Teall Cost 3 Ch07

Chapter 7
Flexible Budgets, Variances and

Management Control: I
Copyright © 2003 Pearson Education Canada Inc. Slide 7-1

Static and Flexible Budgets
Static budget
• a budget based on a single level of output
Flexible budget
• a budget which is adjusted for the actual level of
output, revenue, or cost driver
Standard cost
• a carefully predetermined amount representing what
management thinks a cost should be
Examples
Standard quantity of materials = 2 kg. per unit
Standard cost of materials = $8 per kg.
Standard cost of materials = $16 per unit
Copyright © 2003 Pearson Education Canada Inc. Page 236 Slide 7-2
Variances
• Variances represent the difference between the cost

that was incurred and the budgeted cost
• Actual cost > Budgeted cost = Unfavourable variance
• Budgeted cost > Actual cost = Favourable variance
Static
Actual Variance Budget
Static budget variance
Volume 10,000 2,000 U 12,000
• difference between Revenue $1,850,000 $310,000 U $2,160,000
actual results Variable
Costs 1,120,000 68,000 F 1,188,000
achieved and the Contribution
original static Margin 730,000 242,000 U 972,000
Fixed costs 705,000 5,000 F 710,000
budget Operating
income $25,000 $237,000 U $262,000
Copyright © 2003 Pearson Education Canada Inc. Pages 236 - 238 Slide 7-3
Using A Flexible Budget
Flexible Sales
Budget Flexible Volume Static
Actual Variances Budget Variance Budget
Volume 10,000 0 10,000 2,000 U 12,000

Revenue $1,850,000 $50,000 F $1,800,000 $360,000 U $2,160,000
Variable
Costs 1,120,000 130,000 U 900,000 198,000 F 1,188,000
Contribution
Margin 730,000 80,000 U 810,000 162,000 U 972,000
Fixed costs 705,000 5,000 F 710,000 710,000
Operating
income $25,000 $75,000 U $100,000 $162,000 U $262,000
$75,000 U $162,000 U
Flexible budget variance Sales volume variance
$237,000 U
Total static budget variance
Selling Price Variance
Variance analysis
• used to evaluate performance
• separate measures of effectiveness and efficiency
Selling price variance

Actual Budgeted x Actual
=
selling price - selling price units sold
= ($185 - $180) x 10,000 units
= $50,000 F
Sales Volume Variance
Effectiveness
• degree to which the organization’s goals were met
• measured by the Sales volume variance
Sales volume variance

Budgeted
Actual Budgeted x contribution margin
=
units sold - units sold per unit
= (10,000 - 12,000) x $81
= $162,000 U
Note: This variance can be read as the difference between the

contribution margin in the flexible and static budgets
Price and Efficiency Variances
• Price variance is the difference between the actual price
and the budgeted price multiplied by the actual quantity
of inputs used
• Efficiency variance is the difference between the actual
quantity of inputs used and the budgeted quantity of
inputs that should have been used, multiplied by the
budgeted price
Static Budget Variance
Flexible Budget Variance Sales Volume Variance
Price Variance Efficiency Variance
Price and Efficiency Variance - Materials
Actual Budget
Direct 22,200 sq metres 20,000 sq metres
materials $31 per metre $30 per metre
Price variance
= (Actual price - Budgeted price) x Actual quantity used
= ($31 - $30) x 22,200
= $22,200 U
Efficiency variance
= (Actual quantity used - Budgeted quantity used) x
Budgeted price
= (22,200 - 20,000) x $30
= $66,000 U
Price and Efficiency Variance – Labour I
Actual Budget
Manufacturing 9,000 hours 8,000 hours
labour $22 per hour $20 per hour
Price (or rate) variance

= ($22 - $20) x 9,000
= $18,000 U
Efficiency variance
Budgeted price
= (9,000 - 8,000) x $20
= $20,000 U
Price and Efficiency Variance – Labour II
Actual Budget
Marketing 2,304 hours 2,500 hours
labour $25 per hour $24 per hour
Price (or rate) variance

= ($25 - $24) x 2,304
= $2,304 U
Efficiency variance
Budgeted price
= (2,304 - 2,500) x $25
= $4,704 F
Price and Efficiency Variances

$22,200 U $60,000 U
Material
Flexible Budget Variance
$88,200 U

$18,000 U $20,000 U
Manufacturing
Labour
$38,000 U
Price and Efficiency Variances (Continued)

$2,304 U $4,704 F
Marketing
Labour
$2,400 F
Evaluating Performance
• Variances are used to evaluate performance
• Effectiveness – the degree to which organization’s
predetermined goals were met
• Efficiency - how well inputs were used in relation to a
given level of output
• Variances indicate that something was difference than
expected
• What is critical is to understand why variances arise
and use this knowledge to promote learning and
continuous improvement
• Most companies investigate only significant variances
Continuous Improvement and Variances
• Using continuous improvement budgeted costs is
another way to control variances
• Budgeted cost is successively reduced over
succeeding time periods
• Signals importance of reducing costs
Prior Month’s Reduction in Revised

Month Budgeted Amount Budgeted Amount Budgeted Amount
April - - $60.00
May $60.00 $0.600 (1% x $60.00) 59.40
June 59.40 $0.594 (1% x $59.40) 58.81
July 58.81 $0.588 (1% x $58.81) 58.22
Benchmarking and Variance Analysis
• Can think of budgeted amounts as benchmarks
(points of reference from which comparisons may
be made)
• Benchmarking refers to the continual process of
measuring products, services and activities
against the best levels of performance
• May use internal or external benchmarks\
Key Questions to Ask

• Why are the cost levels different between units?
• How can best practices be transferred from more
efficient to less efficient units?

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Chapter 7

Flexible Budgets, Variances and

Copyright © 2003 Pearson Education Canada Inc. Slide 7-1

• Variances represent the difference between the cost

Volume 10,000 0 10,000 2,000 U 12,000

Selling price variance

Sales volume variance

Note: This variance can be read as the difference between the

Static Budget Variance

Flexible Budget Variance Sales Volume Variance

Price Variance Efficiency Variance

Price (or rate) variance

Price (or rate) variance

Price Variance Efficiency Variance

Price Variance Efficiency Variance

Price Variance Efficiency Variance

Prior Month’s Reduction in Revised

Key Questions to Ask

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