc., has set up the following
standards formaterials and direct labor
Materials 10 lbs. _at_ 3 30 per batch Direct
labor .5 hrs. _at_ 20/hr. 10 per batch
The number of finished units budgeted for the
period was 10,000. The number of actual batches
produced was 9,810. During the month, purchases
amounted to100,000 lbs. at a total cost of
310,000. The actual pricepaid for labor was
21 per hour. Price variances are isolated upon
purchase. Actual inputs used were 98,073lbs.
of material and 4,900 hours of labor.
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Direct material price variances
What might cause a direct material price variance?
Price change in market
Purchase discounts
Transportation costs
Grade of materials
Therefore, purchasing department
15
Direct material quantity variance
What could cause a direct material efficiency
variance?
Defect in material
Inexperienced workers
Poor supervision
Poor scheduling
Therefore, production department
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DM variance computations
Direct material purchase price variance
Direct material quantity variance
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DM activity variance
(actual output - budgeted output) x standard
price per unit of direct materialx standard
quantity of direct material per unit of output
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Direct labor variances
What would cause a direct labor rate variance?
The actual rate approximately average wage
paid, including fringes
Experience of workers
Union contract
Overtime
Change in fringes
Therefore, human resources or management
19
Direct labor variances
What would cause a direct labor efficiency
variance?
Skill
Motivation
Supervision/scheduling
Quality of materials
Late time
Therefore, production, human resources, purchasing
20
Labor variance computations
Rate variance
Efficiency variance
Activity variance
21
Overhead variances
1. By definition, fixed overhead does not vary
with thelevel of planned production.
Flexible budget FOH Master budget FOH
2. By definition, fixed overhead is incurred as
a lumpsum expenditure and there are no partial
input-outputrelationships.
Therefore, the Std. Input column is undefined.
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Overhead variances FOH
FOH budget variance Actual FOH - Budgeted FOH
FOH efficiency variance
Is undefined
FOH applied
(Predetermined rate/unit) x actual units
Production volume variance Applied FOH -
Budgeted FOH
23
Overhead variances VOH
VOH spending variance Actual VOH - Std. Input
col.
VOH efficiency variance
Std. Input - Flexible Budget
VOH activity variance Flexible Budget - Master
Budget
Or VOH applied - Master Budget
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Overhead variances
Over- or underapplied overhead
Actual overhead spending - Overhead applied
Or
The net of all the variances computed
25
Example Murray Manufacturers
VOH Rate 3 per DL hour
FOH Rate 4 per DL hour
One unit requires 2 hours of labor
Denominator volume is 1,000 units of output
Actual production was only 800 units.
Actual costs were 5,800 for variable overhead
and8,130 for fixed overhead 1,590 DL hrs. were
worked.
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Example Murray Manufacturers
VOH spending variance
VOH efficiency variance
VOH activity variance
27
Example Murray Manufacturers
FOH budget variance
FOH production volume variance
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Example The Vanguard Company
The Vanguard Company manufactures one product.
Itsstandard cost system incorporates flexible
budgets and assigns indirect costs on the basis
of standard DL hrs.
At denominator activity, the standard cost per
unit is
Direct materials, 3 lbs. _at_ 5.00 15.00
Direct labor, .4 hr. _at_ 20.00 8.00
Variable indirect costs, .4 hr. _at_ 6.00 2.40
Fixed indirect costs, .4 hr. _at_ 4.00 1.60
Total 27.00
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Example The Vanguard Company
DM
DL
VOH
FOH
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Example The Vanguard Company
Direct materials were quoted at 5.50 per pound
through- out September and October to all
suppliers. There was nopurchase-price variance
for materials in October theprice variance
shown relates solely to the materials used during
October.
Wage standards were set in accordance with an
annual union contract, but a shortage of workers
in the local areas has resulted in rates higher
than standard.
There were no beginning or ending inventories of
workin process.
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Example The Vanguard Company
1. How many units were produced?
32
Example The Vanguard Company
2. What were the actual number of direct labor
hoursused?
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Example The Vanguard Company
3. What was the actual wage rate?
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Example The Vanguard Company
4. What was the budget for fixed indirect costs.
35
Example The Vanguard Company
5. Denominator activity expressed in direct
labor hours.
36
Example The Vanguard Company
6. How many pounds of direct materials were used?
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Review of the discussion so far

• Variances are departures from budget expectations
  - they are performance evaluation measures.
• Each one measures a favorable or unfavorable
  change in (budgeted) net income due to some
  departure from planned sales and production.
• They do not, themselves, provide answers - they
  trigger questions.

38
Review What information do variances convey?

• What do activity variances convey?
• What do price variances convey?
• Material and labor (price)
• Variable overhead (spending)
• Fixed overhead (budget)
• What do efficiency variances convey?
• What do production volume variances convey?

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Variance computations

• Price variances Find the difference between the
  budgeted and the actual prices and multiply the
  difference by the actual number of units of the
  input consumed/purchased.
• Quantity/efficiency variances Find the
  difference between the actual number of units of
  the input consumed and the number of units the
  standards would allow for good production and
  then multiply the difference by the standard
  price of the input.

40
Variance computations

• Spending variance Find the difference between
  the actual amount spent on variable overhead and
  the amount that would have been spent if the
  predetermined overhead rate had accurately
  predicted the price of variable overhead per unit
  of the cost driver. (Actual - Std. Input)
• Budget variance The difference between actual
  fixed overhead spending and budgeted fixed
  overhead. (Actual - Master Budget)

41
Variance computations

• The production volume variance measures the
  difference between budgeted fixed overhead and
  the amount of fixed overhead that has been
  included in production costs. (Master Budget -
  Applied Overhead)
• An unfavorable PVV indicates less production than
  planned Idle capacity.
• A favorable PVV indicates that production (sales)
  levels are more than adequate to cover the amount
  of fixed overhead expected to be covered.

42
Group exercise

• Use Example Company Look at the numbers and
  determine what they all mean.
• Compute
• Direct material price, quantity and activity
  variances
• Direct labor rate, quantity and activity
  variances
• Overhead variances spending/budget, efficiency
  (if applicable), and PVV