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

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

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Learning Objective 1

Distinguish a static budget from a flexible budget.

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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
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Flexible Budget

Based on

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

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
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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?
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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

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

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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.

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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
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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

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

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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
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Flexible-Budget Variance
Actual quantity sold: 10,000 suits Actual results operating income $100,000 Flexible-budget operating income $114,000
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Flexible-budget variance $14,000 U

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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 Amount $160 120 $ 40 Budgeted Amount $155 115 $ 40

Selling price Variable cost Contribution margin

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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
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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
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Sales-Volume Variance
Actual quantity sold: 10,000 suits Flexible-budget operating income $114,000 Static-budget operating income $234,000
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Sales-volume variance $120,000 U

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

Level 2

Flexible-budget variance $14,000 U

Sales-volume variance $120,000 U


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

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

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Standard input allowed for one output unit

Standard cost per input unit

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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

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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

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

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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

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Price Variance Example


Direct-material price variance

= =

Actual price Budgeted price

Actual quantity

($15.95 $16.25) 42,500 = $12,750 F


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

Price Variance Example


Direct-labor price variance

= =

Actual price Budgeted price

Actual quantity

($12.90 $13.00) 21,500 = $2,150 F


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

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

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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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Efficiency Variance Example


Direct-labor efficiency variance

= =

Actual quantity Standard quantity

Standard price

(21,500 20,000) $13.00 = $19,500 U


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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

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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
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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

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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

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

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

Level 2 Sales-volume variance Materials $195,000 F Labor 78,000 F Total $273,000 F


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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

Level 3 Price variance Materials $12,750 F Labor 2,150 F Total $14,900 F

Level 3 Efficiency variance Materials $40,625 U Labor 19,500 U Total $60,125 U


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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.

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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.
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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.

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Learning Objective 6 Integrate continuous improvement into variance analysis.

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

Learning Objective 7 Perform variance analysis in activity-based costing systems.

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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.

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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.
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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
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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
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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
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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
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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

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Learning Objective 8 Describe benchmarking and how it is used in cost management.

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

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End of Chapter 7

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