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Flexible Budgets, Variances,and Management Control
Chapter 7 - 8
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Distinguish
a static budget
from a flexible budget.
Learning Objective 1
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Static Budget ExampleAssume that Pasadena Co. manufactures
and sells dress suits.Budgeted variable costs per suit are as follows:Direct materials cost $ 65
Direct manufacturing labor 26Variable manufacturing overhead 24Total variable costs $115
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Static Budget ExampleBudgeted selling price is $155 per suit.
Fixed manufacturing costs are expectedto be $286,000 within a relevant range
between 9,000 and 13,500 suits.Variable and fixed period costs are ignored.
The static budget for year 2004 is basedon selling 13,000 suits.
What is the static-budget operating income?
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Static Budget ExampleRevenues (13,000 $155) $2,015,000Less Expenses:
Variable (13,000 $115) 1,495,000Fixed 286,000Budgeted operating income $ 234,000
Assume that Pasadena Co. produced and sold10,000 suits at $160 each with actual variablecosts of $120 per suit and fixed manufacturing
costs of $300,000.
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Static Budget Example
Revenues (10,000 $160) $1,600,000Less Expenses:Variable (10,000 $120) 1,200,000
Fixed 300,000Actual operating income $ 100,000
What was the actual operating income?
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Static-Budget Variance ExampleWhat is the static-budget variance of
operating income?Actual operating income $100,000Budgeted operating income 234,000Static-budget variance of
operating income $134,000 U
This is a Level 0 variance analysis.
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Static-Budget Variance ExampleStatic-Budget Based Variance Analysis
(Level 1) in (000)Static Budget Actual Variance
Suits 13 10 3 URevenue $2,015 $1,600 $415 U
Variable costs 1,495 1,200 296 FContribution margin $ 520 $ 400 $120 UFixed costs 286 300 14 UOperating income $ 234 $ 100 $134 U
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Learning Objective 2
Develop a flexible budgetand compute flexible-budgetvariances and sales-volume
variances.
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Steps in DevelopingFlexible Budgets
Step 2:
Determine the actual quantity of output.In the year 2004, 10,000 suits were
produced and sold.
Step 3:Determine the flexible budget for revenues.
$155 10,000 = $1,550,000
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Variances
Level 2 analysis provides information
on the two components of thestatic-budget variance.
1. Flexible-budget variance
2. Sales-volume variance
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Flexible-Budget Variance
Flexible-Budget Variance(Level 2) in (000)
FlexibleBudget Actual Variance
Suits 10 10 0Revenue $1,550 $1,600 $ 50 FVariable costs 1,150 1,200 50 UContribution margin $ 400 $ 400 $ 0Fixed costs 286 300 14 UOperating income $ 114 $ 100 $ 14 U
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Flexible-Budget Variance
Actual quantity sold: 10,000 suits
Flexible-budgetvariance
$14,000 U
Actual resultsoperating income
$100,000
Flexible-budgetoperating income
$114,000
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Flexible-Budget Variance
Total flexible-budget variance= Total actual results
Total flexible budget for actual sales level
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Flexible-Budget Variance
Actual BudgetedAmount Amount
Selling price $160 $155Variable cost 120 115
Contribution margin $ 40 $ 40
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Flexible-Budget Variance
Why is the flexible-budget variance $14,000 U?
Selling-price variance $50,000 F
Actual variable costs exceededflexible budget variable costs 50,000 U
Actual fixed costs exceededflexible budget fixed costs 14,000 UTotal flexible-budget variance $14,000 U
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Sales-Volume Variance
Actual quantity sold: 10,000 suits
Sales-volumevariance
$120,000 U
Flexible-budgetoperating income
$114,000
Static-budgetoperating income
$234,000
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Sales-Volume Variance
Total sales-volume variance $120,000 U
=
Actual sales unit Master budgeted sales units13,000 10,000 = 3,000
Budgeted contribution margin per unit $40
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Learning Objective 3
Explain why standard costs areoften used in variance analysis.
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Standards
Pasadenas budgeted cost for each variable
direct cost item is computed as follows:
Standard inputallowed for
one output unit
Standard cost
per input unit
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Standards
4.00 square yards allowed per output unitat $16.25 standard cost per square yard.
Standard cost per output unit4.00 $16.25 = $65.00
2.00 manufacturing labor-hours of inputallowed per output unit at $13.00 standard
cost per hour.Standard cost per output unit
2.00 $13.00 = $26.00
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Learning Objective 4
Compute price variancesand efficiency variances
for direct-cost categories.
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Actual Data
Direct materials purchased and used:
42,500 square yards at $15.95
Labor hours: 21,500 at $12.90
Cost of direct materials = $677,875
Cost of direct manufacturing labor = $277,350
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Price Variance Example
Direct-material price variance
Actual price Budgeted price
Actualquantity
($15.95 $16.25) 42,500 = $12,750 F=
=
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Price Variance Example
Direct-labor price variance
Actual price Budgeted price
Actualquantity
($12.90 $13.00) 21,500 = $2,150 F=
=
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Price Variance Example
What is the journal entry when the materials price
variance is isolated at the time of purchase?Materials Control 690,625Direct-Materials Price Variance 12,750
Accounts Payable Control 677,875To record direct materials purchased
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Efficiency Variance Example
Direct-material efficiency variance
Actual quantity Standard quantity
Standard price
(42,500 40,000) $16.25 = $40,625 U=
=
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Price and Efficiency Variance
What is the journal entry for direct manufacturing labor?
Work in Process Control 260,000Direct ManufacturingLabor Efficiency Variance 19,500
Direct-Manufacturing
Labor Price Variance 2,150Wages Payable 277,350
To record liability for direct manufacturing labor
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Flexible Budget MaterialVariance Example
ActualCost$677,875
BQ BP40,000 $16.25$650,000
AQ BP42,500 $16.25$690,625
$12,750 F $40,625 U
$27,875 U
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Flexible Budget LaborVariance Example
ActualCost$277,350
BQ BP20,000 $13.00$260,000
AQ BP21,500 $13.00$279,500
$2,150 F $ 19,500 U
$17,350 U
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Static-budget varianceMaterials $167,125 FLabor 60,650 FTotal $227,775 F
Flexible-budget varianceMaterials $27,875 ULabor 17,350 UTotal $45,225 U
Sales-volume varianceMaterials $195,000 FLabor 78,000 FTotal $273,000 F
Level 1
Level 2
Variance Analysis
Level 2
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Flexible-budget varianceMaterials $27,875 ULabor 17,350 UTotal $45,225 U
Price varianceMaterials $12,750 FLabor 2,150 FTotal $14,900 F
Efficiency varianceMaterials $40,625 ULabor 19,500 UTotal $60,125 U
Level 2
Level 3
Variance Analysis
Level 3
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Learning Objective 5
Explain why purchasingperformance measures should
focus on more factors than
just price variances.
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Performance MeasurementUsing Variances
Effectiveness is the degree to which a
predetermined objective or target is met. Efficiency is the relative amount of inputs
used to achieve a given level of output.
Variances should not solely be used toevaluate performance.
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When to Investigate Variances
When should variances be investigated?
Subjective judgmentsRules of thumb as investigate all variances exceeding $10,000 or 25% of expected cost,
whichever is lower.
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Learning Objective 7
Perform variance analysis inactivity-based costing systems.
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Flexible Budgeting andActivity-Based Costing
Materials costs and direct manufacturing labor
costs are examples of output-unit level costs.Batch-level costs are resources sacrificedon activities that are related to a group of
units of product(s) or service(s) rather thanto each individual unit of product or service.
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Flexible Budgeting andActivity-Based Costing
Denver Co. produces metal planters (MP).
Assume that material-handling labor costs varywith the number of batches produced rather
than the number of units in a batch.
Material-handling labor costs are direct batchlevel costs that vary with the number of batches.
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Flexible Budgeting andActivity-Based Costing
Static Actual
Budget AmountsTotal labor-hours 500 468Cost per material-handling
labor-hour $14.00 $14.50Total material-handling
labor cost $7,000 $6,786
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Flexible Budgeting andActivity-Based Costing
How many batches should have been employed
to produce the actual output units?15,660 units 180 units per batch = 87 batches
How many material-handling hours
should have been used?87 batches 5 hours/batch = 435 hours
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Flexible Budgeting andActivity-Based Costing
What is the flexible budget for
material-handling labor-hours?435 hours $14.00/labor-hour = $6,090
Flexible-budget costs $6,090
Actual costs 6,786Flexible-budget variance $ 696 U
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Price and Efficiency Variances
Price variance = ($14.50 $14.00) 468 = $234 U
Efficiency variance = (468 435) $14.00 = $462 UTotal variance $696 U
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Learning Objective 1
Explain in what ways theplanning of variable overhead
costs and fixed overhead
costs are similar and inwhat ways they differ.
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Planning of Variable andFixed Overhead Costs
Effective planning of variable overhead costsinvolves undertaking only those variable
overhead activities that add value forcustomers using the product or service.
The key challenge with planning fixed overheadis choosing the appropriate level of capacity orinvestment that will benefit the company over
an extended time period.
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Learning Objective 2
Identify the features ofa standard-costing system.
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Standard Costing
Standard inputallowed for
one output unit
Standard cost per input unit
Cost ObjectDirect Cost
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Developing Budgeted VariableOverhead Allocation Rates
Step 1:
Choose the time period used to compute the budget .Pasadena Co. uses a twelve-month budget period.Step 2:
Select the cost-allocation base. Pasadena budgets26,000 labor-hours for a budgeted output of13,000 suits in year 2004.
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Developing Budgeted VariableOverhead Allocation Rates
Step 3:Identify the variable overhead costs .
Pasadenas budgeted variable manufacturing costs for 2004 are $312,000.
Step 4:
Compute the rate per unit ofeach cost-allocation base.
$312,000 26,000 hours = $12/hour
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Developing Budgeted VariableOverhead Allocation Rates
What is the budgeted variable overhead
cost rate per output unit (dress suit)?2.00 hours allowed per output unit $12 budgeted variable overhead cost rate per
input unit = $24 per suit (output unit)
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Learning Objective 3
Compute the variable overheadefficiency variance andthe variable overhead
spending variance.
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Variable OverheadCost Variances
The following data are for 2004 when
Pasadena produced and sold 10,000 suits: Output units: 10,000
Labor-hours:
Actual results: 21,500Flexible-budget amount: 20,000
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Variable OverheadCost Variances
Labor-hours per output unit:
Actual results: 21,500 10,000 = 2.15Flexible-budget amount: 20,000 10,000 = 2.00Variable manufacturing overhead costs:
Actual results: $244,775Flexible-budget amount: $240,000
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Variable OverheadCost Variances
Variable manufacturing overhead
cost per labor-hour:Actual results:
$244,775 21,500 = $11.3849
Flexible-budget amount:$240,000 20,000 = $12.00
bl h d
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Variable OverheadCost Variances
Variable manufacturing overhead
cost per output unit:Actual results:
$244,775 10,000 = $24.4775
Flexible-budget amount:$240,000 10,000 = $24.00
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Flexible-Budget Analysis
The variable overhead flexible-budget variance
measures the difference between the actualvariable overhead costs and the flexible-budgetvariable overhead costs.
Actual results: $244,775 Flexible-budget amount $240,000 = $4,775 U
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Flexible-Budget Analysis
ActualCosts Incurred
21,500 $11.3849= $244,775
Budgeted InputsAllowed for Actual
Outputs at Budgeted Rate20,000 $12.00
= $240,000
$4,775 UFlexible-budget variance
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Flexible-Budget Analysis
Actual Quantityof Inputs at
Budgeted Rate21,500 $12.00
= $258,000
Budgeted InputsAllowed for Actual
Outputs at Budgeted Rate20,000 $12.00
= $240,000
$18,000 UVariable overhead efficiency variance
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Flexible-Budget Analysis
ActualCosts
Incurred21,500 $11.3849
= $244,775
Actual Quantityof Inputs at
Budgeted Rate21,500 $12.00
= $258,000
$13,225 FVariable overhead spending variance
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Variable Overhead Variances
Flexible-budget variance
$4,775 U
Efficiency variance$18,000 U Spending variance$13,225 F
Fi i l d N fi i l
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Financial and NonfinancialPerformance
Overhead variances are examples of financial performance measures.
What are examples of nonfinancial measures?
Actual labor time, relative to budgeted time
Actual indirect materials usage per labor-hour,relative to budgeted indirect materials usage
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