PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 23 Flexible Budgets and Standard costs

Management uses budgets to monitor and control operations.  Develop the budget from planned objectives.  Compare actual with budget and analyze any differences.  Take corrective and strategic actions.  Revise objectives and prepare a new budget. Budgetary Control and Reporting

U = Unfavorable variance Actual cost is greater than budgeted cost. F = Favorable variance Actual revenue and income are greater than budgeted revenue and income. If unit sales are higher, should we expect costs to be higher? How much of the higher costs are because of higher unit sales? Fixed Budget Performance Report

Improve performance evaluation. May be prepared for any activity level in the relevant range. Show revenues and expenses that should have occurred at the actual level of activity. Reveal variances due to good cost control or lack of cost control. Purpose of Flexible Budgets

Preparation of Flexible Budgets To a budget for different activity levels, we must know how costs behave with changes in activity levels. –Total variable costs change in direct proportion to changes in activity. –Total fixed costs remain unchanged within the relevant range. Fixed Variable P 1

Variable costs are a constant amount per unit. Total variable cost = $4.80 per unit × budget level in units Total Fixed costs do not change within the relevant range. Preparation of Flexible Budgets P 1

Favorable sales variance indicates that the average selling price was greater than $10.00 per unit. Unfavorable cost variances indicate costs are greater than expected for 12,000 units. Favorable variance because favorable sales variance is greater than unfavorable cost variances. Flexible Budget Performance Report P 1

Benchmarks for measuring performance. The expected level of performance. Based on carefully predetermined amounts. Used for planning materials, labor, and overhead requirements. Standard costs are Standard Costs C 1

Identifying Standard Costs C 1 Ideal standards, that are based on perfection, are unattainable and discouraging to most employees. Practical standards should be set at levels that are currently attainable with reasonable and efficient effort. Engineer Production Manager Managerial Accountant Human Resources Manager

Setting Standard Costs Quantity Standards Price Standards Direct Materials Time Standards Rate Standards Direct Labor Activity Standards Rate Standards Variable Overhead C 1

A standard cost card might look like this: C 1 Setting Standard Costs

A standard cost variance is the amount by which an actual cost differs from the standard cost. Cost Variances Manufacturing Overhead Direct Materials Direct Labor Standard cost Type of Product Cost Amount This variance is favorable because the actual cost is less than the standard cost. This variance is unfavorable because the actual cost exceeds the standard cost. C 2

Cost Variance Analysis C 2 Variance analysis involves comparing actual costs with standard costs. We investigate variances by asking for explanations and possible causes for the variances. We should correct problems that caused unfavorable variances and possibly adopt and reward the practices that resulted in favorable variances.

Standard Cost Variances Cost Variance Computation Quantity VariancePrice Variance The difference between the actual price and the standard price. The difference between the actual quantity and the standard quantity. C 2

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price VarianceQuantity Variance Cost Variance Computation Standard quantity is the quantity that should have been used for the actual good output. Standard price is the amount that should have been paid for the resources acquired. C 2

AQ(AP - SP) SP(AQ - SQ) AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price VarianceQuantity Variance Cost Variance Computation C 2

G-Max Company makes golf club heads with the following standard cost information: Computing Materials and Labor Variances P 2

During May, G-Max produced 3,500 club heads using 1,800 pounds of material. G-Max paid $21.00 per pound for the material. Compute the material price and quantity variances. P 2 Materials Cost Variances

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 1,800 lb. 1,800 lbs. 1,750 lbs. × × × $21.00 per lb. $20.00 per lb. $20.00 per lb. $37,800 $36,000 $35,000 SQ = 3,500 units × 0.5 lb. per unit = 1,750 lbs. Price Variance $1,800 Unfavorable Quantity Variance $1,000 Unfavorable Materials Cost Variances P 2

I am not responsible for this unfavorable material quantity variance. You purchased cheap material, so my people had to use more of it. You used too much material because of poorly trained workers and poorly maintained equipment. Also, your poor scheduling requires me to rush order material at a higher price, causing unfavorable price variances. Materials Cost Variances P 2

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate Rate VarianceEfficiency Variance Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance Variable overhead Variable overhead spending variance efficiency variance AH(AR - SR) SR(AH - SH) AH = Actual Hours SR = Standard Rate AR = Actual Rate SH = Standard Hours Labor Cost Variances P 2

During May, G-Max produced 3,500 club heads working 3,400 hours. G-Max paid an average of $8.30 per hour for the hours worked. Compute the labor rate and efficiency variances. Labor Cost Variances P 2

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 3,400 hours 3,400 hours 3,500 hours × × × $8.30 per hour $8.00 per hour $8.00 per hour $28,220 $27,200 $28,000 SH = 3,500 units × 1.0 hour per unit = 3,500 hours Rate Variance $1,020 Unfavorable Efficiency Variance $800 Favorable Labor Cost Variances P 2

High skill, high rate Low skill, low rate Using highly paid skilled workers to perform unskilled tasks results in an unfavorable rate variance. Production managers who make work assignments are generally responsible for rate variances. Labor Cost Variances P 2

Unfavorable Efficiency Variance Poorly trained workers Poor supervision of workers Poor quality materials Poorly maintained equipment Labor Cost Variances P 2

I am not responsible for the unfavorable labor efficiency variance. You purchased cheap material, so it took more time to process it. You used too much time because of poorly trained workers and poor supervision. Labor Cost Variances P 2

Recall that overhead costs are assigned to products and services using a predetermined overhead rate (POHR): Estimated total overhead costs Estimated activity POHR = Assigned Overhead = POHR × Standard Activity Overhead Standards and Variances P 3

Overhead Rate Contains a variable unit rate which stays constant at all levels of activity. Contains a fixed overhead rate which declines as activity level increases. Function of activity level chosen to determine rate. Setting Overhead Standards Flexible budgets, showing budgeted amount of overhead for various levels of activity, are used to analyze overhead costs. P 3

$7,500 ÷ 3,500 hours = $2.14 per hour Flexible Overhead Budgets G-Max predicted an 80 percent activity level. P 3

Total Overhead Cost Variance Overhead cost variance (OCV) Actual overhead incurred (AOI) Standard overhead applied (SOA) =– During May, G-Max produced 3,500 club heads working 3,400 hours. G-Max budgeted for 4,000 units (80%). Actual variable overhead was $3,650 and actual fixed overhead was $4,000. P 3

Total Overhead Cost Variance Overhead cost variance (OCV) Actual overhead incurred (AOI) Standard overhead applied (SOA) =– $3,650 + $4,000 3,500 hours × $2.00 per hour =– (OCV) = $650 Unfavorable P 3

Controllable and Volume Variances Total Overhead Variance (OCV) Volume Variance Controllable Variance Overhead cost variance (OCV) Actual overhead incurred (AOI) Standard overhead applied (SOA) =– P 3

Controllable and Volume Variances P 3

Global View BMW, uses standard costing and variance analysis concepts.  Material must meet high quality standards, and the company sets quantity standards for each of its machine operations.  BMW also sets standards for how much labor time should be used in the assembly of its automobiles and then monitors its employee performance.

A similar analysis can be applied to sales variances. We will use two additional G-Max products, golf balls and drivers, to illustrate. Sales Variances A 1

$550 F Price Variance $1,000 F Volume Variance $1,400 U Price Variance $2,000 U Volume Variance A 1 Sales Variances

Appendix 23A: Expanded Overhead Variances and Standard Cost Accounting system

Spending Variance Efficiency Variance AH × SVRAH × AVR AH= Actual Hours of Activity AVR= Actual Variable Overhead Rate SVR= Standard Variable Overhead Rate SH= Standard Hours Allowed SH × SVR Actual Flexible Budget Applied Variable for Variable Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours Variable Overhead Variances

Spending Variance Volume Variance SFR= Standard Fixed Overhead Rate SH= Standard Hours Allowed SH × SFR Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied Fixed Overhead Variances

During May, G-Max produced 3,500 club heads working 3,400 hours. G-Max budgeted for 4,000 units (80%). Actual variable overhead was $3,650 and actual fixed overhead was $4,000. Compute the variable overhead spending and efficiency variances and the fixed overhead spending and volume variances. Recall the G-Max information for May: Variable and Fixed Overhead Variances

,400 hours 3,500 hours × × $1.00 per hour $1.00 per hour Spending Variance $250 Unfavorable Efficiency Variance $100 Favorable $3,650$3,400$3,500 Actual Flexible Budget Applied Variable for Variable Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours Variable Overhead Cost Variances

,500 hours × $1.00 per hour Spending Variance $0 Volume Variance $500 Unfavorable Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied $4,000 $3,500 Fixed Overhead Cost Variances

Volume Fixed overhead applied to products 4,000 Expected Units 3,500 Actual Units $4,000 expected fixed OH $3,500 applied fixed OH { $500 Volume Variance Unfavorable 3,500 units × $1.00 fixed overhead rate Cost Fixed Overhead Cost Variances

Spending Variance Efficiency Variance Results from paying more or less than expected for overhead items and from excessive usage of overhead items. A function of the selected cost driver. It does not reflect overhead control. Variable Overhead Spending Variance Volume Variance Results from paying more or less than expected for fixed overhead items. Results from the inability to operate at the activity level planned for the period. It has no significance for cost control. Fixed Overhead Variable and Fixed Overhead Variances

Standard Cost Accounting system P 4 Recording G-Max material costs for May * Many companies record the materials price variance when materials are purchased. For simplicity, we record both the materials price and quantity variances when materials are issued to production.

P 4 Standard Cost Accounting system Recording G-Max labor costs for May

Standard Cost Accounting system P 4 Recording G-Max overhead costs for May

End of Chapter 23