Flexible Budgets and Variance Analysis

Flexible Budgets and
Variance Analysis
Chapter 8
©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 8-1
Static Budgets
A static budget is prepared for only

one level of a given type of activity.
All actual results are compared with the

original budgeted amounts, even if sales
volume is more or less than originally planned.
Master Budget Variance: Sales
The variances of actual results

from the master budget are called
master (static) budget variances.
Actual Budget Variance

$217,000 $279,000 $62,000 U
Master Budget Variance:
Expenses
Actual expenses that exceed

budgeted expenses result in
unfavorable (U) expense variances.
Actual expenses that are less than

budgeted expenses result in
favorable (F) expense variances.
Static Budget
McDonald’s
Budgeted Actual Variance
Purchase (100,000 buns 100,000
@ RM1 per bun)
Purchase (90,000 buns 90,000 10,000
@ RM1 per bun)
Purchase (100,000 buns 110,000 (10,000)
@ RM1.10 per bun)
Purchase (90,000 buns 99,000 1,000
@ RM1.10 per bun)
Flexible Budget
A flexible budget (variable budget) is a

budget that adjusts for changes in sales
volume and other cost-driver activities.
Flexible Budget Formulas
To develop a flexible budget, managers

determine revenue and cost behaviour
(within the relevant range) with
respect to cost drivers.
Activity-Based Flexible Budget
An activity-based flexible budget

is based on budgeted costs for
each activity and related cost driver.
Within each activity centre, costs

depend on an appropriate cost driver.
Evaluation of Financial
Performance
Flexible-budget variances
Activity-level variances
©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 8 - 11
Performance
Actual Flexible
results budget
at actual for actual Flexible-
activity sales budget
level activity variances
Units 7,000 7,000 –

Sales $217,000 $217,000 –
Variable costs 158,200 152,600 5,670 U
Contribution margin $ 58,730 $ 64,400 $5,670 U
Fixed costs 70,300 70,000 300 U
Operating income $ (11,570) $ (5,600) $5,970 U
Performance
Flexible
budget
for actual Sales-
sales Master activity
activity budget variances
Units 7,000 9,000 2,000 U

Sales $217,000 $279,000 $62,000 U
Variable costs 152,600 196,200 43,600 F
Contribution margin $ 64,400 $ 82,800 $18,400 U
Fixed costs 70,000 70,000 –
Operating income $ (5,600) $ 12,800 $18,400 U
Total master budget variances = $5,970 + $18,400 = $24,370
Isolating the Causes of Variances
Managers use comparisons among

actual results, master budgets,
and flexible budgets to evaluate
organizational performance.
Isolating the Causes of Variances
Effectiveness is the degree to which

a goal, objective, or target is met.
Efficiency is the degree to which inputs are

used in relation to a given level of outputs.
Performance may be effective,

efficient, both, or neither.
Flexible-Budget Variances
Total flexible-budget variance

= Total actual results
– Total flexible-budget planned results
Actual Flexible
results budget
$(11,570) $(5,600)
$5,970 Unfavorable
Flexible-budget variances
Sales-Activity Variances
Total sales-activity variance

=
Actual sales unit – Master budgeted sales units
×
Budgeted contribution margin per unit
Sales-Activity Variances
Flexible Master
budget budget
$18,400 Unfavorable
Activity-level variances
(9,000 – 7,000) × $9.20
Setting Standards
An expected cost is the cost that

is most likely to be attained.
A standard cost is a carefully

developed cost per unit
that should be attained.
Perfection Standards...
or ideal standards, are expressions of the

most efficient performance possible
under the best conceivable conditions,
using existing specifications and equipment.
No provision is made for waste, spoilage,

machine breakdowns, and the like.
Currently Attainable Standards...
are levels of performance that

managers can achieve by
realistic levels of effort.
They make allowances for normal

defects, spoilage, waste,
and nonproductive time.
Trade-Offs Among Variances
Improvements in one area could lead to

improvements in others and vice versa.
Likewise, substandard performance

in one area may be balanced by
superior performance in others.
When to Investigate Variances
When should management

investigate a variance?
Many organizations have developed

such rules of thumb as “investigate
all variances exceeding $5,000 or 25%
of expected cost, whichever is lower.”
Comparison with Prior Periods
Some organizations compare the most

recent budget period’s actual results with
last year’s results for the same period.
Flexible-Budget Variance in Detail
Standard per unit of output:
Direct Direct
Material Labour
Std. inputs expected 5 kg ½ hour
Std. price expected $ 2 $16
Std. cost expected $10 $ 8
Variances from Material and
Labour Standards
Actual results for 7,000 units produced:
Direct material
Direct labour
Kgs purchased
Hours used: 3,750
and used: 36,800
Actual price (rate): $16.40
Price/kg: $1.90
Total actual cost:
Total actual cost:
$61,500
$69,920
Labour Standards
Standard Direct-Materials Cost Allowed:
Units of good output achieved: 7,000
×
Input allowed per unit of output: 5 kgs
×
Standard unit price of input: $2/kg
=
Flexible budget or total
standard cost allowed: $70,000
Labour Standards
Actual Flexible
cost budget
$69,920 $70,000
$80 Favourable
Direct material flexible-budget variance
Labour Standards
Standard Direct-Labour Cost Allowed:
Units of good output achieved: 7,000
×
Input allowed per unit of output: ½ hour
×
Standard unit price of input: $16/hour
=
Flexible budget or total
standard cost allowed: $56,000
Labour Standards
Actual Flexible
cost budget
$61,500 $56,000
$5,500 Unfavorable
Direct labour flexible-budget variance
Price and Usage Variances
(Actual price – Standard Price)

× Actual quantity
(Actual quantity – Standard quantity)

× Standard price
Price Variance Computations
($1.90 actual – $2.00 standard) per kg

× 36,800 kg actual = $3,680 F
($16.40 actual – $16.00 standard) per hour

× 3,750 hours actual = $1,500 U
Usage Variance Computations
[36,800 actual – (7,000 × 5 standard)] kg

× $2 per kg standard = $3,600 U
[3,750 actual – (7,000 × ½ standard)] hours

× $16 per hour standard = $4,000 U
Favourable or Unfavourable
Variance?
To determine whether
a variance is favourable
or unfavourable, use
logic rather than
memorizing a formula.
Direct Materials Flexible
Budget Variance
Actual AQ × SP Flexible
cost = budget
$69,920 $73,600 $70,000
$3,680 F $3,600 U
(Price variance) (Usage variance)
Direct material flexible-budget variance
$80 F
Direct Labour Flexible
Budget Variance
Actual AH × SP Flexible
cost = budget
$61,500 $60,000 $56,000
$1,500 U $4,000 U
(Price variance) (Usage variance)
Direct labour flexible-budget variance
$5,500 U
Interpretation of Price and Usage
Variances
Price and usage variances are helpful

because they provide feedback
to those responsible for inputs.
Managers should not use these

variances alone for decision
making, control, or evaluation 
possibility of trade-offs

Flexible Budgets and Variance Analysis

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Flexible Budgets and

A static budget is prepared for only

All actual results are compared with the

The variances of actual results

Actual Budget Variance

Actual expenses that exceed

Actual expenses that are less than

A flexible budget (variable budget) is a

To develop a flexible budget, managers

An activity-based flexible budget

Within each activity centre, costs

Units 7,000 7,000 –

Units 7,000 9,000 2,000 U

Managers use comparisons among

Effectiveness is the degree to which

Efficiency is the degree to which inputs are

Performance may be effective,

Total flexible-budget variance

Total sales-activity variance

An expected cost is the cost that

A standard cost is a carefully

or ideal standards, are expressions of the

No provision is made for waste, spoilage,

are levels of performance that

They make allowances for normal

Improvements in one area could lead to

Likewise, substandard performance

When should management

Many organizations have developed

Some organizations compare the most

Standard per unit of output:

Actual results for 7,000 units produced:

(Actual price – Standard Price)

(Actual quantity – Standard quantity)

($1.90 actual – $2.00 standard) per kg

($16.40 actual – $16.00 standard) per hour

[36,800 actual – (7,000 × 5 standard)] kg

[3,750 actual – (7,000 × ½ standard)] hours

Price and usage variances are helpful

Managers should not use these

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