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Flexible Budgets,

Variances,
and Management Control:
I
Static and Flexible Budgets

Planned level of
Static Budget Based on output at start of
the budget period

Budgeted revenues
Based on
Flexible Budget and cost based on
actual level of output
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
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?
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.
Static Budget Example

What was the actual operating income?


Revenues (10,000 × $160) $1,600,000
Less Expenses:
Variable (10,000 × $120) 1,200,000
Fixed 300,000
Actual operating income $ 100,000
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.
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
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.
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
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
Variances

Level 2 analysis provides information


on the two components of the
static-budget variance.
1. Flexible-budget variance
2. Sales-volume variance
Flexible-Budget Variance

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

Actual quantity sold: 10,000 suits

Actual results
operating income
Flexible-budget $100,000
variance
$14,000 U Flexible-budget
operating income
$114,000
Flexible-Budget Variance

Total flexible-budget variance


= Total actual results
– Total flexible budget for actual sales level
Flexible-Budget Variance

Actual Budgeted
Amount Amount
Selling price $160 $155
Variable cost 120 115
Contribution margin $ 40 $ 40
Flexible-Budget Variance

Why is the flexible-budget variance $14,000 U?


Selling-price variance $50,000 F
Actual variable costs exceeded
flexible budget variable costs 50,000 U
Actual fixed costs exceeded
flexible budget fixed costs 14,000 U
Total flexible-budget variance $14,000 U
Sales-Volume Variance

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

Actual quantity sold: 10,000 suits

Flexible-budget
operating income
Sales-volume $114,000
variance
$120,000 U Static-budget
operating income
$234,000
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
Budget Variances

Static-budget
Level 1 variance
$134,000 U

Flexible-budget Sales-volume
Level 2 variance variance
$14,000 U $120,000 U
Standards

Pasadena’s budgeted cost for each variable


direct cost item is computed as follows:

Standard input × Standard cost


allowed for
per input unit
one output unit
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
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
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
Price Variance Example

Direct-material price variance

Actual price – × Actual


= Budgeted price quantity

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


Price Variance Example

Direct-labor price variance

Actual price – × Actual


= Budgeted price quantity

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


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
Efficiency Variance Example

Direct-material efficiency variance

Actual quantity
× Standard
= – Standard price
quantity

= (42,500 – 40,000) × $16.25 = $40,625 U


Efficiency Variance Example

Direct-labor efficiency variance

Actual quantity
× Standard
= – Standard price
quantity

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


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
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
Flexible Budget Material
Variance Example

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

$12,750 F $40,625 U

$27,875 U
Flexible Budget Labor
Variance Example

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

$2,150 F $ 19,500 U

$17,350 U
Variance Analysis

Level 1
Static-budget variance
Materials $167,125 F
Labor 60,650 F
Total $227,775 F
Level 2 Level 2
Flexible-budget variance Sales-volume variance
Materials $27,875 U Materials $195,000 F
Labor 17,350 U Labor 78,000 F
Total $45,225 U Total $273,000 F
Variance Analysis

Level 2
Flexible-budget variance
Materials $27,875 U
Labor 17,350 U
Total $45,225 U
Level 3 Level 3
Price variance Efficiency variance
Materials $12,750 F Materials $40,625 U
Labor 2,150 F Labor 19,500 U
Total $14,900 F Total $60,125 U
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.
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.”
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?
Continuous Improvement

Prior Period Reduction Revised


Budgeted in
Budgeted
Amount Budget Amount
This Period: – – $65.00
Period 1: $65.00 $0.650 $64.35
Period 2: $64.35 $0.644 $63.71
Period 3: $63.71 $0.637 $63.07
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.
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.
Flexible Budgeting and
Activity-Based Costing

Static Actual
Budget Amounts
Units prod.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
Flexible Budgeting and
Activity-Based Costing

Static Actual
Budget
Amounts
Total labor-hours 500 468
Cost per material-handling
labor-hour $14.00 $14.50
Total material-handling
labor cost $7,000 $6,786
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
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 $6,090
Actual costs 6,786
Flexible-budget variance $ 696 U
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
Benchmarking

It refers to the continuous process of


measuring products, services, and activities
against the best levels of performance.

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