1. Fundamentals of Accounting II
ACCT 2302
Fundamentals of Accounting II
Spring 2011
Lecture 13
Professor Jeff Yu

2. Review:
Cash Budget: (1) determine the amount of cash excess or deficiency; (2) determine required borrowing if cash deficiency; (3) calculate interest expense.
Budgeted Balance Sheet
Budgeted Income Statement

3. Chapter 10: Flexible Budget
The master budgets discussed in Chapter 9 could also be called STATIC budgets because they are prepared based on a fixed level of future activity.
A static budget (also called “planning budget”) is suitable for planning, but is inadequate for evaluating cost control.
because even though they may be easily revised,
– Performance Evaluation is our goal

4. Static Budget and Performance Analysis
11-4
Static Budget and Performance Analysis
Hmm! Comparing static budgets with actual costs is like comparing apples and oranges.
Static budgets are prepared for a single, planned level of activity.
Performance evaluation is difficult when actual activity level differs from the planned activity level.
A static budget is prepared at the beginning of the budgeting period and is valid for only the planned level of activity. It is suitable for planning, but it is inadequate for evaluating how well costs are controlled because the actual level of activity is unlikely to equal the planned level of activity, thus resulting in “apples-to-oranges” cost comparisons.

5. Example: Inference using Static Budget

6. I don’t think I can answer this question using a static budget.
Example: Inference using Static Budget
Did the firm do a good job in cost control?
I do know that actual activity is below budgeted activity which is unfavorable.
But shouldn’t variable costs be lower if actual activity is below budgeted activity?
I don’t think I can answer this question using a static budget.

7. The relevant question?
How much of the favorable cost variance in the example is due to lower activity level and how much is due to good cost control?
To answer the question, we must the budget to the actual level of activity.

8. 11-8
Flexible Budgets
May be prepared for any activity level in the relevant range.
Show costs that should have been incurred at the actual activity level, enabling “apples to apples” cost comparisons.
Help managers control costs.
Improve performance evaluation.
A flexible budget provides estimates of what costs should be for any level of activity, within a specified range. When used for performance evaluation purposes, actual costs are compared to what the costs should have been for the actual level of activity during the period. This enables “apples-to-apples” cost comparisons.

9. Example: Preparing a Flexible Budget

10. Flexible Budget Performance Report
Flexible budget is prepared for the same activity level as actually achieved.

11. Flexible Budget Performance Report
11-11
Flexible Budget Performance Report
Variance Analysis
This $15,000F variance is due to lower actual activity than budgeted. (Activity Variance)
Activity
This $3,300U variance is due to poor cost control. (Spending Variance)
Cost control
The $15,000 favorable variance resulting from the difference between the static budget at 10,000 hours and the flexible budget at 8,000 hours is due to lower activity. The $3,350 unfavorable variance resulting from the difference between the flexible budget at 8,000 hours and actual costs at 8,000 hours is due to poor cost control. These two amounts net to $11,650 favorable.

12. Summary: Flexible Budget
Flexible budget is prepared based on the actual activity level and is used for performance evaluation (control) purpose.
Activity Variance = Flexible budget amount – planning (static) budget amount
Spending Variance = Actual cost – flexible budget cost
Spending variance is unfavorable if positive, favorable if negative;
Spending variance captures the efficiency of cost control.
Revenue Variance = Actual revenue – flexible budget revenue
Revenue variance is favorable if positive, unfavorable if negative; 15

13. Practice Problem: flexible budget
Harrald’s Fish House has following data for April, 2009 operations (Q refers to the number of meals served):
Q: (1) Prepare the planning budget for April assuming Q=1800.
(2) prepare a flexible budget for the actual Q of 1700 meals served.
(3) Calculate activity variances for revenue and all three expenses.
(4) Compute revenue variance;
(5) Compute spending variances for all three expenses.
Formula used for budgeting
Actual data with Q=1700
Revenue
$16.5Q
$27,920
Cost of Ingredients
$6.25Q
$11,110
Wages
$12,600
$12,330
Miscellaneous
$1,400+$1Q
$3,320

14. Practice Problem: multiple cost drivers
Aly Tours operates tours of glaciers on its tour boat with data below.
Aly’s planning budget for July is based on 24 cruises and 1,400 passengers using the historical cost formula as in columns 2-4. The actual activity levels are 20 cruises and 1,500 passengers.
Q: Compute activity variances and spending variances for all three expenses.
Expenses
Fixed cost per month
Cost per Cruise
Cost per Passenger
Actual costs
Boat operating
$5,200
$480 $2
$20,000
Advertising
$4,600
Administrative
$4,300
$24 $1
$6,300

15. Chapter 11 Standard Costs
10-15
Chapter 11 Standard Costs
Standards are benchmarks or “norms” for measuring performance. Two types of standards are commonly used.
Quantity standards specify how much of an input should be used to make one unit of
the product.
Price standards
specify how much should
be paid for each unit of the input.
A standard is a benchmark or “norm” for measuring performance. In managerial accounting, two types of standards are commonly used by manufacturing, service, food and not-for-profit organizations:
 Quantity standards specify how much of an input should be used to make a product or provide a service. For example: a. Auto service centers like Firestone and Sears set labor time standards for the completion of work tasks. b. Fast-food outlets such as McDonald’s have exacting standards for the quantity of meat going into a sandwich.
 Cost (price) standards specify how much should be paid for each unit of the input. For example: a. Hospitals have standard costs for food, laundry, and other items b. Home construction companies have standard labor costs that they apply to sub-contractors such as framers, roofers, and electricians c. Manufacturing companies often have highly developed standard costing systems that establish quantity and cost (price) standards for each separate product’s material, labor and overhead inputs. These standards are listed on a standard cost card.

16. Standard Cost Standard vs. Budget:
A budget is set for total costs;
A standard is set for per unit cost;
Standards are often used when preparing for budgets.
Quantity standards are set for each unit of production (How much units of input are needed for each unit of output?)
Price standards are set for each unit of input (How much should be paid for each unit of input?)
Standard quantity per unit and Standard price (SP) for DM;
Standard hours per unit and Standard rate per hour (SR) for DL;
Standard activity level (allocation base for POHR) per unit and Standard rate (variable portion of POHR) for MOH 14

17. Example: Standard Cost
10-17
Example: Standard Cost
The standard cost card is a detailed listing of the standard amounts of direct materials, direct labor, and variable overhead inputs that should go into a unit of product, multiplied by the standard price or rate that has been set for each input.

18. Management by Exception
Compare the actual quantities and costs of inputs to the quantity and cost standards we have set for performance evaluation purposes.
If the actual quantity or cost departs significantly from the standard, managers investigate the discrepancy.
Goal: Find the cause of the problem and eliminate it.
The act of computing and interpreting the deviation (variance) is called VARIANCE ANALYSIS. 14

19. A General Model for Variance Analysis
Price Variance
Quantity Variance
Materials price variance Labor rate variance VOH rate variance
Price and quantity variances can be computed for all three variable cost elements – direct materials, direct labor, and variable manufacturing overhead – even though the variances have different names as shown.
Materials quantity variance
Labor efficiency variance
VOH efficiency variance

20. A General Model for Variance Analysis
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Materials Price Variance
AQ(AP - SP)
Labor/VOH Rate Variance
AH(AR – SR)
Materials Quantity Variance
SP(AQ - SQ)
Labor/VOH Efficiency Variance
SR(AH – SH)
SQ (SH)= Standard quantity (hours) allowed for the actual output = actual production in units * standard quantity (hours) per unit 19

21. Example: Materials Variances
10-21
Example: Materials Variances
Glacier Peak Outfitters has the following direct material standard for the fiberfill in its mountain parka: 0.1 kg. of fiberfill per parka at $5.00 per kg.
Last month 210 kgs of fiberfill were purchased and used to make 2,000 parkas. The actual cost of fiberfill was $4.90 per kg.
Q: Compute Materials Variances for the company.
Here’s an example that will give us an opportunity to compute material price and quantity variances.

22. 10-22
Materials Variances
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
210 kgs kgs kg. * × × × $4.90 per kg $5.00 per kg $5.00 per kg.
= $1, = $1, = $1,000
Materials Price variance $21 favorable
Materials Quantity variance $50 unfavorable
The materials price variance, defined as the difference between what is paid for a quantity of materials and what should have been paid according to the standard, is $21 favorable. The price variance is labeled favorable because the actual price was less than the standard price by $0.10 per kilogram.
The materials quantity variance, defined as the difference between the quantity of materials used in production and the quantity that should have been used according to the standard, is $50 unfavorable. The quantity variance is labeled unfavorable because the actual quantity exceeds the standard quantity allowed by 10 kilograms

23. Material Variances: Using the Factored Equations
10-23
Material Variances: Using the Factored Equations
Materials price variance
MPV = AQ (AP - SP)
= 210 kgs ($4.90/kg - $5.00/kg)
= 210 kgs (-$0.10/kg)
= $21 F
Materials quantity variance
MQV = SP (AQ - SQ)
= $5.00/kg (210 kgs-(0.1 kg/parka 2,000 parkas))
= $5.00/kg (210 kgs kgs)
= $5.00/kg (10 kgs)
= $50 U
The equations that we have been using thus far can be factored as shown and used to compute price and quantity variances.

24. Material Price and Quantity Variances
10-24
Material Price and Quantity Variances
Price and quantity variances are determined separately for two reasons:
The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used.
The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production.
Price and and quantity standards are determined separately for two reasons:
Different managers are usually responsible for buying and for using inputs For example: The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used.
The buying and using activities occur at different points in time. For example: Raw material purchases may be held in inventory for a period of time before being used in production.

25. Isolation of Material Variances
10-25
Isolation of Material Variances
I’ll start computing the price variance when material is purchased rather than when it’s used.
I need the price variance sooner so that I can better identify purchasing problems.
You accountants just don’t understand the problems that purchasing managers have.
Most companies compute the materials price variance when materials are purchased. They calculate the materials quantity variance after materials are used in production.

26. Materials Quantity Variance Materials Price Variance
10-26
Responsibility for Material Variances
Materials Quantity Variance
Materials Price Variance
Purchasing Manager
Production Manager
The purchasing manager and production manager are usually held responsible for the materials price variance and materials quantity variance, respectively. The standard price is used to compute the quantity variance so that the production manager is not held responsible for the performance of the purchasing manager.
The standard price is used to compute the quantity variance so that the production manager is not held responsible for the purchasing manager’s performance.

27. Responsibility for Material Variances
10-27
Responsibility for Material Variances
Your poor scheduling sometimes requires me to rush order material at a higher price, causing unfavorable price variances.
I am not responsible for this unfavorable material quantity variance.
You purchased cheap material, so my people had to use more of it.
The materials variances are not always entirely controllable by one person or department. For example, the production manager may schedule production in such a way that it requires express delivery of raw materials resulting in an unfavorable materials price variance. The purchasing manager may purchase lower quality raw materials resulting in an unfavorable materials quantity variance for the production manager.

28. Practice Problem: Materials Variances
Bella Inc. has the following direct material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound.
Last week 1,700 pounds of material were purchased at a total cost of $6,630 and all 1,700 pounds are used to make 1,000 Zippies.
Question:
1.What is the actual price per pound paid for the material?
2.What is Bella’s materials price variance for the week?
3.What is Bella’s materials quantity variance for the week? 23

29. When material purchased ≠ material used
Materials Variances: purchased ≠ used
When material purchased ≠ material used
To compute the PRICE variance, use the total quantity of raw materials PURCHASED.
To compute the QUANTITY Variance, use only the quantity of raw materials USED. 27

30. Practice Problem: Materials Variances
Bella has the following material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound.
Last week 2,800 pounds of material were purchased at a total cost of $10,920, and 1,700 pounds were used to make 1,000 Zippies.
Question:
1) What is Bella’s materials price variance for the week?
2) What is Bella’s materials quantity variance for the week? 28

31. Practice Problem: Materials Variances
During February, Pisces Co. produced 1000 fishing rods with the following information:
Materials quantity variance $6,000 U
Materials price variance $1,200 U
Standard cost information for materials:
5 ounces at $6 per ounce.
Q: If the quantity of materials purchased was equal to the quantity of materials used. What was the actual per ounce cost of materials purchased?

32. For Next Class Finish Chapter 11 Start Chapter 12
Attempt the assigned HW problems

33. Homework Problem 1
Harvey Co.’s variable MOH rate is $5 per direct labor hour and fixed MOH is $10,000 per month. Its planning budget for March is based on 6,000 direct labor hours. The actual total MOH cost is $38,000 and the actual activity level is 5,000 direct labor hours in March.
Q: (1) what is the amount of Activity Variance for total MOH cost in March?
(2) What is the amount of Spending Variance for total MOH cost in March?

34. Homework Problem 2
In May, Vail Co. produced 10,000 units of Zippies, purchased 20,000 pounds of material at a total cost of $30,000, and used 15,000 pounds of material. Materials quantity variance is $3,000 U. Material quantity standard indicates that 1.4 pounds of material are needed to produce each unit of Zippy.
Q: What is Vail’s materials price variance in May?