© 2007 Pearson Education Canada Slide 12-1 Flexible Budgets and Variance Analysis 12

© 2007 Pearson Education Canada Slide 12-1

Flexible Budgetsand Variance Analysis

12


Static and Flexible Budgets

Static Budget• Master budget • Carefully forecasted

sales and operating targets

Flexible Budget• Budget that adjusts for

changes in volume and other cost driver activities

• May be prepared for any level of activity

• Provides a basis for comparison with actual results

Flexible BudgetsUnits Per Unit 7,000 8,000

Sales $31.00 $217,000 $248,000

Variable costs:Manufacturing $21.00 $147,000 $168,000Shipping .60 4,200 4,800Administrative .20 1,400 1,600Total variable $21.80 $152,600 $174,400

Contribution margin $9.20 $64,400 $73,600

Fixed costs:Manufacturing $37,000 $37,000Sell & Admin 33,000 33,000Total fixed costs $70,000 $70,000

Operating income (loss) $(5,600) $3,600


Evaluation of Financial Performance• Subdivision of total difference between master or static

budget and actual results to evaluate performance

Flexible SalesActual Budget Flexible Activity MasterResults Variances Budget Variances Budget

Units 7,000 7,000 2,000 U 9,000

Sales $217,000 $217,000 $62,000 U $279,000

Variable costs 158,270 5,670 U 152,600 43,600 F 196,200

ContributionMargin 58,730 5,670 U 64,400 18,400 U 82,800

Fixed costs 70,300 300 U 70,000 70,000

Operating income $(11,570) $5,970 U $(5,600) $18,400 U $12,800


Activity-Based Flexible Budgets

• if employ an activity-based costing system, best to use an activity-based budget as well

• Base budget on activity centres and their cost drivers

Units 7,000 8,000 9,000

Activity Centres

1. Processing

Cost driver – machine hours 14,000 16,000 18,000

Variable costs $147,000 $168,000 $189,000

Fixed costs 13,000 13,000 13,000

Total Processing costs $160,000 $181,000 $202,000

2. Setup (cost driver – number of setups)

3. Marketing (cost driver – number of orders)

4. Administration (cost driver – number of units)


Variance AnalysisVariance Analysis• Used to evaluate performance• Separate measures of effectiveness and efficiency

Effectiveness• Degree to which the goal was met• Usually the responsibility of marketing manager • Measured by the Sales Activity Variance

Sales Activity Variance= (Flexible budgeted units - Master budgeted units) x

Budgeted contribution margin per unit= (9,000 units - 7,000 units) x $9.20= $18,400 unfavourable

Efficiency• How well inputs were used in relation to a given level of outputs• Reducing inputs used to produce a given level of output, increases

efficiency


Standard Costs

Standard Cost• Cost that is most likely to be attained and should be attained

Standard Price $2.00 per kg.Standard Quantity 3 kgs. per unitStandard Cost $6.00 per unit

Standard Cost System• Values products based on standard costs

Currently Attainable Standards• Standards are usually set at the currently attainable level • Achievable by realistic levels of effort by employees• Make a provision for waste, spoilage and machine breakdowns• Better than perfection or ideal standards which assume the most

efficient performance possible under the best conceivable conditions


Investigation & Use of Variances• Variances show that something was different than expected • Variances are attention directors, not problem solvers

VarianceX Interpretation

VarianceDetermination Evaluationof Cause of Reaction

Controller Manager Supervisor

• Management's responsibility is to explain why variances occurred and to say what has been done to prevent them happening again

• ”Favourable" variances are not necessarily good • ”Unfavourable" variances are not necessarily bad • Usually investigate variances above a certain dollar amount or

greater than a specified percentage of the budgeted standard


Efficiency Variances for Material & Labour

• Subdivision of total flexible budget (or efficiency) variance into two parts

• How efficiently were the material and labour inputs acquired?

• How efficiently were the material and labour inputs used?

• Enables management to direct variances to the manager(s) who had influence over the amount spent or the amount used

Price variance= (actual input prices - standard input prices) x actual quantity of inputs used= ($1.90 - $2.00) x 36,800 kilograms= $3,680 favourable

Usage variance= (actual quantity used - standard quantity allowed) x standard price= [ 36,800 - (7,000 x 5) ] x $2.00 per kilogram= $3,600 unfavourable

Note that the usage variance is often called the quantity variance or the efficiency variance


Direct Material Variances

Actual Costs Flexible Budget Flexible Budget

Actual Inputs x Actual Inputs x Standard Inputs x

Actual Prices Standard Prices Standard Prices

Direct material

36,800 kg 36,800 kg 35,000 kgx $1.90 / kg x $2.00 / kg x $2.00 / kg= $69,920 = $73,600 = $70,000

Price Variance$3,680 F

Usage Variance$3,600 U

Flexible Budget Variance $80 F


Direct Labour Variances


Actual Inputs x Actual Inputs x Standard Inputs x

Actual Prices Standard Prices Standard Prices

Direct labour3,750 hours 3,750 hours 3,500 hours

x $16.40 / hour x $16.00 / hour x $16.00 / hour= $61,500 = $60,000 = $56,000Price Variance

$1,500 UUsage Variance

$4,000 U

Flexible Budget Variance $5,500 U


Overhead Variances• Overhead accounts are monitored to a lesser extent in most

organizations due to the nature of overhead costs• Usually limited to an efficiency and spending variance for variable

overhead and a spending variance for fixed overhead

Variable overhead efficiency variance= (actual quantity of input - standard quantity of input allowed) x standard rate= ( 3,750 - 3,500) x $1.20 per hour = $300 U

• ”Quantity" of variable overhead is based on the cost driver selected for variable overhead

Variable overhead spending variance = total flexible budget variance - variable overhead efficiency variance= $500 U - $300 U = $200 U

Fixed overhead budget variance= budgeted fixed overhead - actual fixed overhead= $14,400 - $14,700 = $300 U


Overhead Subdivision


Actual Inputs x Actual Inputs x Standard Inputs xActual Prices Standard Prices Standard Prices

Variable Overhead

3,750 hours 3,500 hoursx $1.20 / hour x $1.20 / hour

$4,700 = $4,500 = $4,200

Fixed Overhead

$14,700 $14,400

Spending Variance$200 U

Efficiency Variance$300 U

Flexible Budget Variance $500 U

Flexible Budget Variance $300 U


Subdividing The Total Variance

Revenue $1,200

Variable COGS 850

Contribution Margin 350

Fixed Costs 220

Operating Income $ 130

Revenue $1,000

Variable COGS 700

Contribution Margin 300

Fixed Costs 200

Operating Income $ 100

SalesPrice

Variance

SalesActivity

Variance

Variable CostFlexible Budget

Variance

Fixed CostFlexible Budget

Variance

Sales QuantityVariance

Sales MixVariance Price

VarianceUsage

Variance

Market ShareVariance

Market SizeVariance

Master BudgetActual Results


Actual, Normal and Standard Costing

• Actual costing: direct material, direct labour and all overhead at actual costs

• Normal costing: direct material and direct labour at actual cost, overhead at budgeted rates x actual inputs

• Standard costing: budgeted prices or rates x standard inputs allowed to actual output achieved

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© 2007 Pearson Education Canada Slide 12-1 Flexible Budgets and Variance Analysis 12