cost accounting horngreen, datar, foster flexible budgets, variances, and management control: i...

Cost Accounting Horngreen, Datar, Foster

Flexible Budgets, Variances, and Management Control: I

Session 7

Cost Accounting Horngreen, Datar, Foster

Learning Objectives

Describe the difference between a static budget and a flexible budget

Develop a flexible budget and compute flexible-budget variances and sales-volume variances

Explain why standard costs are often used in variance analysis

Compute the price and efficiency variances for direct cost categories

Explain why purchasing performance measures should focus on more factors than just price variances

Cost Accounting Horngreen, Datar, Foster

Learning Objective 1

Describe the difference between a static budget and a flexible budget

Cost Accounting Horngreen, Datar, Foster

Static and Flexible Budgets

A static budget is a budget prepared for only one level of activity.• It is based on the level of output planned at the start of the budget

period.• The master budget is an example of a static budget.

A flexible budget is developed using budgeted revenues or cost amounts based on the level of output actually achieved in the budget period.• A key difference between a flexible budget and a static budget is the

use of the actual output level in the flexible budget.

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Static Budget

Assume that Rockville Co. manufactures and sells dress suits.• Budgeted variable costs per suit are as follows:

Direct materials cost $ 65 Direct manufacturing labor 26 Variable manufacturing overhead 24 Total variable costs $115

• Budgeted selling price is $155 per suit.• Fixed manufacturing costs are expected to be $286,000 within a relevant

range between 9,000 and 13,500 suits.• The static budget for year 2001 is based on selling 13,000 suits.

What is the static-budget operating income?• Revenues (13,000 × $155) $2,015,000

Variable Expenses (13,000 × $115) - 1,495,000 Fixed Expenses - 286,000 Budgeted operating income $ 234,000

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Static Budget

Assume that Rockville Co. produced and sold 10,000 suits at $160 each with actual variable costs of $120 per suit and fixed manufacturing costs of $300,000.

What was the actual operating income? Revenues (10,000 × $160) $1,600,000

Less Expenses: Variable (10,000 × $120) 1,200,000 Fixed 300,000 Actual operating income $ 100,000

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Static-Budget Variance

A static-budget variance is the difference between an actual result and a budgeted amount in the static budget.• A favorable variance is a variance that increases operating income

relative to the budgeted amount.• An unfavorable variance is a variance that decreases operating

income relative to the budgeted amount.

Level 0 analysis compares actual operating income with budgeted operating income.• Actual operating income $100,000

Budgeted operating income 234,000 Static-budget variance of operating income $134,000 U

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Static-Budget Variance

Level 1 analysis provides more detailed information on the operating income static- budget variance.

Static Budget Based Variance Analysis(Level 1) in (000)

Static Actual Budget Results VarianceSuits 13 10 3 URevenue $2,015 $1,600 $415 UVariable costs 1,495 1,200 296 FContribution margin $ 520 $ 400 $120 UFixed costs 286 300 14 UOperating income $ 234 $ 100 $134 U

Cost Accounting Horngreen, Datar, Foster

Learning Objective 2

Develop a flexible budget and compute flexible-budget variances

and sales-volume variances

Cost Accounting Horngreen, Datar, Foster

Steps in Developing Flexible Budgets

Step 1: Determine budgeted selling price, budgeted variable cost per unit, and budgeted fixed cost.• The budgeted selling price is $155, the budgeted variable cost is

$115 per suit, and the budgeted fixed cost is $286,000.

Cost Accounting Horngreen, Datar, Foster

Step 1: Determine budgeted selling price, budgeted variable cost per unit, and budgeted fixed cost.

Step 2: Determine the actual quantity of output.• In the year 2001, 10,000 suits were produced and sold.

Steps in Developing Flexible Budgets

Cost Accounting Horngreen, Datar, Foster

Step 1: Determine budgeted selling price, budgeted variable cost per unit, and budgeted fixed cost.

Step 2: Determine the actual quantity of output. Step 3: Determine the flexible budget for revenues based

on budgeted selling price and actual quantity of output. • $155 × 10,000 = $1,550,000

Steps in Developing Flexible Budgets

Cost Accounting Horngreen, Datar, Foster

Step 1: Determine budgeted selling price, budgeted variable cost per unit, and budgeted fixed cost.

Step 2: Determine the actual quantity of output. Step 3: Determine the flexible budget for revenues based

on budgeted selling price and actual quantity of output. Step 4: Determine the flexible budget for costs based on

budgeted variable costs per output unit, actual quantity of output, and the budgeted fixed costs.• Flexible budget:

Variable costs 10,000 × $115 $1,150,000 Fixed costs 286,000 Total costs $1,436,000

Steps in Developing Flexible Budgets

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Variances

Level 2 analysis provides information on the two components of the static-budget variance.1 Flexible-budget variance2 Sales-volume variance

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Flexible-Budget Variance

Flexible-Budget Variance (Level 2) in (000)

Flexible Actual Budget Results VarianceSuits 10 10 0 Revenue $1,550 $1,600 $ 50 FVariable costs 1,150 1,200 50 UContribution margin $ 400 $ 400 $ 0 UFixed costs 286 300 14 UOperating income $ 114 $ 100 $ 14 U

Cost Accounting Horngreen, Datar, Foster

Flexible-Budget Variance

The flexible-budget variance pertaining to revenues is often called a selling-price variance because it arises solely from differences between the actual selling price and the budgeted selling price:• Selling-price variance = ($160 – $155) x 10,000 = $50,000 F• Actual selling price exceeds the budgeted amount by $5.

What does this tell you? • Suppose Rockville Co had started an advertising campaign that

led to the increase in the selling price.• If the campaign had costed more than $50,000 it was unprofitable• If the campaign had costed less than $50,000 it was a profitable

one

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Sales-Volume Variance

The sales-volume variance is the difference between the static budget for the number of units expected to be sold and the flexible budget for the number of units that were actually sold.

The only difference between the static budget and the flexible budget is the output level upon which the budget is based.

Cost Accounting Horngreen, Datar, Foster

Sales-Volume Variance

Sales-Volume Variance (Level 2) in (000)

Flexible Static Sales-Volume Budget Budget VarianceSuits 10 13 3 URevenue $1,550 $2,015 $465 UVariable costs 1,150 1,495 345 FContr. margin $ 400 $ 520 $120 UFixed costs 286 286 0Operating income $ 114 $ 234 $120 U

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Sales-Volume Variance

Actual quantity sold 10,000 suits:

Flexible-budgetoperating income

$114,000

Static-budgetoperating income

$234,000

Sales-volumevariance

$120,000 U

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Budget Variances

Static-budget variance $134,000 U

Flexible-budgetvariance

$14,000 U

Level 1

Level 2Sales-volume variance $120,000 U

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Remark

The above split-up has been derived by introducing the flexible budget as an intermediate step:

static budget variance (level 1)

= budgeted # of pieces * budgeted $ per piece- actual # of pieces * budgeted $ per piece+ actual # of pieces * budgeted $ per piece- actual # of pieces * actual $ per piece

Formally, a similar split-up could have been derived by developing a „flexible budget 2“ as follows

static budget variance (level 1)

= budgeted # of pieces * budgeted $ per piece- budgeted # of pieces * actual $ per piece+ budgeted # of pieces * actual $ per piece- actual # of pieces * actual $ per piece

Flexible budget variance

Sales volume variance

Zero

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Learning Objective 3

Use standard costs in variance analysis

Cost Accounting Horngreen, Datar, Foster

Sources of Information

The two main sources of information about budgeted input prices and budgeted input quantities are:

1 Actual input data from past periods2 Standards developed

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Standards

A standard input is a carefully predetermined quantity of inputs (such as pounds of materials or manufacturing labor-hours) required for one unit of output.

A standard cost is a carefully predetermined cost that is based on a norm of efficiency.

Standard costs can relate to units of inputs or units of outputs.

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Standards

Rockville’s budgeted cost for each variable direct cost item is computed as follows:

Standard input allowed for

one output unit

Standard cost per input unit

×

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Standards

The following standards were developed for Rockville Company:

Direct materials:• 4.00 square yards of cloth input allowed per output unit (suit)

purchased at $16.25 standard cost per square yard.• Standard cost per output unit manufactured

= 4.00 × $16.25 = $65.00 Direct manufacturing labor:

• 2.00 manufacturing labor-hours of input allowed per output unit (suit) manufactured at $13.00 standard cost per hour.

• Standard cost per output unit manufactured = 2.00 × $13.00 = $26.00

Cost Accounting Horngreen, Datar, Foster

Learning Objective 4

Compute the price and efficiency variances for direct cost categories

Cost Accounting Horngreen, Datar, Foster

Price and Efficiency Variances

Level 3 analysis separates the flexible-budget variance into price and efficiency variances.The following relates to Rockville Company:• Direct materials purchased and used: 42,500 square yards• Actual price paid per yard: $15.95• Actual direct manufacturing labor hours: 21,500• Actual price paid per hour: $12.90

What is the actual cost of direct materials?• 42,500 × $15.95 = $677,875

What is the actual cost of direct manufacturing labor?• 21,500 × $12.90 = $277,350

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Price Variances

A price variance is the difference between the actual price and the budgeted price of inputs multiplied by the actual quantity of inputs.– Input-price variance– Rate variance

Price variance = (Actual price of inputs – Budgeted price of inputs) × Actual quantity of inputs• What is the price variance for direct materials?• ($15.95 – $16.25) × 42,500 = $12,750 F

What is the price variance for direct manufacturing labor?• ($12.90 – $13.00) × 21,500 = $2,150 F

Cost Accounting Horngreen, Datar, Foster

Price Variances

Actual Quantity Actual Quantity of Inputs at of Inputs at Actual Price Budgeted Price 42,500 × $15.95 42,500 × $16.25 = $677,875 = $690,625

$12,750 F

Materials price variance

Cost Accounting Horngreen, Datar, Foster

Price Variances

Actual Quantity Actual Quantity of Inputs at of Inputs at Actual Price Budgeted Price 21,500 × $12.90 21,500 × $13.00 = $277,350 = $279,500

$2,150 F

Labor price variance

Cost Accounting Horngreen, Datar, Foster

Price Variances

What may be some of the possible causes for Rockville’s favorable price variances?– Rockville’s purchasing manager negotiated more skillfully

than was planned.– Labor prices were set without careful analysis of the

market.

Cost Accounting Horngreen, Datar, Foster

Efficiency Variances

The efficiency variance is the difference between the actual and budgeted quantity of inputs used multiplied by the budgeted price of input.• Efficiency variance = (Actual quantity of inputs used – Budgeted

quantity of inputs allowed for actual output) × Budgeted price of inputs

What is the efficiency variance for direct materials?• (42,500 – 40,000) × $16.25 = $40,625 U

What is the efficiency variance for direct manufacturing labor?• (21,500 – 20,000) × $13.00 = $19,500 U

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Efficiency Variances

Actual Quantity Budgeted Quantity of Inputs at Allowed for Actual Budgeted Price Outputs at Budgeted Price 42,500 × $16.25 40,000 × $16.25 = $690,625 = $650,000

$40,625 U

Materials efficiency variance

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Efficiency Variances

Actual Quantity Budgeted Quantity of Inputs at Allowed for Actual Budgeted Price Outputs at Budgeted Price 21,500 × $13.00 20,000 × $13.00 = $279,500 = $260,000

$19,500 U

Labor efficiency variance

Cost Accounting Horngreen, Datar, Foster

Efficiency Variances

What may be some of the causes for Rockville’s unfavorable efficiency variances?– Rockville’s purchasing manager received lower quality of

materials.– The personnel manager hired underskilled workers.– The maintenance department did not properly maintain

machines.

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Price and Efficiency Variances

What is the flexible-budget variance for direct materials?Materials-price variance

$12,750 F + Materials-efficiency

variance $40,625 U = $27,875 U

quantity of input

Priceof input

15.95 16.25

40

42.5

pricevariance:$12,750F

Efficiency variance:$40,625U

Cost Accounting Horngreen, Datar, Foster

Price and Efficiency VariancesDirect laborDirect labor

Quantity of input

Price of input12.9 13

20

21,5

Efficiency variance:$19,500U

Flexible budgetvariance:$2,150F

What is the flexible-budget variance for direct manufacturing labor?Labor-price variance $2,150 F

+ Labor- efficiency variance $19,500 U = $17,350 U

Cost Accounting Horngreen, Datar, Foster

Variance Analysis

Static-budget variance Materials $167,125 FLabor 60,650 F Total $227,775 F

Flexible-budget variance Materials $27,875 U Labor 17,350 UTotal $45,225 U

Sales-volume variance Materials $195,000 F Labor 78,000 FTotal $273,000 F

Level 1

Level 2

Cost Accounting Horngreen, Datar, Foster

Variance Analysis

Flexible-budget variance Materials $27,875 U Labor 17,350 UTotal $45,225 U

Efficiency varianceMaterials $40,625 U Labor 19,500 UTotal $60,125 U

Price varianceMaterials $12,750 FLabor 2,150 F Total $14,900 F

Level 2

Level 3

Cost Accounting Horngreen, Datar, Foster

Learning Objective 5

Explain why purchasing performance measures should focus on more factors than just

price variances

Cost Accounting Horngreen, Datar, Foster

Performance Measurement Using Variances

A key use of variance analysis is in performance evaluation. Two attributes of performance are commonly measured:

1 Effectiveness2 Efficiency

Effectiveness is the degree to which a predetermined objective or target is met.

Efficiency is the relative amount of inputs used to achieve a given level of output.

Variances should not solely be used to evaluate performance.

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Performance Measurement Using Variances

If any single performance measure, such as a labor efficiency variance, receives excessive emphasis, managers tend to make decisions that maximize their own reported performance in terms of that single performance measure

“what you measure is what you get”.

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Multiple Causes of Variances

Often the causes of variances are interrelated. A favorable price variance might be due to lower quality

materials. It is best to always consider possible interdependencies

among variances and to not interpret variances in isolation of each other...

Almost all organizations use a combination of financial and nonfinancial performance measures rather than relying exclusively on either type.

Control may be exercised by observation of workers.