1. Flexible Budgets, Standard Costs, and Variances Analysis Chapter 8
Introduction to Managerial Accounting
Brewer, Garrison,Noreen
Power Points from website -adapted by Cynthia Fortin, CPA, CMA

2. Want to compare what actually happened with what should have happened

3. Variance Analysis Cycle
Query ‘material’ variances
Corrective actions implemented
Develop explanations
Determine and analyze variances
Prepare report to management and new Budget
Conduct next period’s operations
Begin

4. Management Control Develop Planning budgets before a period begins
Adjust budgets to reflect actual level of activity => Flexible budget
Compare Actual revenue and spending to flexible budgets => Evaluate performance
Compute variances => Highlight significant problems
Take corrective action to solve problems

5. Flexible Budget
Computes what revenues and costs would have been given the actual level of activity

6. Flexible budget assumption
All costs are either variable or fixed with respect to level of activity

7. Develop flexible budget
Start with Master budget or Planned budget Income Statement
Compute per unit Budget sales price (BSP) , Variable expenses (BV)
Identify Fixed expenses
Determine Actual quantities (AQ) of output
Compute Flexible Revenue = BSP * AQ
Compute Flexible Variable expenses = BV * AQ
Use Budget Fixed expenses
Compute Net Operating Income

8. Develop flexible budget
Start with Master budget or Planned budget Income Statement
Compute per unit Budget sales price (BSP) , Variable expenses (BV)
Identify Fixed expenses
Determine Actual quantities (AQ) of output
Compute Flexible Revenue = BSP * AQ
Compute Flexible Variable expenses = BV * AQ
Use Budget Fixed expenses
Compute Net Operating Income

9. Variances
The Revenue variance = Actual Revenue – Flexible Budget Revenue The Spending variance = Actual spending - Flexible budget spending.

10. Standard costs Benchmark measure performance
Developed at all levels during the planning process
DM (weight, units, length, price per unit of measure)
DL (wages, taxes, benefits, mix of workers, rate per hour, labor time)
Variable manufacturing OH (rates, allocation basis)

11. Setting standards Direct Materials standard cost
Price includes delivery
Allowed Quantity per unit produced
Amount of material required for each unit of finished product including waste

12. Setting standards Direct Labour standard cost
RATE includes employee benefits, taxes and the mix of workers based on skills and seniority
Allowed Quantity per unit produced
Number of hours required to complete 1 unit, by clocking the time required for each task, includes breaks, personal needs, cleanup and machine downtime.

13. Standard Costing Examples:
Standard quantity of materials = 2 kg. per unit
Standard price of materials = $8 per kg.
Standard cost of materials = $16 per unit

14. Webb’s standard cost per jacket
Direct materials: 2sq metres at $30 per sq metre = $60 per jacket
Direct mfg labour: 0.8 mfg labour-hours of input allowed per output unit manufactured at $20 standard cost per hours = $16 per jacket manufactured.
Direct marketing labour: 0.25 marketing labour-hour of input allowed per output unit sold at $24 standard cost per hour: $6 per jacket sold.

15. Variable mfg o/h: Allocated based on 1
Variable mfg o/h: Allocated based on 1.20 machine-hours per output unit mfg at $10 standard cost per machine-hour: $12 per unit manufactured.
Variable marketing overhead: Allocated based on direct marketing l-h per output unit sold at $40 standard cost per hour: $5 per output unit sold.

17. A General Model for Variance Analysis applicable to Materials, Labor and Variable Overhead
Standard Quantity Actual Quantity of input Actual Quantity of input allowed X actual output × × × Standard Price Standard Price Actual Price
Efficiency Variance
Price Variance

18. Material spending Variance
A General Model for Variance Analysis Applied for Materials when Bought and Used are the same Quantity –
Standard Quantity input Actual Quantity of input Actual Quantity of allowed X actual output × input × × Standard Price Standard Price Actual Price
2 m2 x 10,000 jackets ,200 m ,200 m2
× × × $30 /m $30 /m $31 / m2
$600, $666,000
$688,200
$66,000U
$22,200U
Efficiency Variance
Price Variance
$88,200U
Material spending Variance
Actuals Webb purchased and used 22,200 m2 at $31 per m2
for 10,000 jackets

19. Price and Efficiency Variance — Materials
Actual Budget
Direct 22,200 m2 20,000 m2 (2 * 10000)
materials $31 per m2 $30 per m2
Price variance
= (Actual price – Budgeted price) x Actual quantity used
= ($31 – $30) x 22,200
= $22,200 U
Efficiency (Usage) variance
= (Actual quantity used – Budgeted quantity used) x Budgeted price
= (22,200 – 20,000) x $30
= $66,000 U

20. Price and Efficiency Variance — Labour I
Actual Budget
Manufacturing 9,000 hours 8,000 hours (0.8 x 10,000)
labour $22 per hour $20 per hour
Price (or rate) variance
= (Actual price – Budgeted price) x Actual quantity used
= ($22 – $20) x 9,000
= $18,000 U
Efficiency variance
= (Actual quantity used – Budgeted quantity used) x Budgeted price
= (9,000 – 8,000) x $20
= $20,000 U

21. Direct Labour Variances
Higher rates
than expected
Overtime
due to rework
or poor material
Unfavorable Price Variance
Poorly maintained equipment
Employee mix
with more
experienced staff

22. Price and Efficiency Variance — Labour II
Actual Budget
Marketing 2,304 hours 2,500 hours (0.25 X 10,000)
labour $25 per hour $24 per hour
Price (or rate) variance
= (Actual price – Budgeted price) x Actual quantity used
= ($25 – $24) x 2,304
= $2,304 U
Efficiency variance
= (Actual quantity used – Budgeted quantity used) x Budgeted price
= (2,304 – 2,500) x $24
= $4,704 F

23. Direct Labour Variances
Poorly maintained equipment
Poorly trained workers
Poor quality materials
Poor supervision of workers
Unfavorable Efficiency Variance

24. Possible reasons for efficiency variances
Webb’s personnel manager hired under-skilled workers or their training was inadequate. Webb’s production process is being reorganized or a new machine has been installed, creating addition direct manufacturing time per jacket while the workers learn the new process, etc.

25. AN IMPORTANT DETAIL IN THE MATERIALS VARIANCES
Most companies use the quantity of materials purchased to compute the materials price variance and the quantity of materials used in production to compute the materials quantity variance.
Why? Because Purchasing Manager is responsible for the price of materials and Production Manager is responsible for the quantity used for one reason.

26. Materials variance when quantity of materials used and purchased is different
Price variance is calculated on quantity of materials purchased and not quantity of materials used.
The Actual input is restated using the quantity of materials purchased then multiplied by the standard price and compared to the quantity of materials purchased multiplied by the actual price.
The total efficiency variance and price variance will not balance with the spending variance of materials because the quantities of materials are different.

27. Materials when quantity of materials used and purchased is different
Standard Quantity Actual Quantity of input Actual Quantity allowed X actual output X Materials purchased × Standard Price Standard Price x Actual Price
Materials Quantity Variance
Price Variance
Actual Quantity Materials
purchased X Standard Price

28. Evaluating Performance
Variances
Used to evaluate performance
Indicate that something was different than expected
Critical to understand why ( the causes) significant variances arise and use this knowledge to promote learning and continuous improvement

29. Effectiveness
The degree to which organization’s predetermined goals are met
Efficiency
How well inputs were used in relation to a given level of output

30. Multiple causes of variances
1. Always consider possible interdependencies among variances; do not interpret them in isolation.
2. Use broad perspective of actions taken in the supply chain of organizations (supply chain: flow of goods, services, and information from beginning to end of a product or service).
3. Note that improvements in early stages of supply chain can sizably reduce magnitude of variances in subsequent stages.

31. Understand why variances arise and use knowledge to promote learning and continuous improvement –most important task in variance analysis.
Emphasize total organizational objectives by design of performance measurement and reward system by top management.
Use cost-benefit test to decide when and which variances should be investigated.
Realize that the standard is a range of possible acceptable outcomes.

32. Variance Analysis Cycle
Query ‘material’ variances
Corrective actions implemented
Develop explanations
Determine and analyze variances
Prepare report to management and new Budget
Conduct next period’s operations
Begin