You are on page 1of 57

# Flexible Budgets, Variances, and Management Control: I Chapter 7

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7-1

Learning Objective 1

7-2

## Static and Flexible Budgets

Static Budget Based on

## Planned level of output at start of the budget period

Budgeted revenues and cost based on actual level of output
7-3

Flexible Budget

Based on

## Static Budget Example

Assume that Pasadena Co. manufactures and sells dress suits. Budgeted variable costs per suit are as follows: Direct materials cost \$ 65 Direct manufacturing labor 26 Variable manufacturing overhead 24 Total variable costs \$115
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7-4

## Static Budget Example

Budgeted selling price is \$155 per suit.
Fixed manufacturing costs are expected to 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 based on selling 13,000 suits. What is the static-budget operating income?
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7-5

## Static Budget Example

Revenues (13,000 \$155) \$2,015,000 Less Expenses: Variable (13,000 \$115) 1,495,000 Fixed 286,000 Budgeted operating income \$ 234,000 Assume that Pasadena Co. produced and sold 10,000 suits at \$160 each with actual variable costs of \$120 per suit and fixed manufacturing costs of \$300,000.
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7-6

## Static Budget Example

What was the actual operating income? Revenues (10,000 \$160) Less Expenses: Variable (10,000 \$120) Fixed Actual operating income \$1,600,000 1,200,000 300,000 \$ 100,000
7-7

## Static-Budget Variance Example

What is the static-budget variance of operating income? Actual operating income \$100,000 Budgeted operating income 234,000 Static-budget variance of operating income \$134,000 U This is a Level 0 variance analysis.
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7-8

## Static-Budget Variance Example

Static-Budget Based Variance Analysis (Level 1) in (000) Static Budget Actual Variance Suits 13 10 3U Revenue \$2,015 \$1,600 \$415 U Variable costs 1,495 1,200 296 F Contribution margin \$ 520 \$ 400 \$120 U Fixed costs 286 300 14 U Operating income \$ 234 \$ 100 \$134 U
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7-9

Learning Objective 2 Develop a flexible budget and compute flexible-budget variances and sales-volume variances.

7 - 10

## Steps in Developing Flexible Budgets

Step 1: Determine budgeted selling price, variable cost per unit, and budgeted fixed cost. Budgeted selling price is \$155, variable cost is \$115 per suit, and the budgeted fixed cost is \$286,000.

7 - 11

## Steps in Developing Flexible 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
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 12

## Steps in Developing Flexible Budgets

Step 4: Determine the flexible budget for costs. Variable costs: 10,000 \$115 = \$1,150,000 Fixed costs 286,000 Total costs \$1,436,000

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 13

Variances
Level 2 analysis provides information on the two components of the static-budget variance. 1. Flexible-budget variance 2. Sales-volume variance

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 14

Flexible-Budget Variance
Flexible-Budget Variance (Level 2) in (000)
Suits Revenue Variable costs Contribution margin Fixed costs Operating income
Flexible Budget 10 \$1,550 1,150 \$ 400 286 \$ 114 Actual 10 \$1,600 1,200 \$ 400 300 \$ 100 Variance 0 \$ 50 F 50 U \$ 0 14 U \$ 14 U
7 - 15

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Flexible-Budget Variance
Actual quantity sold: 10,000 suits Actual results operating income \$100,000 Flexible-budget operating income \$114,000
7 - 16

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Flexible-Budget Variance

Total flexible-budget variance = Total actual results Total flexible budget for actual sales level

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 17

Flexible-Budget Variance
Actual Amount \$160 120 \$ 40 Budgeted Amount \$155 115 \$ 40

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 18

Flexible-Budget Variance
Why is the flexible-budget variance \$14,000 U? Selling-price variance Actual variable costs exceeded flexible budget variable costs Actual fixed costs exceeded flexible budget fixed costs Total flexible-budget variance \$50,000 F

50,000 U
14,000 U \$14,000 U
7 - 19

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Sales-Volume Variance
Sales-Volume Variance (Level 2) in (000)
Suits Revenue Variable costs Contr. margin Fixed costs Operating income
Flexible Budget 10 \$1,550 1,150 \$ 400 286 \$ 114 Static Sales-Volume Budget Variance 13 3U \$2,015 \$465 U 1,495 295 F \$ 520 \$120 U 286 0 \$ 234 \$120 U
7 - 20

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Sales-Volume Variance
Actual quantity sold: 10,000 suits Flexible-budget operating income \$114,000 Static-budget operating income \$234,000
7 - 21

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Sales-Volume Variance
Actual sales unit Master budgeted sales units 13,000 10,000 = 3,000

## Budgeted contribution margin per unit \$40

=
Total sales-volume variance \$120,000 U
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 22

Budget Variances
Level 1 Static-budget variance \$134,000 U

Level 2

7 - 23

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 3 Explain why standard costs are often used in variance analysis.

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 24

Standards
Pasadenas budgeted cost for each variable direct cost item is computed as follows:

## Standard cost per input unit

7 - 25

Standards
4.00 square yards allowed per output unit at \$16.25 standard cost per square yard. Standard cost per output unit 4.00 \$16.25 = \$65.00

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 26

Standards
2.00 manufacturing labor-hours of input allowed per output unit at \$13.00 standard cost per hour. Standard cost per output unit 2.00 \$13.00 = \$26.00

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 27

Learning Objective 4 Compute price variances and efficiency variances for direct-cost categories.

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 28

Actual Data
Direct materials purchased and used: 42,500 square yards at \$15.95 Cost of direct materials = \$677,875 Labor hours: 21,500 at \$12.90 Cost of direct manufacturing labor = \$277,350

7 - 29

## Price Variance Example

Direct-material price variance

= =

Actual quantity

7 - 30

## Price Variance Example

Direct-labor price variance

= =

Actual quantity

7 - 31

## Price Variance Example

What is the journal entry when the materials price variance is isolated at the time of purchase? Materials Control 690,625 Direct-Materials Price Variance 12,750 Accounts Payable Control 677,875 To record direct materials purchased

7 - 32

## Efficiency Variance Example

Direct-material efficiency variance

= =

Standard price

7 - 33

## Efficiency Variance Example

Direct-labor efficiency variance

= =

Standard price

7 - 34

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Efficiency Variance
What is the journal entry to record materials used? Work in Process Control 650,000 Direct-Materials Efficiency Variance 40,625 Materials Control 690,625 To record direct materials used

7 - 35

## Price and Efficiency Variance

What is the journal entry for direct manufacturing labor?

Work in Process Control 260,000 Direct Manufacturing Labor Efficiency Variance 19,500 Direct-Manufacturing Labor Price Variance 2,150 Wages Payable 277,350 To record liability for direct manufacturing labor
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 36

## Flexible Budget Material Variance Example

Actual Cost \$677,875 AQ BP 42,500 \$16.25 \$690,625 BQ BP 40,000 \$16.25 \$650,000

\$12,750 F \$27,875 U

\$40,625 U

7 - 37

## Flexible Budget Labor Variance Example

Actual Cost \$277,350 AQ BP 21,500 \$13.00 \$279,500 BQ BP 20,000 \$13.00 \$260,000

\$2,150 F \$17,350 U

\$ 19,500 U

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 38

Variance Analysis
Level 1 Static-budget variance Materials \$167,125 F Labor 60,650 F Total \$227,775 F

7 - 39

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Variance Analysis
Level 2 Flexible-budget variance Materials \$27,875 U Labor 17,350 U Total \$45,225 U

7 - 40

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 5 Explain why purchasing performance measures should focus on more factors than just price variances.

7 - 41

## Performance Measurement Using 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 to evaluate performance.
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 42

## When to Investigate Variances

When should variances be investigated? Subjective judgments

Rules of thumb as investigate all variances exceeding \$10,000 or 25% of expected cost, whichever is lower.

7 - 43

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 44

Continuous Improvement
Assume that the budgeted direct materials cost for each suit that Pasadena Co. manufactures is \$65. Pasadena Co. wants to implement continuous improvement budgets based on a target 1% materials cost reduction each period. What should the budgeted cost be for the next 3 subsequent periods?
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 45

Continuous Improvement
Prior Period Budgeted Amount This Period: Period 1: \$65.00 Period 2: \$64.35 Period 3: \$63.71 Reduction in Budget \$0.650 \$0.644 \$0.637 Revised Budgeted Amount \$65.00 \$64.35 \$63.71 \$63.07
7 - 46

7 - 47

## Flexible Budgeting and Activity-Based Costing

Materials costs and direct manufacturing labor costs are examples of output-unit level costs. Batch-level costs are resources sacrificed on activities that are related to a group of units of product(s) or service(s) rather than to each individual unit of product or service.

7 - 48

## Flexible Budgeting and Activity-Based Costing

Denver Co. produces metal planters (MP). Assume that material-handling labor costs vary with the number of batches produced rather than the number of units in a batch. Material-handling labor costs are direct batch level costs that vary with the number of batches.
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 49

## Flexible Budgeting and Activity-Based Costing

Static Actual Budget Amounts Units produced and sold 18,000 15,660 Batch size 180 174 Number of batches 100 90 Material-handling labor-hours per batch 5.00 5.20
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 50

## Flexible Budgeting and Activity-Based Costing

Static Actual Budget Amounts 500 468
\$14.00 \$14.50

Total labor-hours Cost per material-handling labor-hour Total material-handling labor cost

\$7,000

\$6,786
7 - 51

## Flexible Budgeting and Activity-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
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 52

## Flexible Budgeting and Activity-Based Costing

What is the flexible budget for material-handling labor-hours?

## 435 hours \$14.00/labor-hour = \$6,090

Flexible-budget costs Actual costs Flexible-budget variance \$6,090 6,786 \$ 696 U
7 - 53

## Price and Efficiency Variances

Price variance = (\$14.50 \$14.00) 468 = \$234 U Efficiency variance = (468 435) \$14.00 = \$462 U

Total variance

\$696 U

7 - 54

## 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

7 - 55

Benchmarking
It refers to the continuous process of measuring products, services, and activities against the best levels of performance.

7 - 56

End of Chapter 7

7 - 57