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Chapter 8

Flexible Budgets and
Variance Analysis

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Chapter 8 Learning Objectives
When you have finished studying this chapter,
you should be able to:
1.Identify variances and label them as favorable
or unfavorable.
2.Distinguish between flexible budgets and static
3. Use flexible-budget formulas to construct a
flexible budget.
4. Compute and interpret static-budget variances,
flexible-budget variances, and sales-activity
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7. Compute and interpret price and quantity variances for materials and labor. 8. Compute the fixed-overhead spending variance. publishing as 8-4 . Inc.5. Compute variable overhead spending and efficiency variances. Copyright © 2014 Pearson Education. Understand how the setting of standards affects the computation and interpretation of variances. 6.

Learning Objective 1 Favorable and Unfavorable Variances Favorable variances arise when actual results exceed budgeted. Unfavorable variances arise when actual results fall below budgeted. publishing as Costs U F 8-5 . Favorable (F) versus Unfavorable (U) Variances Profits Revenue Actual > Expected F F Actual < Expected U U Copyright © 2014 Pearson Education. Inc.

Actual revenues that exceed budgeted revenues result in favorable revenue variances.Types of Favorable and Unfavorable Variances Favorable profit variances arise when actual profits exceed budgeted profits. Inc. Unfavorable profit variance occurs when actual profit falls below budgeted profit. Copyright © 2014 Pearson Education. and actual revenues that fall short of budgeted revenues result in unfavorable revenue variances. publishing as 8-6 .

Types of Favorable and Unfavorable Variances When actual costs exceed budgeted costs. we have unfavorable cost variances. when actual costs are less than budgeted costs. publishing as 8-7 . Copyright © 2014 Pearson Education. Inc. The favorable and unfavorable labels indicate only the directional relationships summarized in the charts—they do not indicate that the explanation for the variance is necessarily good or bad. we have favorable cost variances.

A quantity variance is favorable if the actual quantity used is less than the standard quantity allowed. use logic rather than memorizing a formula. A price variance is favorable if the actual price is less than the standard. Inc. publishing as 8-8 . Copyright © 2014 Pearson Education.Favorable or Unfavorable Variance? To determine whether a variance is favorable or unfavorable.

A budget that adjusts to different levels of activity is a flexible budget (sometimes called a variable budget). publishing as 8-9 . Inc. Copyright © 2014 Pearson Education.Learning Objective 2 Static and Flexible Budgets A static budget is prepared for only one expected level of activity.

Note that the static budget is just the flexible budget for a single assumed level of activity. publishing as 8 . managers determine revenue and cost behavior (within the relevant range) with respect to cost drivers. Copyright © 2014 Pearson Education. Inc.10 .Learning Objective 3 Flexible Budget Formulas To develop a flexible budget.

Activity-Based Flexible Budget An activity-based flexible budget is based on budgeted costs for each activity and related cost driver. costs depend on a different cost driver. For each activity. Copyright © 2014 Pearson Education. Inc. publishing as 8 .11 .

publishing as 8 .12 .Activity-Based Flexible Budget Copyright © 2014 Pearson Education. Inc.

13 . Copyright © 2014 Pearson Education. Inc.Learning Objective 4 Static-Budget Variances and Flexible-Budget Variances Differences between actual results and the static budget for the original planned level of output are static-budget variances. Flexible budget variances reflect how actual results deviate from what was expected. given the achieved activity level. publishing as 8 . Differences between actual results and the flexible budget for the actual level of output achieved are flexible-budget variances.

14 .. Inc. sales and other cost-driver activities were not the same as originally forecasted revenue or variable costs per unit of activity and fixed costs per period were not as expected. publishing as 8 .Static-Budget Variances and Flexible-Budget Variances Actual results may differ from the master budget because. Copyright © 2014 Pearson Education..

000 2.000 Operating income $ (11.000 – 7.670 U $ 64.570) $5.Evaluation of Financial Performance Actual results at actual Flexibleactivity budget level* variances (1) Flexible budget for actual sales activity (2) = (1)-(3) (3) Sales Activity Variance (4) = (3)–(5) Static Budget (5) Units 7.970 U $(5.200 5. publishing as 8 .000 U $27 Variable costs 158.670 U 152.000 $62.0 Sales $217.15 .600 Contribution margin $ 58.600) $1 Copyright © 2014 Pearson Education.730 $ 5. Inc.400 $1 Fixed costs 70.000 – $217.300 300 U 70.

16 . publishing as 8 .Flexible-Budget Variances Flexible-budget variance = Actual results – Flexible-budget Copyright © 2014 Pearson Education. Inc.

400 of the shortfall of income relative to the amount initially budgeted.000) Contribution margin per unit $9.17 .000 units explains $18.400 Unfavorable Falling short of the sales target by 2.Sales-Activity Variances Sales – activity income variance Actual unit Static budget units (9. Inc.000 – 7. Copyright © 2014 Pearson Education.20 $18. publishing as 8 .

Standard costs are defined in different ways by different companies. Inc.Learning Objective 5 Role of Standards in Determining Variances Static-budget variances and flexiblebudget variances depend on the costs used in the budget formulas. Copyright © 2014 Pearson Education. Budget formula costs are standard costs —costs that should be achieved. The level at which standards are set will affect the variances generated and the incentives created.18 . publishing as 8 .

using existing specifications and equipment. An expected cost is the cost that is most likely to be attained. Perfection (ideal) standards are expressions of the Most efficient performance possible under the best conceivable conditions. machine breakdowns. Copyright © 2014 Pearson Education.19 .Setting Standards A standard cost is a carefully developed cost per unit that should be attained. and the like. Inc. publishing as 8 . No provision is made for waste. spoilage.

. Copyright © 2014 Pearson Education. .Currently Attainable Standards Currently Attainable Standards . Inc. publishing as 8 .20 . waste. They make allowances for normal defects. are levels of performance that managers can achieve by realistic levels of effort. and nonproductive time. spoilage.

Likewise. substandard performance in one area may be balanced by superior performance in others. publishing as 8 .Trade-Offs Among Variances Improvements in one area could lead to improvements in others and vice versa. Copyright © 2014 Pearson Education.21 . Inc.

publishing as 8 .000 or 15% of expected cost.When to Investigate Variances When should management investigate a variance? Many organizations have developed such rules of thumb as “investigate all variances exceeding either $5.22 .” Copyright © 2014 Pearson Education. Inc.

objective. or neither. Copyright © 2014 Pearson Education. publishing as 8 . Inc. both. efficient. or target is met.23 . Efficiency is the degree to which inputs are used in relation to a given level of outputs. Performance may be effective.Isolating the Causes of Variances Effectiveness is the degree to which a goal.

Copyright © 2014 Pearson Education.24 .Comparison with Prior Periods Some organizations compare the most recent budget period’s actual results with last year’s results for the same period. publishing as 8 . Even comparisons with the prior month’s actual results may not be as useful as comparisons with an up-to-date flexible budget. Inc.

publishing as 8 .Flexible-Budget Variance in Detail Flexible-budget amounts based on $10 per unit of output for direct materials and $8 per unit for direct labor. Standard per unit of output: Std.25 . inputsStd. Inc. price Flexible expected expected Budget Amou Direct Material Direct Labor 5 pounds ½ hour $ 2 /pound $ $16/hour $ Copyright © 2014 Pearson Education.

00 per pound = $70. publishing as 8 .000 Direct labor Cost allowed 7.Variances for Material and Labor Standards Standard Costs Allowed: Direct material Cost allowed 7.000 units X 1/2 hour X $16.26 .00 per hour = $56. Inc.000 units X 5 pounds X $2.000 Copyright © 2014 Pearson Education.

000 units produced: Direct material Pounds purchased and used: 36.40 = Total actual cost $61.Variances for Material and Labor Standards Actual results for 7.800 Price/pound X $1. Inc.90 = Total actual cost $69.920 Direct labor Hours used: 3. publishing as 8 .750 X Actual price (rate) X $16.500 Copyright © 2014 Pearson Education.27 .

Inc. publishing as 8 .Variances for Material and Labor Standards Flexible Budget or Total Standard Cost Allowed = Units of good output achieved × Input allowed per unit of output × Standard unit price of input Copyright © 2014 Pearson Education.28 .

Flexible-budget variances for direct material and direct labor: $80 F and $5. respectively. (1) (2) (3) Flexible Actual Flexible Budget Costs Budget Variance Direct Materials $69.500 Copyright © 2014 Pearson Education.000 $ Direct Labor 61.Variances for Material and Labor Standards Flexible-budget cost is the standard quantity allowed for the actual level of activity multiplied by the standard price per unit. publishing as 8 . Inc.500 **$56.000 $5.29 .500 U.920 *$70.

Inc.Learning Objective 6 Price and Quantity Variances (Actual price – Standard Price) × Actual quantity used (Actual quantity used – standard quantity allowed for actual output) × Standard price Copyright © 2014 Pearson Education. publishing as 8 .30 .

Quantity (Usage) Variance Computations [36.31 . publishing as 8 .000 × 5)] pounds × $2 per pound = $3.800 – (7.000 U Copyright © 2014 Pearson Education.750 – (7. Inc.600 U [3.000 × ½)] hours × $16 per hour = $4.

publishing as 8 .00) per hour × 3.32 . Inc.40 – $16.680 F ($16.90 – $2.00) per pound × 36.750 hours = $1.800 pounds = $3.Price Variance Computations ($1.500 U Copyright © 2014 Pearson Education.

500 unfavorable Direct-Materials Flexible-budget variance: $3. the sum of the direct-materials price and quantity variances equals the total direct-materials flexible-budget variance. publishing as 8 .33 .500 unfavorable + $4. Direct-Labor Flexible-budget variance: $1. Inc.Direct Materials Flexible Budget Variance The sum of the direct-labor price and quantity variances equals the direct-labor flexible-budget variance.600 unfavorable = $80 favorable Copyright © 2014 Pearson Education. Similarly.680 favorable + $3.000 unfavorable = $5.

Price and quantity variances are helpful because they provide feedback to those responsible for managing inputs.Interpretation of Price and Quantity Variances By dividing flexible-budget variances into price and quantity variances. control.34 . or evaluation. Inc. managers can be better evaluated on variances that they can control. publishing as 8 . Managers should not use these variances alone for decision making. Copyright © 2014 Pearson Education.

publishing as 8 .35 . A variable-overhead spending variance occurs when the difference between the actual variable overhead and the amount of variable overhead budgeted for the actual level of cost-driver activity. Inc. Copyright © 2014 Pearson Education.Learning Objective 7 Variable-Overhead Spending and Efficiency Variances A variable-overhead efficiency variance occurs when actual cost-driver activity differs from the standard amount allowed for the actual output achieved.

publishing as X actual cost-driver activity used 8 . Inc.Variable-Overhead Variances variableoverhead efficiency variance = actual cost-driver activity variableactual overhead variable spending overhead variance = - - standard cost-driver activity allowed X standard variable-overhead rate per cost-driver unit standard variable-overhead rate per unit of cost-driver Copyright © 2014 Pearson Education.36 .

Learning Objective 8 Fixed Overhead Spending Variance The flexible budget based on actual use of the cost driver and the flexible budget based on standard use of the cost driver are always the same because fixed overhead does not vary with the level of use of the cost driver. Copyright © 2014 Pearson Education. . Therefore . publishing as 8 . Inc. . The difference between actual fixed overhead and budgeted fixed overhead is the fixed overhead spending variance.37 .

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