Horngrenima14e ch08

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

Flexible Budgets andFlexible Budgets andVariance AnalysisVariance Analysis

Chapter 8Chapter 8

Introduction to Management AccountingIntroduction to Management Accounting


Favorable and Unfavorable VariancesFavorable and Unfavorable Variances

ProfitProfit Revenue CostsRevenue CostsActual > Expected Actual > Expected F F F F U UActual < ExpectedActual < Expected U U U U F F

Favorable variances arise Favorable variances arise when actual when actual results exceed budgeted.results exceed budgeted.

Unfavorable variances arise when Unfavorable variances arise when actual results fall below actual results fall below

budgeted.budgeted.Favorable (F) versus Unfavorable (U) Favorable (F) versus Unfavorable (U) VariancesVariances


Static and Flexible BudgetsStatic and Flexible Budgets

A static budget is prepared for only one levelA static budget is prepared for only one levelof a given type of activity. Differences between of a given type of activity. Differences between

actual results and the static budget for level actual results and the static budget for level of output achieved are static-budget variances.of output achieved are static-budget variances.

LearningLearningObjective 1Objective 1

A flexible budget (variable budget) adjustsA flexible budget (variable budget) adjustsfor different levels of activities. Differences for different levels of activities. Differences

between actual results and the flexible between actual results and the flexible budget are flexible-budget variances.budget are flexible-budget variances.


Flexible Budget FormulasFlexible Budget Formulas

To develop a flexible budget, managersTo develop a flexible budget, managersdetermine revenue and cost behaviordetermine revenue and cost behavior

(within the relevant range) with(within the relevant range) withrespect to cost drivers.respect to cost drivers.


Note that the static budget is just Note that the static budget is just the flexible budget for a singlethe flexible budget for a single

assumed level of activity.assumed level of activity.


Activity-Based Flexible BudgetActivity-Based Flexible Budget

An activity-based flexible budgetAn activity-based flexible budgetis based on budgeted costs foris based on budgeted costs for

each activity and related cost driver.each activity and related cost driver.

For each activity, costsFor each activity, costsdepend on an different cost driver.depend on an different cost driver.



Evaluation of Financial Evaluation of Financial PerformancePerformance

2) revenue or variable costs per unit of activity and2) revenue or variable costs per unit of activity andfixed costs per period were not as expected.fixed costs per period were not as expected.

Actual results may differ fromActual results may differ fromthe master budget because...the master budget because...

1) sales and other cost-driver activities were1) sales and other cost-driver activities werenot the same as originally forecasted, ornot the same as originally forecasted, or



Evaluation of Financial PerformanceEvaluation of Financial Performance

UnitsUnits 7,000 7,000 – – 7,000 2,000U 9,000 7,000 2,000U 9,000 SalesSales $217,000$217,000 – – $217,000 $217,000 $62,000 U $279,000 $62,000 U $279,000Variable costsVariable costs 158,200 158,200 5,6705,670 U U 152,600 43,600 152,600 43,600 F F 196,200 196,200Contribution marginContribution margin $ 58,730 $ 5,670 U $ 58,730 $ 5,670 U $ 64,400 $ 64,400 $18,400 U $ 82,800 $18,400 U $ 82,800Fixed costsFixed costs 70,300 300 70,300 300 U U 70,000 70,000 – – 70,00070,000Operating incomeOperating income $ (11,570) $5,970 U $ (11,570) $5,970 U $(5,600) $(5,600) $18,400 U $ 12,800 $18,400 U $ 12,800

ActuaActual l

resulresults at ts at actuaactua

l l activiactivi

ty ty levellevel

(1)(1)

Flexible-Flexible-budget budget

variancevariances s

(2) = (2) = (1)-(3)(1)-(3)

FlexibFlexible le

budgebudget for t for

actual actual sales sales activitactivit

yy

(3)(3)

Sales-Sales-Activity Activity VarianceVariance

(4) = (4) = (3)–(5)(3)–(5)

StatiStatic c

BudgBudgetet

(5)(5)


Isolating the Causes of VariancesIsolating the Causes of Variances

Managers use comparisons amongManagers use comparisons among actual results, master budgets,actual results, master budgets,and flexible budgets to evaluateand flexible budgets to evaluate

organizational performance.organizational performance.


Isolating the Causes of VariancesIsolating the Causes of Variances

Effectiveness is the degree to whichEffectiveness is the degree to whicha goal, objective, or target is met.a goal, objective, or target is met.

Performance may be effective,Performance may be effective,efficient, both, or neither.efficient, both, or neither.

Efficiency is the degree to which inputs areEfficiency is the degree to which inputs areused in relation to a given level of outputs.used in relation to a given level of outputs.


Flexible-Budget VariancesFlexible-Budget Variances

Total flexible-budget varianceTotal flexible-budget variance= Total actual results= Total actual results–– Total flexible-budget planned resultsTotal flexible-budget planned results

Flexible-budget variances Flexible-budget variances

ActualActualresultsresults

$(11,570)$(11,570)

FlexibleFlexiblebudgetbudget

$(5,600)$(5,600)


$5,970 Unfavorable$5,970 Unfavorable


Sales-Activity VariancesSales-Activity Variances

Total sales - activity varianceTotal sales - activity variance==Actual sales unit – Master budgeted sales unitsActual sales unit – Master budgeted sales units

××Budgeted contribution margin per unitBudgeted contribution margin per unit

Activity-level variances Activity-level variances

(7,000 – 9,000) × $9.20 (7,000 – 9,000) × $9.20

$18,400 Unfavorable$18,400 Unfavorable

FlexiFlexible ble budgbudgetet

MasteMaster r budgbudgetet==


Setting StandardsSetting Standards

An expected cost is the cost thatAn expected cost is the cost thatis most likely to be attained.is most likely to be attained.

A standard cost is a carefullyA standard cost is a carefullydeveloped cost per unitdeveloped cost per unitthat should be attained.that should be attained.

Perfection (ideal) standards are expressions of the most Perfection (ideal) standards are expressions of the most efficient performance possible under the best conceivableefficient performance possible under the best conceivableconditions, using existing specifications and equipment.conditions, using existing specifications and equipment.

No provision is made for waste, spoilage,No provision is made for waste, spoilage,machine breakdowns, and the like.machine breakdowns, and the like.


Currently Attainable Standards...Currently Attainable Standards...

are levels of performance thatare levels of performance thatmanagers can achieve bymanagers can achieve byrealistic levels of effort.realistic levels of effort.

They make allowances for normalThey make allowances for normaldefects, spoilage, waste,defects, spoilage, waste,and nonproductive time.and nonproductive time.


Trade-Offs Among VariancesTrade-Offs Among Variances

Improvements in one area could lead toImprovements in one area could lead toimprovements in others and vice versa.improvements in others and vice versa.

Likewise, substandard performanceLikewise, substandard performancein one area may be balanced byin one area may be balanced bysuperior performance in others.superior performance in others.


When to Investigate VariancesWhen to Investigate Variances

When should managementWhen should managementinvestigate a variance?investigate a variance?

Many organizations have developedMany organizations have developedsuch rules of thumb as “investigatesuch rules of thumb as “investigate

all variances exceeding $5,000 or 25%all variances exceeding $5,000 or 25%of expected cost, whichever is lower.”of expected cost, whichever is lower.”


Comparison with Prior PeriodsComparison with Prior Periods

Some organizations compare the mostSome organizations compare the mostrecent budget period’s actual results withrecent budget period’s actual results with

last year’s results for the same period.last year’s results for the same period.

These comparisons are not as useful as comparisons These comparisons are not as useful as comparisons of actual outcomes with planned results.of actual outcomes with planned results.


Flexible-Budget Variance in DetailFlexible-Budget Variance in Detail

Standard per unit of output:Standard per unit of output:

Std. inputs Std. inputs Flexible Flexible expected expected Budget Amount Budget Amount

DirectDirect Material Material 5 pounds5 pounds $ 2 /pound $ 2 /pound $10 $10Direct LaborDirect Labor ½ hour ½ hour $16/hour $16/hour $ 8 $ 8

Std. price Std. price expected expected


Variances from Material and Labor Variances from Material and Labor StandardsStandards

Actual results for 7,000 units produced:Actual results for 7,000 units produced:

Direct materialDirect materialPounds purchasedPounds purchasedand used: 36,800and used: 36,800

Price/pound: $1.90Price/pound: $1.90Total actual cost:Total actual cost:

$69,920$69,920

Direct laborDirect laborHours used: 3,750Hours used: 3,750

Actual price (rate): $16.40Actual price (rate): $16.40Total actual cost:Total actual cost:

$61,500$61,500



Units of good output achievedUnits of good output achieved

Input allowed per unit of outputInput allowed per unit of output

Standard unit price of inputStandard unit price of input

××

××

==Flexible Budget or Total Standard Cost AllowedFlexible Budget or Total Standard Cost Allowed



(1)(1) (2) (2) (3) (3)FlexibleFlexible

Actual Actual Flexible Flexible Budget Budget CostsCosts Budget Budget VarianceVariance

DirectDirect Materials Materials $69,920 $69,920 *$70,000 *$70,000 $ 80 F $ 80 FDirect LaborDirect Labor 61,500 61,500 **$56,000 **$56,000 $5,500 U $5,500 U

Standard Direct-Labor Cost Allowed:Standard Direct-Labor Cost Allowed:7,000 units X 1/2 hour X $16 per hour = $56,000**7,000 units X 1/2 hour X $16 per hour = $56,000**

Standard Direct-Materials Cost Allowed:Standard Direct-Materials Cost Allowed:7,000 units X 5 pounds X $2.00 per pound = $70,000*7,000 units X 5 pounds X $2.00 per pound = $70,000*


Price and Quantity VariancesPrice and Quantity Variances

(Actual quantity used – standard quantity allowed(Actual quantity used – standard quantity allowedfor actual output) × Standard pricefor actual output) × Standard price

(Actual price – Standard Price) × Actual quantity used (Actual price – Standard Price) × Actual quantity used



Price Variance ComputationsPrice Variance Computations

($16.40 – $16.00) per hour($16.40 – $16.00) per hour× 3,750 hours = $1,500 U× 3,750 hours = $1,500 U

($1.90 – $2.00) per pound($1.90 – $2.00) per pound× 36,800 pounds = $3,680 F× 36,800 pounds = $3,680 F


Quantity (Usage) Variance Quantity (Usage) Variance ComputationsComputations

[3,750 – (7,000 × ½)] hours[3,750 – (7,000 × ½)] hours× $16 per hour = $4,000 U× $16 per hour = $4,000 U

[36,800 – (7,000 × 5)] pounds[36,800 – (7,000 × 5)] pounds× $2 per pound = $3,600 U× $2 per pound = $3,600 U


Favorable or Unfavorable Variance?Favorable or Unfavorable Variance?

To determine whether a variance is Favorable or To determine whether a variance is Favorable or unfavorable, use logic rather than memorizing a formula.unfavorable, use logic rather than memorizing a formula.

A price A price variance is variance is favorable is favorable is the actual the actual

price is less price is less than the than the standard.standard.

A quantity A quantity variance is variance is

favorable if the favorable if the actual quantity actual quantity

used is less than used is less than the standard the standard

quantity allowed.quantity allowed.


Direct Materials Flexible Budget Direct Materials Flexible Budget VarianceVariance

Direct-Labor Flexible-budget variance:Direct-Labor Flexible-budget variance:$1,500 unfavorable $1,500 unfavorable

+ $4,000 unfavorable + $4,000 unfavorable

= $5,500 unfavorable= $5,500 unfavorable

Direct-Materials Flexible-budget variance: Direct-Materials Flexible-budget variance: $3,680 favorable $3,680 favorable

+ $3,600 unfavorable + $3,600 unfavorable

= $80 favorable= $80 favorable


Interpretation of Price and Usage Interpretation of Price and Usage VariancesVariances

Price and usage variances are helpfulPrice and usage variances are helpfulbecause they provide feedback tobecause they provide feedback to

those responsible for managing inputs.those responsible for managing inputs.

Managers should not use theseManagers should not use thesevariances alone for decisionvariances alone for decision

making, control, or evaluation.making, control, or evaluation.


Variable-Overhead Spending Variable-Overhead Spending and Efficiency Variancesand Efficiency Variances

A variable-overhead efficiency variance occurs whenA variable-overhead efficiency variance occurs whenactual cost-driver activity differs from the standard actual cost-driver activity differs from the standard

amount allowed for the actual output achieved.amount allowed for the actual output achieved.

A variable-overhead spending variance occurs whenA variable-overhead spending variance occurs when the difference between the actual variable overheadthe difference between the actual variable overhead

and the amount of variable overhead budgeted and the amount of variable overhead budgeted for the actual level of cost-driver activity.for the actual level of cost-driver activity.



Variable-Overhead VariancesVariable-Overhead Variances

variable- variable- actual actual standard standard standard standardoverhead overhead cost-driver cost-driver variable-overhead cost-driver cost-driver variable-overhead efficiency efficiency activity activity activity activity rate per rate pervariance variance allowed allowed cost-driver unit cost-driver unit

XX== -

variable- variable- actual actual standard standard actual actual overhead overhead variable variable-overhead cost-driver variable variable-overhead cost-driverspendingspending overhead overhead rate per unit rate per unit activityactivityvariance variance of cost-driver of cost-driver usedused

== XX-


Fixed Overhead Spending Fixed Overhead Spending VarianceVariance

The difference between actual fixed The difference between actual fixed overhead and budgeted fixed overheadoverhead and budgeted fixed overhead

Is the fixed overhead spending variance.Is the fixed overhead spending variance.



End of Chapter 8End of Chapter 8

The EndThe End

Horngrenima14e ch08

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