Horngren’s Financial & Managerial

Accounting: The Managerial Chapters

Seventh Edition

Flexible Budgets

Houke
Copyright © 2018, 2016, 2014 Holswilder
Pearson Education, Inc. All Rights Reserved
 Cost and Efficiency Variances
• Remainder of chapter 8
• We go one level deeper
– Last week we covered level 1 and 2 of budget variances
– Today we go to level 3: cost and efficiency variances

• Suppose a firm sees that it has spend $10,000 less on direct

materials last month than expected for quantity produced
– Is that because materials were purchased more cheaply?
– Is that because fewer materials were used?
• Cost and efficiency variances allow us to answer these

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-2

 Budget Variances
A=Actual
B=Budget

PA * Q A PB * Q A PB * Q B
Actual Results Flexible Budget Static Budget
Based on actual Based on expected
number of units sold number of units sold

Static Budget Variance Level 1 variance

Flexible Budget Variance Sales Volume Variance

Level 2 variance
Change in P Change in Q

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 Flexible Budget (Level 2)Performance Report
Exhibit 23-5
8 Flexible Budget Performance Report
CHEERFUL COLORS
Flexible Budget Performance Report
For the Year Ended December 31, 2015
1 2 3 4 5
(1) – (3) (3) – (5)
Budget
Amounts PActual
A* Q A PFlexible
B* Q A PStatic
B* Q B
Per Unit Results Budget Budget

Units (Batches of 100) 52,000 52,000 50,000

$ $ $ $ $ $

Sales Revenue 7.50 384,800 5,200 U 390,000 15,000 F 375,000

Variable Costs:
Manufacturing:

Direct Materials 1.75 104,000 13,000 U 91,000 3,500 U 87,500

Direct Labor 3.00 145,600 10,400 F 156,000 6,000 U 150,000

Variable Overhead 0.75 30,160 8,840 F 39,000 1,500 U 37,500

Selling and Administrative:

Supplies 5% of sales 19,200 300 F 19,500 750 U 18,750

Total Variable Costs 298,960 6,540 F 305,500 11,750 U 293,750

Contribution Margin 85,840 1,340 F 84,500 3,250 F 81,250

Fixed Costs: Flexible Budget Variance Sales Volume Variance
$ 680 U $ 3,250 F
Manufacturing 23,920 1,080 F 25,000
Static 0
Budget Variance 25,000
$ 2,570 F
Selling and Administrative 25,600 3,100 U 22,500 0 22,500

Total Fixed Costs Copyright © 2014 Pearson

49,520 Education,
2,020Inc. Publishing
U as Prentice Hall
47,500 0 47,500 23-4
$ $ $ $ $
 Standard Cost System Benefits
Standard costing helps managers:
• Prepare the master budget
• Set target levels of performance for flexible
budgets
• Identify performance standards
• Set sales prices of products and services
• Decrease accounting costs

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Learning Objective 3
1. Compute the standard
Cost variances
2. Efficiency variances
for DM and DL

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 Level 3 Variances
All Product Costs can have Level 3
Variances
Actual/budgeted Rods purchase price ( P)
• DM Actual/budgeted Rods used per tent ( Q)
Actual/budgeted Labor hourly rate ( P)
• DL Actual/budgeted Labour hours used per tent ( Q)
• MOH Not for exam calculations

Level 3 including
1. cost variance (caused by P)
2. Efficiency variance (caused by Q)
 Flexible Budget (Level 3)Performance Report
Exhibit 23-5 Flexible Budget Performance Report

CHEERFUL COLORS
Flexible Budget Performance Report
For the Year Ended December 31, 2015
1 2 3 4 5
(1) – (3) (3) – (5)
Budget
Amounts Actual Flexible Static
Per Unit Results Budget Budget

Units (Batches of 100) 52,000 52,000 50,000

$ $ $ $ $ $

Sales Revenue 7.50 384,800 5,200 U 390,000 15,000 F 375,000

Variable Costs: Irrelevant
Manufacturing:
for cost and
Direct Materials 1.75 104,000 13,000 U 91,000 3,500 U 87,500
efficiency
Direct Labor 3.00 145,600 10,400 F 156,000 6,000
variances
U 150,000

Variable Overhead 0.75 30,160 8,840 F 39,000 1,500 U 37,500

Selling and Administrative:

Supplies 5% of sales 19,200 300 F 19,500 750 U 18,750

Total Variable Costs 298,960 6,540 F 305,500 11,750 U 293,750

Contribution Margin 85,840 1,340 F 84,500 3,250 F 81,250

Fixed Costs: Flexible Budget Variance Sales Volume Variance
$ 680 U $ 3,250 F
Manufacturing 23,920 1,080 F 25,000
Static 0
Budget Variance 25,000
$ 2,570 F
Selling and Administrative 25,600 3,100 U 22,500 0 22,500

Total Fixed Costs Copyright © 2014 Pearson

49,520 Education,
2,020Inc. Publishing
U as Prentice Hall
47,500 0 47,500 23-8
$ $ $ $ $
 Level 3 Variances
• Flexible budget variance can be divided into two
components:
– Cost variance: caused by to a difference between actual and
budgeted costs, vs.
• Example: firm paid $10/kg for raw materials instead of $12/kg
– Efficiency variance: caused by a difference between actual and
budgeted quantities, vs.
• Example: firm used 1 kg of raw materials per unit instead of 0.9 kg

• These level 3 variances further help a manager pinpoint

where and how a process went over/under budget

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 Two methods
• Using the table format of the actual results
and flexible budget
• Using the formulas

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Exhibit
CC 8
23-11 Direct Materials Variances
DM cost standard $1.75 per pound of paraffin

DM efficiency standard 1.00 pound of paraffin per batch of crayons 52,000 units were produced
Actual amount of paraffin purchased and used 65,000 pounds

Actual cost of paraffin purchased and used $104,000

PB* QA
PA* QA P B* Q B
$1.60 per pound $1.75 per pound $1.75 per pound
× × ×
65,000 pounds 65,000 pounds 52,000 pounds

$104,000 $113,750 $91,000

Cost Efficiency
Variance Variance
Formula = $22,750 U Formula =
$9,750 F
(PA - PB )* QA (QA - QB )* PB

Total Direct Materials Variance

$13,000 U
Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-11
 8
Exhibit 23-12 Direct Labor Variances

52,000 units were produced

Actual cost*Actual Quantity Standard cost*Actual Quantity Standard cost*Standard Quantity

PA*×Q P * QA
AC AQA SCB× AQ SC
PB*×QSQ
B

$14.00 per DLHr $12.00 per DLHr $12.00 per DLHr

× × ×
10,400 DLHr 10,400 DLHr 13,000 DLHr
$145,600 $124,800 $156,000

Cost Efficiency
Variance Variance
Formula = Formula =
$20,800 U $31,200 F
(PA - PB )* QA (QA - QB )* PB

Total Direct Labor Variance

$10,400 F
Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-12
 Recap: Formulas
• Cost variance:
– How much more/less did we pay for the materials?
– Valued at the actual quantity

• Efficiency variance:
– How much more/less materials did we use?
– Valued at the budgeted cost

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-13

S8-6 Calculating materials variances

Martin Inc. is a manufacturer of lead crystal glasses. The standard direct materials
quantity is 1.0 pound per glass at a cost of $0.50 per pound. The actual result for one
month’s production of 6,500 glasses was 1.2 pounds per glass, at a cost of $0.30 per
pound. Calculate the direct materials cost variance and the direct materials efficiency
variance.

• Direct materials cost variance

• Direct materials efficiency variance

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-14

S8-6 Calculating materials variances

Martin Inc. is a manufacturer of lead crystal glasses. The standard direct materials
quantity is 1.0 pound per glass at a cost of $0.50 per pound. The actual result for one
month’s production of 6,500 glasses was 1.2 pounds per glass, at a cost of $0.30 per
pound. Calculate the direct materials cost variance and the direct materials efficiency
variance.

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-15

S8-6 Calculating materials variances

Follow-up question:
What does this analysis mean for the firm?

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S-6 Calculating materials variances

Follow-up question:
What does this analysis mean for the firm?

• Direct material cost variance: $1,560 F

• Direct material efficiency variance: $ 650 U

• The firm spent less on direct materials compared to the flexible

budget
• The analysis shows that:
– This advantage is purely due to purchasing at a lower price
– Materials are actually being used less efficiently, i.e. more materials are used
than normal
• Management should:
1. Investigate why the purchasing price was so much lower
2. Investigate why more materials were being used

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-17

S8-7 Calculating labor variances

Martin Inc. is a manufacturer of lead crystal glasses. The standard direct labor time is
0.5 hours per glass, at a cost of $18 per hour. The actual results for one month’s
production of 6,500 glasses were 0.2 hours per glass, at a cost of $11 per hour. Calculate
the direct labor cost variance and the direct labor efficiency variance.

• Direct labor cost variance

• Direct labor efficiency variance

• labor hours standard or budgeted

• labor hours actual

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S8-7 Calculating labor variances

Martin Inc. is a manufacturer of lead crystal glasses. The standard direct labor time is
0.5 hours per glass, at a cost of $18 per hour. The actual results for one month’s
production of 6,500 glasses were 0.2 hours per glass, at a cost of $11 per hour. Calculate
the direct labor cost variance and the direct labor efficiency variance.

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-19

S8-7 Calculating labor variances

Follow-up question:
What does this analysis mean for the firm?

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-20

S8-7 Calculating labor variances

Follow-up question:
What does this analysis mean for the firm?

• Direct labor cost variance $ 9,100 F

• Direct labor efficiency variance $ 35,100 F

• Direct labor costs are in total lower compared to the flexible budget
• The analysis shows that:
– The cost of one hour of labor was significantly lower, resulting in a benefit of
$9,100 for the firm
– Far fewer labor hours were used, resulting in a benefit of $35,100 for the firm

• Management should:
– Investigate how it was possible to pay only $11/hour instead of $18
– Investigate how the same output was produced with 1,950 fewer labor hours

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-21

P23-32B (equals 8-32B, only different numbers) Computing standard cost variances
and reporting to management
PC Accessories manufactures laptop cases. During October 2018, the company produced
95,400 cases and recorded the following cost data:

Requirements:
1. Compute the cost
and efficiency
variances for direct
materials and direct
labor.
2. PC Accessories’
management used
better-quality
materials during
October. Discuss the
trade-off between
the two direct
material variances.

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P8-32B: Requirement 1
Direct materials Formula Calculation
Cost variance
Efficiency variance

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P23-32B: Requirement 1
Direct materials Formula Calculation
Cost variance U
Efficiency variance

Note: to calculate , use the actual number of units sold  we want to know
how many parts would normally be used to produce the actual amount
parts

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-24

P23-32B: Requirement 1
Direct materials Formula Calculation
Cost variance U
Efficiency variance F

Note: to calculate , use the actual number of units sold  we want to know
how many parts would normally be used to produce the actual amount
parts

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P23-32B: Requirement 1
Direct labor Formula Calculation
Cost variance
Efficiency variance

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-26

P23-32B: Requirement 1
Direct labor Formula Calculation
Cost variance U
Efficiency variance

Note: to calculate , use the actual number of units sold  we want to know
how much labor would normally be used to produce the actual amount
direct labor hours

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-27

P23-32B: Requirement 1
Direct labor Formula Calculation
Cost variance U
Efficiency variance F

Note: to calculate , use the actual number of units sold  we want to know
how much labor would normally be used to produce the actual amount
direct labor hours

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-28

P23-32B: Requirement 1
Direct materials Calculation
Cost variance U
Efficiency variance F

Direct labor Calculation

Cost variance U
Efficiency variance F

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-29

P23-32B Computing standard cost variances and reporting to management

PC Accessories manufactures laptop cases. During October 2018, the company produced
95,400 cases and recorded the following cost data:

Requirements:
1. Compute the cost
and efficiency
variances for direct
materials and direct
labor.
2. PC Accessories’
management used
better-quality
materials during
October. Discuss the
trade-off between
the two direct
material variances.

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-30

P23-32B: Requirement 2
Direct materials Calculation
Cost variance U
Efficiency variance F

• The firm used better quality materials

• As a result, it seems the firm used fewer parts, resulting in a
favorable efficiency variance
– 150,480 parts used instead of 152,640

• However, the better quality materials were also a lot more

expensive, resulting in a large unfavorable cost variance
• Looking at the costs this was thus clearly a bad idea
• However, if this results in a higher quality product, the firm may still
benefit
Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-31
 Questions?
• If any pop up later, feel free to send me an
email (h.b.j.j.holswilder@pl.hanze.nl)

• In week 7 there is a one hour overview /

Q&A session