©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Flexible Budgets and Variance Analysis Chapter 8

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Learning Objective 1 Distinguish between flexible budgets and master (static) budgets.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Static Budgets A static budget is prepared for only one level of a given type of activity. All actual results are compared with the original budgeted amounts, even if sales volume is more or less than originally planned.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Master Budget Variance: Sales Actual$217,000 The variances of actual results from the master budget are called master (static) budget variances. Budget$279,000Variance $62,000 U

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Master Budget Variance: Expenses Actual expenses that are less than budgeted expenses result in favorable expense variances. Actual expenses that exceed budgeted expenses result in unfavorable expense variances.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Objective 2 Use flexible-budget formulas to construct a flexible budget based on the volume of sales.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Flexible Budget A flexible budget (variable budget) is a budget that adjusts for changes in sales volume and other cost-driver activities.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Flexible Budget Formulas To develop a flexible budget, managers determine revenue and cost behavior (within the relevant range) with respect to cost drivers.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Objective 3 Prepare an activity-based flexible budget.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Activity-Based Flexible Budget An activity-based flexible budget is based on budgeted costs for each activity and related cost driver. Within each activity center, costs depend on an appropriate cost driver.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Objective 4 Explain the performance evaluation relationship between master (static) budgets and flexible budgets.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Evaluation of Financial Performance Comparing the flexible budget to actual results accomplishes an importantperformance evaluation purpose.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Evaluation of Financial Performance 2) revenue or variable costs per unit of activity and fixed costs per period were not as expected. Actual results may differ from the master budget because... 1) sales and other cost-driver activities were not the same as originally forecasted, or

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Evaluation of Financial Performance Flexible-budget variances Activity-level variances

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Evaluation of Financial Performance Units 7,000 7,000– Sales$217,000$217,000– Variable costs 158, ,600 5,670 U Contribution margin$ 58,730$ 64,400$5,670 U Fixed costs 70,300 70, U Operating income$ (11,570)$ (5,600)$5,970 U Actualresults at actual activitylevelFlexiblebudget for actual salesactivityFlexible-budgetvariances

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Evaluation of Financial Performance Units 7,000 9,000 2,000 U Sales$217,000$279,000$62,000 U Variable costs 152, ,200 43,600 F Contribution margin$ 64,400$ 82,800$18,400 U Fixed costs 70,000 70,000– Operating income$ (5,600)$ 12,800$18,400 U MasterbudgetFlexiblebudget for actual salesactivitySales-activityvariances Total master budget variances = $11,570 + $12,800 = $24,370

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Objective 5 Compute flexible-budget variances and sales-activity variances.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Isolating the Causes of Variances Managers use comparisons among actual results, master budgets, actual results, master budgets, and flexible budgets to evaluate organizational performance.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Isolating the Causes of Variances Effectiveness is the degree to which a goal, objective, or target is met. Performance may be effective, efficient, both, or neither. Efficiency is the degree to which inputs are used in relation to a given level of outputs.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Flexible-Budget Variances Total flexible-budget variance = Total actual results – Total flexible-budget planned results Flexible-budget variances Actualresults$(11,570)Flexiblebudget$(5,600) $5,970 Unfavorable

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Sales-Activity Variances Total sales-activity variance = Actual sales unit – Master budgeted sales units × Budgeted contribution margin per unit

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Sales-Activity Variances Activity-level variances FlexiblebudgetMasterbudget $18,400 Unfavorable (9,000 – 7,000) × $9.20

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Objective 6 Compute and interpret price and usage variances for inputs based on cost-driver activity.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Setting Standards An expected cost is the cost that is most likely to be attained. A standard cost is a carefully developed cost per unit that should be attained.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Perfection Standards... or 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.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 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.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 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.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 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.”

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Comparison with Prior Periods Some organizations compare the most recent budget period’s actual results with last year’s results for the same period.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Flexible-Budget Variance in Detail Standard per unit of output: Direct Direct Direct Direct Material Labor Material Labor Std. inputs expected5 pounds½ hour Std. price expected$ 2$16 Std. cost expected$10$ 8

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 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

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 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 × × = Standard Direct-Materials Cost Allowed:

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Variances from Material and Labor Standards Direct material flexible-budget variance Actualcost$69,920Flexiblebudget$70,000 $80 Favorable

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Variances from Material and Labor Standards Flexible budget or total standard cost allowed: $56,000 Units of good output achieved: 7,000 Input allowed per unit of output: ½ hour Standard unit price of input: $16/hour × × = Standard Direct-Labor Cost Allowed:

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Variances from Material and Labor Standards Direct labor flexible-budget variance Actualcost$61,500Flexiblebudget$56,000 $5,500 Unfavorable

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Price and Usage Variances (Actual quantity – Standard quantity) × Standard price (Actual price – Standard Price) × Actual quantity

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Price Variance Computations ($16.40 – $16.00) per hour × 3,750 hours = $1,500 U ($1.90 – $2.00) per pound × 36,800 pounds = $3,680 F

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Usage Variance Computations [3,750 – (7,000 × ½)] hours × $16 per hour = $4,000 U [36,800 – (7,000 × 5)] pounds × $2 per pound = $3,600 U

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Favorable or Unfavorable Variance? To determine whether a variance is favorable or unfavorable, use logic rather than memorizing a formula.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Direct Materials Flexible Budget Variance Direct material flexible-budget variance Actualcost$69,920Flexiblebudget$70,000 $80 F AQ × SP =$73,600 $3,680 F $3,600 U

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Direct Labor Flexible Budget Variance Direct labor flexible-budget variance Actualcost$61,500Flexiblebudget$56,000 $5,500 U AH × SP =$60,000 $1,500 U $4,000 U

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Interpretation of Price and Usage Variances Price and usage variances are helpful because they provide feedback to those responsible for inputs. Managers should not use these variances alone for decision making, control, or evaluation.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Objective 7 Compute variable overhead spending and efficiency variances.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Variable-Overhead Efficiency Variance When actual cost-driver activity differs from the standard amount allowed for the actual output achieved, a variable-overhead efficiency variance will occur.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Variable-Overhead Spending Variance This is the difference between the actual variable overhead and the amount of variable overhead budgeted for the actual level of cost-driver activity.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Variable Overhead Example The variable-overhead cost rate of $.60 per unit is equivalent to $1.20 per direct labor hour because each unit of output requires ½ hour of labor Suppose that Dominion Company’s cost of supplies, a variable-overhead cost, is driven by direct labor hours.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Variable Overhead Example Actual variable overhead = $4,700 Variable overhead allowed = $.60 × 7,000 units = $4,200 $500 unfavorable variance

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Variable Overhead Example ($4,700 – ($1.20 × 3,750 actual hours used) = $200 U (3,750 act. hours – 3,500 std. hours allowed) × $1.20 per hour = $300 U

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton End of Chapter 8