Copyright © 2015 Pearson Education, Inc., All Rights Reserved Flexible Budgets, Direct-Cost Variances, and Management Control

1. Understand static budgets and static- budget variances 2. Examine the concept of a flexible budget and learn how to develop it 3. Calculate flexible-budget variances and sales-volume variances 4. Explain why standard costs are often used in variance analysis Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-2

5. Compute price variances and efficiency variances for direct-cost categories. 6. Understand how managers use variances 7. Describe benchmarking and explain its role in cost management Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-3

 Variance—difference between actual results and expected (budgeted) performance.  Management by exception—the practice of focusing attention on areas not operating as expected (budgeted).  Static (master) budget is based on the output planned at the start of the budget period. Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-4

 Static-budget variance—the difference between the actual result and the corresponding static budget amount  Favorable variance (F)—has the effect of increasing operating income relative to the budget amount  Unfavorable variance (U)—has the effect of decreasing operating income relative to the budget amount Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-5

 Variances may start out “at the top” with a Level 0 analysis.  This is the highest level of analysis, a super- macro view of operating results.  The Level 0 analysis is nothing more than the difference between actual and static-budget operating income. Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-6

 Further analysis decomposes (breaks down) the Level 0 analysis into progressively smaller and smaller components.  Answers: “How much were we off?”  Levels 1, 2, and 3 examine the Level 0 variance into progressively more-detailed levels of analysis.  Answers: “Where and why were we off?” Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-7

 Level 0 tells the user very little other than how much operating income was off from budget.  Level 0 answers the question: “How much were we off in total?”  Level 1 gives the user a little more information: it shows which line-items led to the total Level 0 variance.  Level 1 answers the question: “Where were we off?” Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-8

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 Flexible budget—shifts budgeted revenues and costs up and down based on actual operating results (activities)  Represents a blending of actual activities and budgeted dollar amounts  Will allow for preparation of Level 2 and 3 variances  Answers the question: “Why were we off?” Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-10

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Some possible reasons we might incur an unfavorable Sales-Volume Variance include: 1. Failure to execute the sales plan 2. Weaker than anticipated demand 3. Aggressive competitors taking market share 4. Unanticipated market preference away from the product 5. Quality problems Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-12

 All product costs can have Level 3 variances. Direct materials and direct labor will be handled next. Overhead variances are discussed in detail in a later chapter.  Direct materials and direct labor both have price and efficiency variances, and their formulae are the same. Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-13

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Price variance formula:  Efficiency variance formula: 7-14

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Budgeted input prices and budgeted input quantities can be obtained from a number of sources including actual input data from past periods, data from other companies that have similar processes and standards developed by the firm itself. A standard is a carefully determined price, cost or quantity that is used as a benchmark for judging performance. Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-17

 Each variance may be journalized.  Each variance has its own account.  Favorable variances are credits; unfavorable variances are debits.  Variance accounts are generally closed into cost of goods sold at the end of the period, if immaterial. Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-18

 Targets or standards are established for direct material and direct labor.  The standard costs are recorded in the accounting system.  Actual price and usage amounts are compared to the standard and variances are recorded. Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-19

 Price and efficiency variances provide feedback to initiate corrective actions.  Standards are used to control costs.  Managers use variance analysis to evaluate performance after decisions are implemented.  Part of a continuous improvement program. Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-20

 Benchmarking is the continuous process of comparing the levels of performance in producing products and services against the best levels of performance in competing companies.  Variances can be extended to include comparison to other entities. Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-21

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Terms to LearnPage Number Reference BenchmarkingPage 267 Budgeted performancePage 249 Direct materials mix variancePage 272 Direct materials yield variancePage 272 EffectivenessPage 265 EfficiencyPage 265 Efficiency variancePage 258 Favorable variancePage 251 Flexible budgetPage 252 Flexible-budget variancePage 253 Management by exceptionPage 249 Price variancePage 258 Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-23

Terms to LearnPage Number Reference Rate variancePage 258 Sales-volume variancePage 253 Selling-price variancePage 255 StandardPage 257 Standard costPage 257 Standard inputPage 257 Standard pricePage 257 Static budgetPage 251 Static-budget variancePage 251 Unfavorable variancePage 251 Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-24

Terms to LearnPage Number Reference Usage variancePage 258 VariancePage 249 Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 7-25

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