chapter 10 the use of budgets for cost control and performance evaluation
TRANSCRIPT
Chapter 10
The Use of Budgets for Cost Control and Performance
Evaluation
Topics to be Discussed
Introduction
Standard Costing
Ideal Versus Practical Standards
Use of Standards by Nonmanufacturing Organizations
Application in Business
Introduction
Key Concept
The purpose of the control function in management is to make sure that the goals of the organization are being attained.
Introduction
Variance Analysis
At the end of the an accounting period, managers use the budget as a control tool by comparing budgeted sales, budgeted production and budgeted manufacturing costs with actual sales, production and manufacturing costs.
Variance analysis allows managers to see whether sales, production and manufacturing costs are higher or lower than planned, and WHY actual sales, production and costs differ from those budgeted.
Introduction
Management by Exception: Managers choose deviations to investigate by focusing on material or significant differences.
Standard Costing
Standard Price: the Budgeted Price of the material, labor or overhead for each unit.
Standard Quantity: the Budgeted Quantity of the material, labor or overhead for each unit.
Standard Costing
Task Analysis: examines the production process in detail with an emphasis on determining what it should cost to produce a product, not what it cost last year.
Ideal vs Practical Standards
Ideal Standards: One that is attained only when near perfect conditions are present. Assumes that every aspect of the production process, from purchasing through shipment, is at peak efficiency.
Ideal vs Practical Standards
Practical Standards: Should be attained under normal, efficient operating conditions. Take into consideration that machines break down occasionally, that employees are not always perfect, that waste in materials does occur.
Ideal vs Practical Standards
Pause and Reflect
How do you think you would react to being evaluated using ideal standards?
Only A’s or F’s for a grade?
What about practical standards?
Use of Standards by Nonmanufacturing
OrganizationsAuto dealership: How much should it cost to sell a car?
City: How much should it cost to provide garbage pickup?
State University: How much should it cost to provide an education per student?
CPA firm: How much time is needed to prepare certain types of tax forms or returns?
Use of Standards by Nonmanufacturing
OrganizationsPause and Reflect
The estimated cost of providing an education to a student at a typical state university has been estimated to exceed $30,000 per year. However, in-state tuition at most public universities rarely exceeds $3,000 to $5,000 per year. Who is paying the rest of the cost?
Application in Business
Some managed health care companies have a standard amount of time for doctors seeing patients for particular ailments.
Initial visit: 20 minutes
Full physical: 45 minutes
Standard Costing Topics
Flexible Budgeting with Standard Costs
Sales Volume Variance
Variable Manufacturing Cost Variances
A Model Variance Analysis
Direct Material Variances
Direct Labor Variances
Variable Overhead Variances
Fixed Overhead Variances
Flexible Budgeting with Standard Costs
Standard Costs for Corinne’s Country Rocker
Direct Material
Direct Labor
Variable OH
Standard Quantity
20 linear ft of oak
5 labor hours
5 labor hours
Standard Price
$2 per foot
$12 per hour
$ 3 per hour
Standard Cost
$40
$60
$15
$115Total Variable Production Costs
Flexible Budgeting with Standard Costs
Comparison of Budget to Actual
Units sold
Units produced
Sales revenue
Variable manuf. Costs
Variable S & A
Contribution margin
Static Budget
1,500
1,500
$375,000
172,500
37,500
$165,000
Flexible Budget
1,600
1,600
$400,000
184,000
40,000
$176,000
Actual Results
1,600
1,600
$396,800
189,200
40,800
$166,800
Flexible Budgeting with Standard Costs
Comparison of Budget to Actual, cont.
Contribution margin
Fixed manuf. Costs
Fixed S & A
Operating Income
Static Budget
$165,000
15,000
18,000
$132,000
Flexible Budget
$176,000
15,000
18,000
$143,000
Actual Results
$166,800
16,000
16,000
$134800
Flexible Budgeting with Standard Costs
Why is the difference between the static budget and flexible budget contribution margin the same as the difference between the static budget and flexible budget operating income?
Sales Volume Variance
Sales Volume Variance =
(Actual – Budgeted Sales Volume)
X
(Budgeted Contribution Margin Per Unit)
For Corrine’s:
$11,000 = (1,600 – 1,500) x $110
Sales Volume Variance
Units sold
Units produced
Sales revenue
Variable manuf. Costs (-)
Variable S & A (-)
Contribution margin
Fixed manuf. Costs (-)
Fixed S & A (-)
Operating Income
Static Budget
1,500
1,500
375,000
172,000
37,500
165,000
15,000
18,000
132,000
Sales Vol Var
25,000
11,500
2,500
11,000
11,000
Flexible Budget
1,600
1,600
400,000
184,000
40,000
176,000
15,000
18,000
143,000
Flexible Budget Variance
The difference between the flexible budget operating income and actual operating income is called the flexible budget variance. The flexible budget removes any differences due to volume.
Flexible Budget Variance
Units sold
Avg. sales price per unit
Sales revenue
Variable manuf. Costs (-)
Variable S & A (-)
Contribution Margin
Fixed manuf. Costs (-)
Fixed S & A (-)
Operating Income
Flexible Budget
1,600
$250
400,000
184,000
40,000
176,000
15,000
18,000
143,000
Flexible Budget Variance
(3,200)
5,200
800
(9.200)
1,000
(2,000)
(8,200)
Actual Results
1,600
$248
398,800
189,200
40,800
166,800
16,000
16,000
134,800
Flexible Budget Variance
Key Concept
The flexible budgeting process removes any differences or variances due only to variations in volume.
Sales Price Variance
Sales Price Variance =
(Actual - Expected Sales Price)
x
Actual volume
-$3,200 = ($248-$250) x 1,600
Why?
Variance Analysis
AQ x AP Actual Cost
AQ (AP-SP) Price Variance
SQ x SP Flexible Budget Amount
SP (AQ - SQ) Usage Variance
Basic Variance Analysis Model
AQ x SP
Variance Analysis
SQ = Actual number of units produced multiplied by the standard (budgeted) quantity of material or hours of labor per unit
X = Standard (budgeted) quantity of material or number of hours budgeted per unit
Direct Material Variances
AQ x AP 33,600 x $1.90
= $63,840
AQ x SP 33,600 x $2.00
=$67,200
SQ x SP 32,000 x $2.00
=$64,000
33,600 ($1.90 - 2.00) $3,360 F Price Var.
$2.00 (33,600 - 32,000) $3,200 U Usage Var
Total Variance = $3,360 F + $3,200 U = $160 F
SQ = 20 ft./unit x 1,600 chairs
Direct Material Variances
What are some possible reasons for a favorable direct material price variance and an unfavorable material usage variance?
Direct Material Variances
When the actual amount of material purchased is different from the amount of material used, the direct material variance model must be modified.
For example, let’s assume that Corinne’s purchased 35,000 feet of lumber but only used 33,600 feet in production.
Direct Material Variances
AQ X AP AQ X SP AQ X SP SQ X SP35,000 X $1.90 35,000 X $2.00 33,600 X $2.00 32,000
X $2.00 = $66,500 = $70,000 = $67,200 =
$64,000 $3,500 F $3,200 Price Var Usage Var
The model above is when quantities purchased are not the same as quantities used.
Direct Labor Variances
AH X AR AH X SR SH X SR
8,400 X $12.10 8,400 X $12.00 8,000 X $12.00
= $101,640 = $100,800 = $96,000
$840 U $4,800 U Rate Var Efficiency Var
Total Direct Labor Variance = $840 U + $4,800 U = $5,640 U
SH = 1,600 chairs X 5 hrs/chair
Direct Labor Variances
What are some possible reasons for unfavorable direct labor rate and efficiency variances?
Variable Overhead Variances
Actual Variable AH X SVR SH X SVR
Overhead Expense 8,400 X $3.00 8,000 X $3.00
= $23,720 =$25,200 = $24,000
$1,480 F $1,200 U Spending Variance Efficiency Variance
Total Variable Overhead Variance = $1,480 F +$1,200 U = $280 F
Variable Overhead Variances
Key Concept
The variable overhead efficiency variance does not measure the efficient use of overhead but rather the efficient use of the cost driver or overhead allocation base used in the flexible budget.
Fixed Overhead Variances
Budget Variance: the difference between the amount of fixed overhead actually incurred and the flexible budget amount.
Volume Variance: the difference between the flexible budget amount and the amount of fixed overhead applied to products.
Fixed Overhead Variances
Actual Fixed Budgeted AppliedOverhead Expense Fixed Overhead Fixed
Overhead= $16,000 = $15,000 = $16,000
$1,000 U $1,000 F Spending Variance Volume Variance
Overhead Variances
Key Concept
Total over- or underapplied overhead is the sum of the four overhead variances (two variable overhead variances and the two fixed overhead variances).
Overhead Variances
Key Concept
The fixed overhead volume variance should not be interpreted as favorable or unfavorable, or as a measure of the efficient utilization of facilities.
More Topics
ABC and Variance Analysis
Selling and Administrative Expense Variance
Interpreting and Using Variance Analysis
Behavioral Considerations
Selling and Administrative Expense Variance
A price standard can be developed for the time spent to process each mail-order sales by telephone, which includes the salary costs incurred by the sales representatives handling the call and the direct costs of the toll-free line. Then the actual costs incurred can be compared to the the flexible budget and the price and usage variances can be calculated.
Selling and Administrative Expense Variance
Drawbacks on Variances
The information from VA is likely to be too aggregated for operating managers to use.
The information from VA is not timely enough to be useful to managers.
Selling and Administrative Expense Variance
Drawbacks on Variances
Traditional VA of variable and fixed overhead provides little useful information for managers.
Traditional VA focuses on cost control instead of product quality, customer service, delivery time, and other nonfinancial measures of performance.
Interpreting and Using Variance Analysis
Use the decision model:
Define the problem
Identify objectives
Identify and analyze available options
Select the best option
Interpreting and Using Variance Analysis
An unfavorable direct material usage variance generally points to a problem in production.
However, further analysis might reveal that usage was high because of an unusual number of defective parts and the large number of defective parts was a result of the purchasing manager buying materials of inferior quality.
Interpreting and Using Variance Analysis
Pause and Reflect
Even though the purchasing manager caused the “problem,” the material price variance would be favorable. As discussed earlier, favorable variances are not necessarily “good.”
Behavioral Considerations
Standards Costs and Variance Analysis can provide very useful control and performance evaluations, or they can cause dysfunctional behavior among employees and management.
End of Chapter 10
What variances do you need for your business?