CHAP 2: FLEXIBLE BUDGET, DIRECT-COST VARIANCES AND MANAGEMENT CONTROL

INTRODUCTION: VARIANCE IN LIFE

SPM TARGET 10As IN MA - BUDGETED

ACTUAL 7As

Or SPM TARGET 8As IN MA - BUDGETED

ACTUAL 10As

MA ICE-CREAM BUDGETED 200

ACTUAL 180
 F = FAVOURABLE
- A favourable variance (F) means, in the case of REVENUE, F means actual revenues exceed
budgeted revenues. For COST item, F means, actual costs are less than budgeted costs.

U = UNFAVOURABLE
- An Unfavourable variance (U), means, decreasing operating income relative to the
budgeted amount.
- In this topic, there are 3 levels of variance analysis that we will learn.
- Level 1: When we compare the static budget with the actual results
- Level 2: When we compare (i) Flexible budget with actual result (flexible –budget variance)
and (ii) Static budget with flexible budget (Sales-volume variance)
- Level 3: Flexible budget variance (in Level 2) is divided into another 2 analyses, that we
called it as (i) Price variance or rate variance and (ii) Efficiency variance or usage variance
LEVEL 1: EXAMPLE OF STATIC –BUDGET-BASED VARIANCE ANALYSIS FOR ABC COMPANY FOR APRIL 2017
ACTUAL RESULTS (1) STATIC-BUDGET STATIC BUDGET (3)
VARIANCES
(2) = (1) – (3)
Units sold 10,000 2,000 U 12,000
Revenues $1,250,000 $190,000 U $1,440,000
Variable costs
Direct materials $621,600 $98,400 F $720,000
Direct $198,000 $6,000 U $192,000
manufacturing labor
Variable $130,500 $13,500 F $144,000
manufacturing
overhead
Total variable costs $950,000 $105,900 F $1,056,000
Contribution margin $299,900 $84,100 U $384,000
Fixed costs $285,000 $9,000 U $276,000
Operating income $14,900 $93,100 U $108,000
$93,100 U
Level 1 Static Budget Variance
LEVEL 2 FLEXIBLE-BUDGET-BASED VARIANCE ANALYSIS FOR ABC COMPANY FOR APRIL 2017
ACTUAL FLEXIBLE- FLEXIBLE SALES- STATIC
RESULTS BUDGET BUDGET VOLUME BUDGET
(1) VARIANCES (3) VARIANCES (5)
(2) = (1) – (4) = (3) –
(3) (5)
Unit sold 10,000 0 10,000 2,000 U 12,000
Revenues $1,250,000 $50,000 F $1,200,000 $240,000 U $1,440,000
SP (1) = $125
SP (3) = $120
Variable costs
Direct materials 621,600 21,600 U 600,000 120,000 F 720,000
Direct 198,000 38,000 U 160,000 32,000 F 192,000
manufacturing
labor
Variable 130,500 10,500 U 120,000 24,000 F 144,000
manufacturing
overhead
 Total variable 950,000 70,100 U 880,000 176,000 F 1,056,000
costs
Contribution 299,900 20,100 U 320,000 64,000 U 384,000
margin
Fixed 285,000 9,000 U 276,000 0 276,000
manufacturing
costs
Operating income 14,900 29,100 U 44,000 64,000 U 108,000
Level 2 $29,100 U $64,000 U
Flexible budget variance Sales-volume variance
Level 1 $93,100 U
Static Budget Variance
SALES-VOLUME VARIANCES
Note: This variance arises due to different unit sold in Column 3 and Column 5. For Flexible
budget (column 3), the unit sold is based on actual results, but used the budgeted selling price,
budgeted VC and budgeted fixed cost as in static budget. While in the Column 5, the unit sold is
based on budgeted unit sold.
Sales-volume variance for operating = Flexible budget - Static budget
income amount amount
= $44,000 - $108,000
= $64,000 U
Why it happened? Underlying reasons might include:
- Problem in marketing and sales department to achieve their sales plan. (Action: Sales
promotion, Advertisement)
- Low demand from the customers/ market. (Action: Sales promotion, Advertisement)
- Competitors came up with better products. (Action: Market study, identifying target
customers)
- Changes in customer’s taste and preference. (Action: Market study)
- Quality problems, that lead to customer dissatisfaction. (Action: the production managers
must take action to improve the situation).
FLEXIBLE BUDGET VARIANCES/ SELLING PRICE VARIANCE
Note: This variance arises from the difference between actual selling price and budgeted selling
price. (Revenue in Column 1 is different than Revenue in Column 3, although the unit sold is
similar).
Flexible –budget variance = Actual result - Flexible budget
amount
= $14,900 - $44,000
= $29,100 U

Note: The Revenue for column (2) is $50,000 F due to increase in actual selling price. Why? It
might be due to overall increase in market price, etc.

Total variable cost for column (2) is $70,100 U where the actual in Column (1) is higher than the
Flexible budget in Column (3). Why? It is due to higher DM and DL cost.
Fixed manufacturing cost also higher in Column (1) that is $285,000 when compared to $276,000
in Column (3) and it resulted in $9000 U in Flexible-budget variance in Column (2). Why? Need
to investigate further, it might be due to the increase in factory’s rent, or supervisors salary.

Selling price variance = (Actual selling price – X Actual units sold

budgeted selling
price)
= ($125 per product - X 10,000 unit sold
$120 per product)
= $50,000 F
 TUTORIAL QUESTION (Level 1 & 2)
Sweet Enterprises manufactures cakes for the wedding ceremony and events. For August 2017,
it budgeted to manufacture and sell 3,600 cakes at a variable cost of $71 per cake and total fixed
costs of $55,000. The budgeted selling price was $114 per cake. Actual results in August 2017
were 3,500 cakes manufactured and sold at a selling price of $116 per cake. The actual total
variable costs were $280,000, and the actual total fixed costs were $51,000.

Required:
1. Prepare a performance report that uses a flexible budget and a static budget.
2. Comment on the results in requirement 1.
SOLUTION
The key information items are: (Classify, which item is budgeted, which one is actual)

Actual Budgeted
Units 3,500 3,600
Unit selling price $ 116 $ 114
Unit variable cost $ 80 $ 71
Fixed costs $51,000 $55,000
 Variance Analysis for Sweet Enterprises for August 2017
Actual Result Flexible- Flexible Sales-volume Static budget
(1) budget budget variances (5)
variance (3) (4) = (3) – (5)
(2) = (1) – (3)
Units (cakes) 3,500g 0 3,500g 100 U 3,600g
sold
Revenue $406,000a $7,000 F 399,000b 11,400 U 410,400c
Variable costs 280,000d $31,500 U 248,500e 7,100 F 255, 600f
Contribution 126,000 24,500 150,500 4,300 154,800
margin
Fixed costs 51,000 4,000 55,000 0 55,000
Operating 75,000 20,500 U 95,500 4,300 U 99,800
income
Level 2 $20,500 U $4,300 U
Total flexible-budget variance Total sales-volume variance
Level 1 $ 24,800 U
Total static-budget variance
a
$116 × 3,500 = $406,000
b
$114 × 3,500 = $399,000
c
$114 × 3,600 = $410,400
d
Given. Unit variable cost = $280,000 ÷ 3,500 = $80 per cake
e
$71 × 3,500 = $248,500
f
$71 × 3,600 = $255,600
g
Given

2. The total static-budget variance in operating income is $24,800 U. There is both an

unfavorable total flexible-budget variance ($20,500) and an unfavorable sales-volume variance
($4,300).
The unfavorable sales-volume variance arises solely because actual units manufactured and
sold were 100 less than the budgeted 3,600 units. The unfavorable flexible-budget variance of
$20,500 in operating income is due primarily to the $9 increase in unit variable costs. This
increase in unit variable costs is only partially offset by the $2 increase in unit selling price and
the $4,000 decrease in fixed costs