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2. Chapter 8
Flexible Budgets and
Variance Analysis

3. Chapter 8 Learning Objectives
When you have finished studying this chapter, you should be able to:
Identify variances and label them as favorable or unfavorable.
Distinguish between flexible budgets and static budgets.
3. Use flexible-budget formulas to construct a flexible budget.
4. Compute and interpret static-budget variances, flexible-budget variances, and sales-activity variances.
Copyright Prentice Hall Publishing

4. Chapter 8 Learning Objectives
5. Understand how the setting of standards affects the computation and interpretation of variances.
6. Compute and interpret price and quantity variances for materials and labor.
7. Compute variable overhead spending and efficiency variances.
8. Compute the fixed-overhead spending variance.
Copyright Prentice Hall Publishing

5. Favorable and Unfavorable Variances
Learning
Objective 1
Favorable and Unfavorable Variances
Favorable variances arise when actual results exceed budgeted.
Unfavorable variances arise when actual results fall below budgeted.
Favorable (F) versus Unfavorable (U) Variances
Profits Revenue Costs
Actual > Expected F F U
Actual < Expected U U F

6. Types of Favorable and Unfavorable Variances
Favorable profit variances arise when actual profits exceed budgeted profits. Unfavorable profit variance occurs when actual profit falls below budgeted profit.
Actual revenues that exceed budgeted revenues result in favorable revenue variances, and actual revenues that fall short of budgeted revenues result in unfavorable revenue variances.

7. Types of Favorable and Unfavorable Variances
When actual costs exceed budgeted costs, we have unfavorable cost variances; when actual costs are less than budgeted costs, we have favorable cost variances.
The favorable and unfavorable labels indicate only the directional relationships summarized in the charts—they do not indicate that the explanation for the variance is necessarily good or bad.

8. 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 if 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.

9. Static and Flexible Budgets
Learning
Objective 2
Static and Flexible Budgets
A static budget is prepared for
only one expected level of activity.
A budget that adjusts to different
levels of activity is a flexible budget
(sometimes called a variable budget).

10. Flexible Budget Formulas
Learning
Objective 3
Flexible Budget Formulas
To develop a flexible budget, managers
determine revenue and cost behavior
(within the relevant range) with
respect to cost drivers.
Note that the static budget is just
the flexible budget for a single
assumed level of activity.

11. 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 a different cost driver.

12. Activity-Based Flexible Budget

13. Static-Budget Variances and Flexible-Budget Variances
Learning
Objective 4
Static-Budget Variances and Flexible-Budget Variances
Differences between actual results and the
static budget for the original planned level
of output are static-budget variances.
Differences between actual results and the
flexible budget for the actual level of output
achieved are flexible-budget variances.
Flexible budget variances reflect how actual
results deviate from what was expected, given
the achieved activity level.

14. Static-Budget Variances and Flexible-Budget Variances
Actual results may differ from
the master budget because...
sales and other cost-driver activities were
not the same as originally forecasted
Or . . .
revenue or variable costs per unit of activity
and fixed costs per period were not as expected.

15. Evaluation of Financial Performance
Actual results at actual activity level*
(1)
Flexible budget for actual sales activity
(3)
Sales -
Activity Variance
(4) =
(3)–(5)
Flexible-budget variances
(2) = (1)-(3)
Static Budget
(5)
Units , – , ,000U ,000
Sales $217, – $217,000 $62,000 U $279,000
Variable costs , ,670 U , ,600 F ,200
Contribution margin $ 58,730 $ 5,670 U $ 64,400 $18,400 U $ 82,800
Fixed costs , U , – ,000
Operating income $ (11,570) $5,970 U $(5,600) $18,400 U $ 12,800

16. Flexible-Budget Variances
= Actual results – Flexible-budget
Activity-level variances:
The differences between the static budget
amounts and the flexible budget amounts.
Sales-activity variances:
The activity-level variances when sales is
used as the cost driver.

17. Sales-Activity Variances
income
variance = X
Actual unit -
Static budget units
Contribution margin per unit X =
(9,000 – 7,000) $9.20 =
$18,400 Unfavorable
Falling short of the sales target by 2,000 units explains $18,400 of the shortfall of income relative to the amount initially budgeted.

18. Role of Standards in Determining Variances
Learning
Objective 5
Role of Standards in Determining Variances
Static-budget variances and flexible- budget variances depend on the costs used in the budget formulas.
Budget formula costs are standard costs—costs that should be achieved. Standard costs are defined in different ways by different companies.
The level at which standards are set will affect the variances generated and the incentives created.

19. Setting Standards An expected cost is the A standard cost is a
carefully developed cost per
unit that should be attained.
An expected cost is the
cost that is most likely
to 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.

20. 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.

21. 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.

22. When to Investigate Variances
When should management
investigate a variance?
Many organizations have developed
such rules of thumb as “investigate
all variances exceeding either
$5,000 or 15% of expected cost.”

23. Isolating the Causes of Variances
Effectiveness is the degree to which
a goal, objective, or target is met.
Efficiency is the degree to which
inputs are used in relation to
a given level of outputs.
Performance may be effective,
efficient, both, or neither.

24. Comparison with Prior Periods
Some organizations compare the most
recent budget period’s actual results with
last year’s results for the same period.
Even comparisons with the prior
month’s actual results may not be
as useful as comparisons with an
up-to-date flexible budget.

25. Flexible-Budget Variance in Detail
Flexible-budget amounts based on $10 per unit of output for direct materials and $8 per unit for direct labor.
Standard per unit of output:
Std. inputs Flexible
expected Budget Amount
Direct Material 5 pounds $ 2 /pound $10
Direct Labor ½ hour $16/hour $ 8
Std. price
expected

26. Variances for Material and Labor Standards
Standard Costs Allowed:
Direct material
Cost allowed
7,000 units X
5 pounds X $2.00 per
pound =
$70,000
Direct labor
Cost allowed
7,000 units X 1/2 hour
X $16.00 per hour =
$56,000

27. Variances for Material and Labor Standards
Actual results for 7,000 units produced:
Direct material
Pounds purchased
and used: 36,800
Price/pound X $1.90
= Total actual cost
$69,920
Direct labor
Hours used: 3,750 X
Actual price (rate)
X $16.40
= Total actual cost
$61,500

28. Variances for 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

29. Variances for Material and Labor Standards
Flexible-budget cost is the standard quantity allowed for the actual level of activity multiplied by the standard price per unit.
Flexible-budget variances for direct material and direct labor: $80 F and $5,500 U, respectively.
(1) (2) (3)
Flexible
Actual Flexible Budget
Costs Budget Variance
Direct Materials $69, *$70,000 $ F
Direct Labor , **$56, $5,500 U

30. Price and Quantity Variances
Learning
Objective 6
Price and Quantity Variances
Price variance:
(Applied to labor is called a rate variance)
(Actual price – Standard Price) × Actual quantity used
Quantity variance:
(Often called usage or efficiency variance)
(Actual quantity used – standard quantity allowed
for actual output) × Standard price

31. Quantity (Usage) Variance Computations
Direct-materials quantity variance:
[36,800 – (7,000 × 5)] pounds
× $2 per pound = $3,600 U
Direct-labor quantity variance:
[3,750 – (7,000 × ½)] hours
× $16 per hour = $4,000 U

32. Price Variance Computations
Direct materials price variance:
($1.90 – $2.00) per pound
× 36,800 pounds = $3,680 F
Direct labor price (rate) variance:
($16.40 – $16.00) per hour
× 3,750 hours = $1,500 U

33. Direct Materials Flexible Budget Variance
The sum of the direct-labor price and quantity variances equals the direct-labor flexible-budget variance. Similarly, the sum of the direct-materials price and quantity variances equals the total direct-materials flexible-budget variance.
Direct-Labor
Flexible-budget variance:
Direct-Materials
Flexible-budget variance:
$1,500 unfavorable
+ $4,000 unfavorable
= $5,500 unfavorable
$3,680 favorable
+ $3,600 unfavorable
= $80 favorable

34. Interpretation of Price and Quantity Variances
By dividing flexible-budget variances into price and quantity variances, managers can be better evaluated on variances that they can control.
Price and quantity 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.

35. Variable-Overhead Spending and Efficiency Variances
Learning
Objective 7
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
and the amount of variable overhead budgeted
for the actual level of cost-driver activity.

36. 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 standard actual overhead variable variable-overhead cost-driver
spending overhead rate per unit activity
variance of cost-driver used - = X

37. Fixed Overhead Spending Variance
Learning
Objective 8
Fixed Overhead Spending Variance
The flexible budget based on actual use of the cost driver and the flexible budget based on standard use of the cost driver are always the same because fixed overhead does not vary with the level of use of the cost driver.
Therefore . . .
The difference between actual fixed
overhead and budgeted fixed overhead
is the fixed overhead spending variance.

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