1. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 1 Flexible Budgets Distinguish between flexible budgets and master (static) budgets. Learning Objective 1

2. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 2 Flexible Budget l A flexible budget (variable budget) is a budget that adjusts for changes in sales volume and other cost-driver activities.

3. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 3 Flexible Budget Formulas The flexible budget is based on the same assumptions of revenue and cost behavior (within the relevant range) as is the master budget. The flexible budget incorporates effects on each cost and revenue caused by changes in activity.

4. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 4 E.g. of Flexible Budgets

5. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 5 Objective 3 Understand the performance evaluation relationship between master (static) budgets and flexible budgets.

6. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 6 Performance Evaluation Using Flexible Budgets Comparing the flexible budget to actual results accomplishes an important performance evaluation purpose.

7. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 7 Performance Evaluation Using Flexible Budgets l There are basically two reasons why actual results might differ from the master budget. 1 Sales and other cost-driver activities were not the same as originally forecasted. 2 Revenue or variable costs per unit of activity and fixed costs per period were not as expected.

8. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 8 Performance Evaluation Using Flexible Budgets The intent of using the flexible budget for performance evaluation is to isolate unexpected effects on actual results that can be corrected if adverse or enhanced if beneficial.

9. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 9 Flexible-Budget Variances Total flexible-budget variance = Total actual results – Total flexible budget for actual sales activity level

10. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 10 Sales-Activity Variances Total sales-activity variance = Actual sales unit – Master budgeted sales units × Budgeted contribution margin per unit

11. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 11 Currently Attainable Standards... – are standards based on levels of performance that can be achieved by realistic levels of effort. l Allowances are made for normal defects, spoilage, waste, and nonproductive time.

12. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 12 When to Investigate Variances When should variances be investigated? Knowing exactly when to investigate is difficult. Many organizations have developed such rules of thumb as “investigate all variances exceeding $5,000 or 25% of expected cost, whichever is lower”.

13. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 13 Flexible-Budget Variance Example Flexible budget (or total standard cost allowed) Units of good output achieved Input allowed per unit of output Standard unit price on input × × =

14. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 14 Flexible-Budget Variance Example Flexible budget (or total standard cost allowed): $70,000 Units of good output achieved: 7,000 Input allowed per unit of output: 5 pounds Standard unit price on input: $2 per pound × × = Standard Direct-Materials Cost Allowed

15. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 15 Flexible-Budget Variance Example Direct material flexible budget variance = $80 F Actual Cost $69,920 Flexible Budget $70,000

16. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 16 Flexible-Budget Variance Example 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 on input: $16 per hour × × = Standard Direct-Labor Cost Allowed

17. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 17 Price Variance Computations Direct-material price variance Actual price – Standard price × Actual quantity ($1.90 – $2.00) per pound × 36,800 pounds = $3,680 favorable = =

18. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 18 Price Variance Computations Direct-labor price variance Actual price – Standard price × Actual quantity ($16.40 – $16.00) per hour × 3,750 hours = $1,500 unfavorable = =

19. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 19 Price Variance Computations Direct-material usage variance Actual quantity – Standard quantity × Standard price [36,800 – (7,000 × 5)] pounds × $2.00 per pound = $3,600 unfavorable = =

20. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 20 Price Variance Computations Direct-labor usage variance Actual quantity – Standard quantity × Standard price [3,750 – (7,000 × ½)] hours × $16 per hour = $4,000 unfavorable = =

21. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 21 Favorable or Unfavorable Variance? l To determine whether a variance is favorable or unfavorable, use logic rather than memorizing a formula.

22. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 22 Effects of Inventories l What if production does not equal sales? l The sales-activity variance then is the difference between the static budget and the flexible budget for the number of units sold. l In contrast, the flexible-budget cost variances compare actual costs with flexible-budgeted costs for the number of units produced.

23. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 23 Objective 7 Compute variable overhead spending and efficiency variances.

24. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 24 Variable Overhead Variances Spending variance Efficiency variance

25. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 25 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.

26. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 26 Variable-Overhead Spending Variance... – is the difference between the actual variable overhead and the amount of variable overhead budgeted for the actual level of cost-driver activity.

27. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 27 Flexible-Budget Variance Example Standard variable overhead rate per unit of output: $0.60 per unit or $1.20 per direct labor hour ½ hour is allowed per unit of output Suppose that Dominion Company’s cost of supplies, a variable-overhead cost, is driven by direct-labor hours.

28. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 28 Flexible-Budget Variance Example Actual variable overhead = $4,700 Variable overhead allowed = $.60 × 7,000 units = $4,200 $500 unfavorable variance

29. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 29 Price Variance Computations Variable-overhead efficiency variance Actual direct labor hours – Standard hours × Standard rate per hour (3,750 actual hours – 3,500 standard hours allowed) × $1.20 per hour = $300 unfavorable = =

30. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 30 Price Variance Computations Variable-overhead spending variance Actual variable overhead – Expected rate per hour × Actual direct-labor hours used ($4,700 – ($1.20 × 3,750 hours) = $200 unfavorable = =