Managerial Accounting

Wild and Shaw

2010 Edition
McGraw-Hill/Irwin

Copyright 2010 by The McGraw-Hill Companies, Inc. All

Chapter 8
Flexible Budgets and
Standard Costing

Conceptual Learning
Objectives
C1: Define standard costs and explain
their computation and uses.
C2: Describe variances and what they
reveal about performance.
C3: Explain how standard cost
information is useful for management
by exception.
8-3

Analytical Learning Objectives

A1: Compare fixed and flexible budgets.
A2: Analyze changes in sales from
expected amounts.

8-4

Procedural Learning
Objectives
P1: Prepare a flexible budget and
interpret a flexible budget performance
report.
P2: Compute materials and labor variances.
P3: Compute overhead variances.
P4: Prepare journal entries for standard costs
and account for price and quantity
variances.
8-5

Budgetary Control and

Reporting

P1

Develop the budget

from planned objectives.

Revise
objectives
and prepare
a new
budget.

Management uses
budgets to monitor
and control
operations.

Compare
actual with
budget and
analyze any
differences.

Take corrective and

strategic actions.
8-6

A2

Fixed Budget Performance

Report

8-7

A2

Fixed Budget Performance

Report
Optel
If unit sales are higher, should
we expect costs to be higher?

Fixed Budget Performance Report

How much ofFor
thethe
higher
costs are because of higher unit sales?
Month Ended January 31, 2005

Sales: In units
In dollars

Fixed
Budget
10,000
$ 100,000

Actual
Results
12,000
$ 125,000

Cost of goods sold

Selling expenses
Gen. & admin. expenses
Total expenses
Income from operations

$ 49,000
13,000
26,000
$ 88,000
$ 12,000

$ 58,100
15,100
26,400
$ 99,600
$ 25,400

Variances
$ 25,000 F
$

9,100
2,100
400
$ 11,600
$ 13,400

U
U
U
U
F
8-8

A1

Purpose of Flexible Budgets

Show revenues and expenses
that should have occurred at the
actual level of activity.
May be prepared for any activity
level in the relevant range.
Reveal variances due to good cost
control or lack of cost control.
Improve performance evaluation.

8-9

P1

Preparing Flexible Budgets

To
a budget for different activity
levels, we must know how costs
behave with changes in activity levels.

Total variable costs change

in direct proportion to
changes in activity.

Total fixed costs remain

unchanged within the
relevant range.

le
b
ria
a
V

Fixed

8-10

P1

Preparing Flexible Budgets

Variable costs are expressed as

a constant amount per unit.
8-11

P1

Preparing Flexible Budgets

Total variable cost = $4.80 per unit budget level in units

8-12

P1

Preparing Flexible Budgets

Fixed costs are expressed as a total amount that does

not change within the relevant range of activity.
8-13

P1

Flexible Budget Performance

Report

Favorable sales variance indicates that the

average selling price was greater than $10.00.
8-14

P1

Flexible Budget Performance

Report

Unfavorable cost variances indicate

costs that are greater than expected.
8-15

P1

Flexible Budget Performance

Report

Favorable variances because favorable sales

variance overcomes unfavorable cost variances.
8-16

C1

Standard Costs
Based on carefully
predetermined amounts.

Standard
Costs are

Used for planning labor, material

and overhead requirements.
The expected level
of performance.
Benchmarks for
measuring performance.

8-17

C1

Setting Standard Costs

Should we use
practical standards
or ideal standards?

Engineer

Practical standards should be

set at levels that are currently
attainable with reasonable and
efficient effort.

Production
Manager

Managerial
Accountant
8-18

C1

Setting Direct Material

Standards
Price
Standards

Quantity
Standards

Use competitive
bids for the quality
and quantity desired.

Use product
design specifications.

8-19

C1

Setting Direct Material

Standards
The standard material cost for one unit of product is:
standard price for
one unit of material

standard quantity
of material
required for one
unit of product

8-20

C1

Setting Direct Labor Standards

Rate
Standards

Time
Standards

Use wage
surveys and
labor contracts.

Use time and

motion studies for
each labor operation.

8-21

C1

Setting Direct Labor Standards

The standard labor cost for one unit of product is:
standard wage rate
for one hour

standard number
of labor hours
for one unit
of product

8-22

C1

Setting Variable Overhead

Standards
Rate
Standards

Activity
Standards

The rate is the

variable portion of the
predetermined overhead
rate.

The activity is the

cost driver used to
calculate the
predetermined overhead.

8-23

C1

Setting Variable Overhead

Standards
The standard variable overhead cost for one unit of
product is:
standard variable
overhead rate for
one unit of
activity

standard number
of activity units
for one unit of
product

8-24

C1

Standard Cost Card

A standard cost card might look like this:

Cost factor
Direct materials
Direct labor
Variable mfg. overhead
Total standard unit cost

Standard
Quantity
or Hours
1 kg.
2 hours
2 hours

Standard
Price
or Rate
$
$
$

Standard
Cost

25 per kg.
$
20 per hour
10 per hour
$

25.00
40.00
20.00
85.00

8-25

P2

Variances

Amount

A standard cost variance

is the amount by which
an actual cost differs from
the standard cost.
Standard cost
Direct
Material

Direct
Labor

Manufacturing
Overhead

Type of Product Cost

8-26

P2

Variance Analysis
Identify
questions

Receive
explanations

Conduct next
periods
operations

Analyze
variances

Begin

Take
corrective
actions

Prepare standard
cost performance
report
8-27

P2

Computing Variances
Standard Cost Variances

Price Variance

Quantity Variance

The difference between

the actual price and the
standard price

The difference between

the actual quantity and
the standard quantity
8-28

P2

Computing Variances
Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance

Standard Quantity

Standard Price

Quantity Variance

Standard price is the amount that should

have been paid for the resources acquired.

8-29

P2

Computing Variances
Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance

Standard Quantity

Standard Price

Quantity Variance

Standard quantity is the quantity that should

have been used for the actual good output.

8-30

P2

Computing Variances
Actual Quantity

Actual Price

Actual Quantity

Standard Price

Standard Quantity

Standard Price

Price Variance

Quantity Variance

AQ(AP - SP)

SP(AQ - SQ)

AQ = Actual Quantity
AP = Actual Price

SP = Standard Price
SQ = Standard Quantity
8-31

P2

Labor Variances
Actual Hours

Actual Rate

Actual Hours

Standard Rate

Rate Variance
Materials
price- SR)
variance
AH(AR
Labor rate variance
AH
= Actual
Hours
Variable
overhead
AR
= Actual
Rate
spending
variance

Standard Hours

Standard Rate

Efficiency Variance
Materials
quantity
variance
SR(AH
- SH)
Labor efficiency variance
SRVariable
= Standard
Rate
overhead
SHefficiency
= Standard
Hours
variance
8-32

P2

Labor Variances
Poorly
trained
workers

Poor
quality
materials

Unfavorable
Efficiency
Variance
Poor
supervision
of workers

Poorly
maintained
equipment
8-33

Overhead Standards and

Variances

P3

Recall that overhead costs are assigned

to products and services using a
predetermined overhead rate (POHR):
Assigned Overhead = POHR Standard Activity

POHR

Estimated total overhead costs

Estimated activity

8-34

P3

Setting Overhead Standards

Contains a fixed
overhead rate which
declines as activity
level increases.

Contains a variable
unit rate which stays
constant at all levels
of activity.

Overhead Rate
Function of activity level
chosen to determine rate.
8-35

Computing Overhead
Variances

P3

Actual
Variable
Overhead

Flexible Budget
for Variable
Overhead at

Applied
Variable
Overhead at

Incurred
AH AVR

Actual
Hours
AH SVR

Standard
Hours
SH SVR

Spending
Variance
AH
AVR
SVR
SH

=
=
=
=

Efficiency
Variance

Actual Hours of Activity

Actual Variable Overhead Rate
Standard Variable Overhead Rate
Standard Hours Allowed
8-36

Computing Overhead
Variances

P3

Actual Fixed
Overhead

Fixed
Overhead

Incurred

Budget

Spending
Variance

Fixed
Overhead
Applied
SH SFR

Volume
Variance

SFR = Standard Fixed Overhead Rate

SH = Standard Hours Allowed

8-37

P3

Overhead Variance Analysis

Total
Overhead
Variance
Variable
Overhead

Spending
Variance

Efficiency
Variance

Controllable
Variance

Fixed
Overhead

Spending
Variance

Volume
Variance

8-38

P3

Variable Overhead Variances

Spending Variance

Efficiency Variance

Results from paying more

or less than expected for
overhead items and from
excessive usage of
overhead items.

A function of the
selected cost driver.
It does not reflect
overhead control.

8-39

P3

Fixed Overhead Variances

Spending Variance
Results from paying more
or less than expected for
fixed overhead items.

Volume Variance
Results from the inability
to operate at the activity
planned for the period.
Has no significance for
cost control.

8-40

C3

Standard Costs for Control

Amount

Managers focus on quantities and costs

that differ from standards, a practice known as
management by exception.

Standard cost
Direct
Material

Direct
Labor

Manufacturing
Overhead

Type of Product Cost

8-41

End of Chapter 8

8-42