2. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 1 Introduction to Management Accounting

3. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 2 Flexible Budgets and Variance Analysis Chapter 8 Introduction to Management Accounting

4. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 3 Favorable and Unfavorable Variances ProfitRevenue Costs Actual > Expected F F U Actual < Expected U U F Favorable variances arise when actual results exceed budgeted. Unfavorable variances arise when actual results fall below budgeted. Favorable (F) versus Unfavorable (U) Variances

5. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 4 Static and Flexible Budgets A static budget is prepared for only one level of a given type of activity. Differences between actual results and the static budget for level of output achieved are static-budget variances. Learning Objective 1 A flexible budget (variable budget) adjusts for different levels of activities. Differences between actual results and the flexible budget are flexible-budget variances.

6. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 5 Flexible Budget Formulas To develop a flexible budget, managers determine revenue and cost behavior (within the relevant range) with respect to cost drivers. Learning Objective 2 Note that the static budget is just the flexible budget for a single assumed level of activity.

7. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 6 Activity-Based Flexible Budget An activity-based flexible budget is based on budgeted costs for each activity and related cost driver. For each activity, costs depend on an different cost driver. Learning Objective 3

8. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 7 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 Learning Objective 4

9. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 8 Evaluation of Financial Performance Units 7,000 – 7,000 2,000U 9,000 Sales$217,000 – $217,000 $62,000 U $279,000 Variable costs 158,200 5,670 U 152,600 43,600 F 196,200 Contribution margin$ 58,730 $ 5,670 U $ 64,400 $18,400 U $ 82,800 Fixed costs 70,300 300 U 70,000 – 70,000 Operating income$ (11,570) $5,970 U $(5,600) $18,400 U $ 12,800 Actual results at actual activity level (1) Flexible- budget variances (2) = (1)-(3) Flexible budget for actual sales activity (3) Sales- Activity Variance (4) = (3)–(5) Static Budget (5)

10. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 9 Isolating the Causes of Variances Managers use comparisons among actual results, master budgets, actual results, master budgets, and flexible budgets to evaluate organizational performance.

11. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 10 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.

12. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 11 Flexible-Budget Variances Total flexible-budget variance = Total actual results – Total flexible-budget planned results Flexible-budget variances Actualresults$(11,570)Flexiblebudget$(5,600)Learning Objective 5 $5,970 Unfavorable

13. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 12 Sales-Activity Variances Total sales - activity variance = Actual sales unit – Master budgeted sales units × Budgeted contribution margin per unit Activity-level variances (7,000 – 9,000) × $9.20 $18,400 Unfavorable Flexible budget Master budget =

14. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 13 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. Perfection (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.

15. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 14 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.

16. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 15 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.

17. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 16 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.”

18. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 17 Comparison with Prior Periods Some organizations compare the most recent budget period’s actual results with last year’s results for the same period. These comparisons are not as useful as comparisons of actual outcomes with planned results.

19. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 18 Flexible-Budget Variance in Detail Standard per unit of output: Std. inputs Flexible expected Budget Amount expected Budget Amount Direct Material5 pounds $ 2 /pound $10 Direct Labor ½ hour $16/hour $ 8 Std. price expected

20. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 19 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

21. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 20 Variances from Material and Labor Standards Units of good output achieved Input allowed per unit of output Standard unit price of input × × = Flexible Budget or Total Standard Cost Allowed

22. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 21 Variances from Material and Labor Standards (1) (2) (3) (1) (2) (3)Flexible Actual Flexible Budget Actual Flexible Budget Costs Budget Variance Costs Budget Variance Direct Materials $69,920 *$70,000 $ 80 F Direct Labor 61,500 **$56,000 $5,500 U Standard Direct-Labor Cost Allowed: 7,000 units X 1/2 hour X $16 per hour = $56,000** Standard Direct-Materials Cost Allowed: 7,000 units X 5 pounds X $2.00 per pound = $70,000*

23. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 22 Price and Quantity Variances (Actual quantity used – standard quantity allowed for actual output) × Standard price (Actual price – Standard Price) × Actual quantity used Learning Objective 6

24. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 23 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

25. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 24 Quantity (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

26. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 25 Favorable or Unfavorable Variance? To determine whether a variance is Favorable or unfavorable, use logic rather than memorizing a formula. A price variance is favorable is the actual price is less than the standard. A quantity variance is favorable if the actual quantity used is less than the standard quantity allowed.

27. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 26 Direct Materials Flexible Budget Variance Direct-Labor Flexible-budget variance: $1,500 unfavorable + $4,000 unfavorable = $5,500 unfavorable Direct-Materials Flexible-budget variance: $3,680 favorable + $3,600 unfavorable = $80 favorable

28. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 27 Interpretation of Price and Usage Variances Price and usage variances are helpful because they provide feedback to those responsible for managing inputs. Managers should not use these variances alone for decision making, control, or evaluation.

29. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 28 Variable-Overhead Spending and Efficiency Variances A variable-overhead efficiency variance occurs when actual cost-driver activity differs from the standard amount allowed for the actual output achieved. A variable-overhead spending variance occurs when the difference between the actual variable overhead the difference between the actual variable overhead and the amount of variable overhead budgeted for the actual level of cost-driver activity. Learning Objective 7

30. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 29 Variable-Overhead Variances variable- actual standard standard overhead cost-driver cost-driver variable-overhead efficiency activity activity rate per variance allowed cost-driver unit X = - variable- actual standardactual overhead variable variable-overhead cost-driver spendingoverhead rate per unit activity variance of cost-driver used =X -

31. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 30 Fixed Overhead Spending Variance The difference between actual fixed overhead and budgeted fixed overhead Is the fixed overhead spending variance. Learning Objective 8

32. ©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 31 End of Chapter 8 The End