Ch 10 Budgeting

7/29/2019 Ch 10 Budgeting

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Budgeting


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Purposes of Budgeting Systems

Budget

a detailed plan,

expressed infinancial terms, thatspecifies how

resources will be

acquired and usedduring a specifiedperiod of time.

Planning

Controlling Profit andOperations

Evaluating Performance

and Providing Incentives


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Types of Budgets

DetailBudget

DetailBudget

DetailBudget

MasterBudget

Covering allphases of

a companysoperations.

Production


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Budgeted Financial Statements

Materialspurchase

budget

CashBudget

Sales of Services or Goods

EndingInventory

BudgetRaw Materials,

Work in Processand Finished

Goods

ProductionBudget

Selling andAdministrative

Budget

DirectLabor

Budget

OverheadBudget

Exh.

9-1

Capitalbudget

Financingbudget


5/83

Sales Budget

Breakers, Inc. is preparing budgets for thequarter ending June 30, 2012.

Budgeted sales for the next five months are:

April 20,000 unitsMay 50,000 units

June 30,000 units

July 25,000 unitsAugust 15,000 units.

The selling price is $10 per unit.


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Sales Budget

April May June Quarter

Budgeted

sales (units) 20,000 50,000 30,000 100,000Selling price

per unit 10$ 10$ 10$ 10$Total

Revenue 200,000$ 500,000$ 300,000$ 1,000,000$


7/83

Production Budget

SalesBudget

ProductionBudget

Production must be adequate to meet budgetedsales and provide for sufficient ending inventory.


8/83

Production Budget

The management of Breakers, Inc. wants endingfinished goods inventory to be equal to 20% ofthe following months budgeted sales in units.

On March 31, 4,000 units were on hand.

Lets prepare the production budget.


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April May June Quarter Sales in units 20,000

Add: desired

end. inventory

Total neededLess: beg.

inventoryUnits to be

produced

Production Budget

From salesbudget


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Add: desired

end. inventory 10,000

Total needed 30,000Less: beg.

inventoryUnits to be

started

Production Budget

May sales 50,000 units

Desired percent 20%

Desired inventory 10,000 units


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Add: desired

end. inventory 10,000

Total needed 30,000Less: beg.

inventory 4,000Units to be

started 26,000

Production Budget

March 31ending inventory


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April May June Quarter Sales in units 20,000 50,000

Add: desired

end. inventory 10,000 6,000

Total needed 30,000 56,000Less: beg.

inventory 4,000 10,000Units to be

started 26,000 46,000

Production Budget


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April May June Quarter Sales in units 20,000 50,000 30,000 100,000

Add: desired

end. inventory 10,000 6,000 5,000 5,000

Total needed 30,000 56,000 35,000 105,000Less: beg.

inventory 4,000 10,000 6,000 4,000Units to be

started 26,000 46,000 29,000 101,000

Production Budget


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Direct-Material Budget

At Breakers, five pounds of material arerequired per unit of product.

Management wants raw materials on hand at

the end of each month equal to 10% of thefollowing months production.

On March 31, 13,000 pounds of material are on

hand. Material cost $.40 per pound.

Lets prepare the direct materials budget.


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Production in units 26,000 46,000 29,000 101,000

Materials per unit

Production needs

Add: desired

ending inventory

Total needed

Less: beginning

inventoryMaterials to be

purchased


From ourproduction

budget


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Production in units 26,000 46,000

Materials per unit 5 5

Production needs 130,000 230,000

Add: desired

ending inventory 23,000

Total needed 153,000

Less: beginning

inventoryMaterials to be

purchased

10% of the followingmonths production



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Materials per unit 5 5 5 5

Production needs 130,000 230,000 145,000 505,000

Add: desired

ending inventory 23,000

Total needed 153,000

Less: beginning

inventory 13,000Materials to be

purchased 140,000

March 31inventory



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Add: desired

ending inventory 23,000 14,500 11,500 11,500

Total needed 153,000 244,500 156,500 516,500

Less: beginning

inventory 13,000 23,000 14,500 13,000Materials to be

purchased 140,000 221,500 142,000 503,500



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Add: desired

ending inventory 23,000 14,500 11,500 11,500

Total needed 153,000 244,500 156,500 516,500

Less: beginning

inventory 13,000 23,000 14,500 13,000Materials to be

purchased 140,000 221,500 142,000 503,500

June Ending Inventory

July production in units 23,000

Materials per unit 5Total units needed 115,000

Inventory percentage 10%

June desired ending inventory 11,500


July ProductionSales in units 25,000

Add: desired ending inventory 3,000

Total units needed 28,000

Less: beginning inventory 5,000

Production in units 23,000


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Direct-Labor Budget

At Breakers, each unit of product requires 0.1 hoursof direct labor.

The Company has a no layoff policy so allemployees will be paid for a minimum of 40 hours of

work each week.

In exchange for the no layoff policy, workers agreedto a wage rate of $8 per hour regardless of the hoursworked (No overtime pay).

For the next three months, the direct labor workforcewill be paid for a minimum of 3,000 hours per month.

Lets prepare the direct labor budget.


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April May June Quarter Production in units 26,000 46,000 29,000 101,000

Direct labor hours

Labor hours required

Guaranteed labor

hoursLabor hours paid

Wage rate

Total direct labot cost

From ourproduction

budget

Direct-Labor Budget


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Direct-Labor Budget


Direct labor hours 0.10 0.10 0.10 0.10

Labor hours required 2,600 4,600 2,900 10,100

Guaranteed labor

hoursLabor hours paid

Wage rate



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Guaranteed labor

hours 3,000 3,000 3,000Labor hours paid 3,000 4,600 3,000 10,600

Wage rate


This is the greater oflabor hours required orlabor hours guaranteed.

Direct-Labor Budget


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Guaranteed labor

hours 3,000 3,000 3,000Labor hours paid 3,000 4,600 3,000 10,600

Wage rate 8$ 8$ 8$ 8$

Total direct labot cost 24,000$ 36,800$ 24,000$ 84,800$

Direct-Labor Budget


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Overhead Budget

Here is Breakers Overhead Budget for the quarter.


Indirect labor 17,500$ 26,500$ 17,900$ 61,900$

Indirect material 7,000 12,600 8,600 28,200Utilities 4,200 8,400 5,200 17,800

Rent 13,300 13,300 13,300 39,900

Insurance 5,800 5,800 5,800 17,400

Maintenance 8,200 9,400 8,200 25,800

56,000$ 76,000$ 59,000$ 191,000$


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Selling and Administrative

Expense Budget

At Breakers, variable selling andadministrative expenses are $0.50 per unitsold.

Fixed selling and administrative expensesare $70,000 per month.

The $70,000 fixed expenses include$10,000 in depreciation expense that doesnot require a cash outflow for the month.


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Sales in units 20,000 50,000 30,000 100,000

Variable S&A rate

Variable expense

Fixed S&Aexpense

Total expense

Less: noncash

expenses

Cashdisbursements


Expense Budget

From our

Sales budget


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Expense BudgetApril May June Quarter

Sales in units 20,000 50,000 30,000 100,000

Variable S&A rate 0.50$ 0.50$ 0.50$ 0.50$

Variable expense 10,000$ 25,000$ 15,000$ 50,000$

Fixed S&Aexpense 70,000 70,000 70,000 210,000

Total expense 80,000 95,000 85,000 260,000

Less: noncash

expenses

Cashdisbursements


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Expense BudgetApril May June Quarter

Sales in units 20,000 50,000 30,000 100,000

Variable S&A rate 0.50$ 0.50$ 0.50$ 0.50$

Variable expense 10,000$ 25,000$ 15,000$ 50,000$

Fixed S&Aexpense 70,000 70,000 70,000 210,000

Total expense 80,000 95,000 85,000 260,000

Less: noncash

expenses 10,000 10,000 10,000 30,000

Cashdisbursements 70,000$ 85,000$ 75,000$ 230,000$


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At Breakers, all sales are on account.

The companys collection pattern is:

70% collected in the month of sale,25% collected in the month following sale,

5% is uncollected.

The March 31 accounts receivablebalance of $30,000 will be collected in full.

Cash Receipts Budget


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April May June Quarter Accounts rec. - 3/31 30,000$ 30,000$

April sales

70% x $200,000 140,000 140,000

25% x $200,000 50,000$ 50,000

Total cash collections 170,000$


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April May June Quarter Accounts rec. - 3/31 30,000$ 30,000$

April sales

70% x $200,000 140,000 140,000

25% x $200,000 50,000$ 50,000

May sales

70% x $500,000 350,000 350,000

25% x $500,000 125,000$ 125,000

June sales

70% x $300,000 210,000 210,000

Total cash collections 170,000$ 400,000$ 335,000$ 905,000$



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Cash Disbursement Budget

Breakers pays $0.40 per pound for itsmaterials.

One-half of a months purchases are paid for in

the month of purchase; the other half is paid inthe following month.

No discounts are available.

The March 31 accounts payable balance is$12,000.


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Accounts pay. 3/31 12,000$ 12,000$

April purchases

50% x $56,000 28,000 28,000

50% x $56,000 28,000$ 28,000

Total cash payments

for materials 40,000$

140,000 lbs. $.40/lb. = $56,000



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Accounts pay. 3/31 12,000$ 12,000$

April purchases

50% x $56,000 28,000 28,000

50% x $56,000 28,000$ 28,000

May purchases

50% x $88,600 44,300 44,300

50% x $88,600 44,300$ 44,300

June purchases

50% x $56,800 28,400 28,400Total cash payments

for materials 40,000$ 72,300$ 72,700$ 185,000$



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Cash Budget

Breakers: Maintains a 12% open line of credit for $75,000.

Maintains a minimum cash balance of $30,000.

Borrows and repays loans on the last day of themonth.

Pays a cash dividend of $25,000 in April.

Purchases $143,700 of equipment in May and$48,300 in June paid in cash.

Has an April 1 cash balance of $40,000.


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April May June Quarter Beginning cash balance 40,000$

Add: cash collections 170,000

Total cash available 210,000

Less: disbursements

MaterialsDirect labor

Mfg. overhead

Selling and admin.

Equipment purchase

DividendsTotal disbursements

Excess (deficiency) of

Cash available over

disbursements

From our CashReceipts Budget

Cash BudgetContinued


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Less: disbursements

Materials 40,000Direct labor

Mfg. overhead

Selling and admin.

Equipment purchase



Cash available over

disbursements

From our CashDisbursements

Budget



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Less: disbursements

Materials 40,000Direct labor 24,000

Mfg. overhead

Selling and admin.

Equipment purchase



Cash available over

disbursements

From our DirectLabor Budget



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Less: disbursements


Mfg. overhead 56,000

Selling and admin.

Equipment purchase



Cash available over

disbursements

From ourOverhead Budget



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Less: disbursements



Selling and admin. 70,000

Equipment purchase



Cash available over

disbursements

From ourSelling and Administrative

Expense Budget



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Less: disbursements




Equipment purchase -

Dividends 25,000Total disbursements 215,000


Cash available over

disbursements (5,000)$

To maintain a cashbalance of $30,000,

Breakers must borrow

$35,000 on its line of credit.



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Cash available over


Financing:Borrowing 35,000

Repayments -

Interest -

Total financing 35,000

Ending cash balance 30,000$

Ending cash balance for Aprilis the beginning May balance.

Cash BudgetFinancing and Repayment



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Beginning cash balance 40,000$



Less: disbursements

Materials 40,000

Direct labor 24,000



Equipment purchase -

Dividends 25,000

Total disbursements 215,000

Excess (deficiency) ofCash available over

disbursements (5,000)$Excess (deficiency) of

Cash available over


Financing:

Borrowing 35,000

Repayments -Interest -

Total financing 35,000

Ending cash balance 30,000$


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April May June Quarter Beginning cash balance 40,000$ 30,000$

Add: cash collections 170,000 400,000

Total cash available 210,000 430,000

Less: disbursements

Materials 40,000 72,300Direct labor 24,000 36,800

Mfg. overhead 56,000 76,000

Selling and admin. 70,000 85,000

Equipment purchase - 143,700

Dividends 25,000 -Total disbursements 215,000 413,800


Cash available over

disbursements (5,000)$ 16,200$


Breakers mustborrow an

addition $13,800to maintain a

cash balanceof $30,000.


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Cash available over

disbursements (5,000)$ 16,200$

Financing:Borrowing 35,000 13,800

Repayments - -

Interest - -

Total financing 35,000 13,800

Ending cash balance 30,000$ 30,000$


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April May June Quarter Beginning cash balance 40,000$ 30,000$ 30,000$

Add: cash collections 170,000 400,000 335,000

Total cash available 210,000 430,000 365,000

Less: disbursements

Materials 40,000 72,300 72,700Direct labor 24,000 36,800 24,000

Mfg. overhead 56,000 76,000 59,000

Selling and admin. 70,000 85,000 75,000

Equipment purchase - 143,700 48,300

Dividends 25,000 - -Total disbursements 215,000 413,800 279,000


Cash available over

disbursements (5,000)$ 16,200$ 86,000$

At the end of June, Breakershas enough cash to repay

the $48,800 loan plus interest

at 12%.



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Cash available over

disbursements (5,000)$ 16,200$ 86,000$

Financing:Borrowing 35,000 13,800

Repayments - - (48,800)

Interest - - (838)

Total financing 35,000 13,800 (49,638)

Ending cash balance 30,000$ 30,000$ 36,362$

Borrowing RateAnnualInterest

MonthsOutstanding

InterestExpense

35,000$ 12% = 4,200$ 2 mths = 700$

13,800 12% = 1,656 1 mth. = 138

838$


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Cash available over

disbursements (5,000)$ 16,200$ 86,000$ 37,200$

Financing:

Borrowing 35,000 13,800 48,800

Repayments - - (48,800) (48,800)

Interest - - (838) (838)

Total financing 35,000 13,800 (49,638) (838)

Ending cash balance 30,000$ 30,000$ 36,362$ 36,362$


Beginning cash balance 40,000$ 30,000$ 30,000$ 40,000$

Add: cash collections 170,000 400,000 335,000 905,000

Total cash available 210,000 430,000 365,000 945,000

Less: disbursementsMaterials 40,000 72,300 72,700 185,000

Direct labor 24,000 36,800 24,000 84,800

Mfg. overhead 56,000 76,000 59,000 191,000

Selling and admin. 70,000 85,000 75,000 230,000

Equipment purchase - 143,700 48,300 192,000

Dividends 25,000 - - 25,000Total disbursements 215,000 413,800 279,000 907,800


Cash available over

disbursements (5,000)$ 16,200$ 86,000$ 37,200$


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Budgeted Income Statement

CashBudget

BudgetedIncome

Statement

After we complete the cash budget, we can preparethe budgeted income statement for Breakers.


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Budgeted Ending Inventory

Production costs per unit Quantity Cost Total

Direct materials 5.00 lbs. 0.40$ 2.00$

Direct labor 0.10 hrs. 8.00$ 0.80

Manufacturing overhead 0.10 hrs. 18.02$ 1.80

4.60$

Budgeted finished goods inventory

Ending inventory in units 5,000

Unit product cost 4.60$

Ending finished goods inventory 23,000$

Total overhead $191,000Total labor hours 10,600 hrs.

= $18.02 per hr.*

*rounded

Manufacturing overhead is applied on the basis of direct labor hours.


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Revenue (100,000 $10) 1,000,000$

Cost of goods sold (100,000 $4.60) 460,000

Gross margin 540,000Operating expenses:

Selling and admin. Expenses 260,000$

Interest expense 838

Total operating expenses 260,838

Net income 279,162$

Breakers, Inc.


For the Three Months Ended June 30


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Budgeted Balance Sheet

Breakers reports the following accountbalances on June 30 prior to preparing its

budgeted financial statements:

Land - $50,000 Building (net) - $148,000

Common stock - $200,000

Retained earnings (beginning of year) -$46,400

Breakers, Inc.


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June 30

Current assets

Cash 36,362$Accounts receivable 75,000

Raw materials inventory 4,600

Finished goods inventory 23,000

Total current assets 138,962

Property and equipment

Land 50,000

Building 148,000

Equipment 192,000

Total property and equipment 390,000

Total assets 528,962$

Accounts payable 28,400$

Common stock 200,000

Retained earnings 300,562

Total liabilities and equities 528,962$

25%of June

sales of$300,000

11,500 lbs. at

$.40 per lb.

5,000 units at$4.60 per unit.

Breakers, Inc.


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June 30

Current assets

Cash 36,362$Accounts receivable 75,000

Raw materials inventory 4,600

Finished goods inventory 23,000

Total current assets 138,962

Property and equipment

Land 50,000

Building 148,000

Equipment 192,000

Total property and equipment 390,000

Total assets 528,962$

Accounts payable 28,400$

Common stock 200,000

Retained earnings 300,562

Total liabilities and equities 528,962$

50% of June

purchasesof $56,800

Beginning balance 46,400$

Add: net income 279,162

Deduct: dividends (25,000)

Ending balance 300,562$


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Flexible Budgets

Hmm! Comparingstatic budgetswith actual costsis like comparing

apples and oranges.

Static budgets areprepared for a single,

planned level ofactivity.

Performanceevaluation is difficult

when actual activitydiffers from theplanned level of

activity.

Static Budgets and


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Static Actual

Budget Results Variance

Machine hours 10,000 8,000 2,000 U

Variable costsIndirect labor 40,000$

Indirect materials 30,000

Power 5,000

Fixed costsDepreciation 12,000

Insurance 2,000

Total overhead costs 89,000$

Static Budgets and

Performance Reports

U = Unfavorable varianceCheese Company wasunable to achieve the

budgeted level of activity.

Static Budgets and


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Static Actual


Machine hours 10,000 8,000 2,000 U

Variable costsIndirect labor 40,000$ 34,000$ $6,000 F

Indirect materials 30,000 25,500 4,500 F

Power 5,000 3,800 1,200 F

Fixed costsDepreciation 12,000 12,000 0

Insurance 2,000 2,000 0

Total overhead costs 89,000$ 77,300$ $11,700 F

Static Budgets and

Performance Reports

Static Budgets and


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Static Actual


Machine hours 10,000 8,000 2,000 U

Variable costsIndirect labor 40,000$ 34,000$ $6,000 F

Indirect materials 30,000 25,500 4,500 F

Power 5,000 3,800 1,200 F

Fixed costsDepreciation 12,000 12,000 0

Insurance 2,000 2,000 0

Total overhead costs 89,000$ 77,300$ $11,700 F

Since cost variances are favorable, have

we done a good job controlling costs?

Static Budgets and

Performance Reports

Static Budgets and


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I dont think I cananswer this question

using a static budget.

I do know thatactual activity is belowbudgeted activity which

is unfavorable.

But shouldnt variable costsbe lower if actual activity

is below budgeted activity?

Static Budgets and

Performance Reports

Static Budgets and


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The relevant question is . . .

How much of the favorable cost variance is due tolower activity, and how much is due to good cost

control?

To answer the question,we must

the budget to theactual level of activity.

Static Budgets and

Performance Reports


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Preparing a Flexible Budget

To a budget for different activitylevels, we must know how costs behavewith changes in activity levels.

Total variable costs changein direct proportion tochanges in activity.

Total fixed costs remain

unchanged within therelevant range.

Fixed


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Variable Total Flexible Budgets

Cost Fixed 8,000 10,000 12,000

Per Hour Cost Hours Hours Hours

Machine hours 8,000 10,000 12,000

Variable costs

Indirect labor 4.00Indirect material 3.00

Power 0.50

Total variable cost 7.50$

Fixed costs

Depreciation 12,000$

Insurance 2,000

Total fixed cost

Total overhead costs


Note that the cost

budgets are prepared

using a cost behavior

format, similar to

variable costing.


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Variable Total Flexible BudgetsCost Fixed 8,000 10,000 12,000


Machine hours 8,000 10,000 12,000

Variable costsIndirect labor 4.00 32,000$

Indirect material 3.00 24,000

Power 0.50 4,000

Total variable cost 7.50$ 60,000$

Fixed costsDepreciation 12,000$ 12,000$

Insurance 2,000 2,000

Total fixed cost 14,000$



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Machine hours 8,000 10,000 12,000

Variable costsIndirect labor 4.00 32,000$ 40,000$ 48,000$

Indirect material 3.00 24,000 30,000 36,000

Power 0.50 4,000 5,000 6,000

Total variable cost 7.50$ 60,000$ 75,000$ 90,000$

Fixed costsDepreciation 12,000$ 12,000$ 12,000$ 12,000$

Insurance 2,000 2,000 2,000 2,000

Total fixed cost 14,000$ 14,000$ 14,000$

Total overhead costs 74,000$ 89,000$ 104,000$


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Machine hours 8,000 10,000 12,000

Variable costsIndirect labor 4.00 32,000$ 40,000$ 48,000$

Indirect material 3.00 24,000 30,000 36,000

Power 0.50 4,000 5,000 6,000

Total variable cost 7.50$ 60,000$ 75,000$ 90,000$

Fixed costsDepreciation 12,000$ 12,000$ 12,000$ 12,000$

Insurance 2,000 2,000 2,000 2,000

Total fixed cost 14,000$ 14,000$ 14,000$

Total overhead costs 74,000$ 89,000$ 104,000$

Note: There is no flexin the fixed costs.

Fl ibl B d t


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Flexible Budget

Performance ReportVariable Total

Cost Fixed Flexible Actual

Per Hour Costs Budget Results Variances

Machine hours 8,000 0

Variable costsIndirect labor 4.00$ 34,000$

Indirect material 3.00 25,500

Power 0.50 3,800

Total variable costs 7.50$ 63,300$

Fixed Expenses

Depreciation 12,000$ 12,000$

Insurance 2,000 2,000

Total fixed costs 14,000$


Original actual results forCheese Company that we saw

earlier.

Fl ibl B d t


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Flexible Budget




Machine hours 8,000 8,000 0

Variable costsIndirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U

Indirect material 3.00 24,000 25,500 1,500 U

Power 0.50 4,000 3,800 200 F

Total variable costs 7.50$ 60,000$ 63,300$ $ 3,300 U

Fixed Expenses

Depreciation 12,000$ 12,000$ 12,000$ 0

Insurance 2,000 2,000 2,000 0

Total fixed costs 14,000$ 14,000$ 0

Total overhead costs 74,000$ 77,300$ $ 3,300 U

Fl ibl B d t


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Flexible Budget







Power 0.50 4,000 3,800 200 F


Fixed Expenses

Depreciation 12,000$ 12,000$ 12,000$ 0

Insurance 2,000 2,000 2,000 0



Indirect labor andindirect material haveunfavorable variancesbecause actual costs

are more than theflexible budget costs.

Fle ible B dget


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Flexible Budget







Power 0.50 4,000 3,800 200 F


Fixed Expenses

Depreciation 12,000$ 12,000$ 12,000$ 0

Insurance 2,000 2,000 2,000 0



Power has a favorablevariance because the

actual cost is less thanthe flexible budget cost.


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Handout 10 (a):Static and Flexible

Budgetingd

Standard Costs, C-P-V, Flexible Budgets and Analysis of Standard


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Cost Variations

This example provides a comprehensive illustration of standard costing, flexible

budgeting, and analysis of differences between budgeted and actual operating results.

Per Unit Standards, Product X:Sales price $ 100

Quantity Price TotalDirect materials 1 lb. $ 10 $ 10Direct labor 2 hours $ 12 $ 24Variable overhead 2 hours $ 15 $ 30

Total variable cost $ 64Contribution margin $ 36Fixed overhead* 2 hours $ 7.50 $ 15

Gross margin $ 21

* Budgeted annual fixed costs are $ 1,200,000. Budgeted production is 80,000 units.Budgeted direct labor hours are therefore 160,000 (2 x 80,000).Therefore, the fixed overhead rate per labor hour is $7.50 ($1,200,000 / 160,000

DLH).

Static budget and flexible budget


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The static budget is prepared based on the companys budgeted output of 80,000units, using standard sales prices and production costs. The flexible budget uses thesame per-unit standards, at the companys actual output. In substance, the profit

volume equation is an alternative way of expressing the firms flexible budget.Assume that the company has actual output of 100,000 units. The static and flexible

budgets are as follows:

Item

Static budget

(80,000 units)

Flexible budget

(100,000 units)Revenues $100 x 80,000 u. $ 8,000,000 $100 x 100,000 u. $ 10,000,000Directmaterials

$ 10 x 80,000 u. $ 800,000 $ 10 x 100,000u.

$ 1,000,000

Direct labor $ 24 x 80,000 u. $ 1,920,000 $ 24 x 100,000 u. $ 2,400,000Variableoverhead $ 30 x 80,000 u. $ 2,400,000 $ 30 x 100,000 u. $ 3,000,000Contribution $ 36 x 80,000 u. $ 2,880,000 $ 36 x 100,000 u. $ 3,600,000Fixedoverhead

- $ 1,200,000 - $ 1,200,000

Operatingprofit

- $ 1,680,000 - $ 2,400,000

The next step is a comparison of the firms actual revenues and

t th t ll d i th fl ibl b d t


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expenses to the amounts allowed in theflexible budget.

Item

Actual results

(100,000 units)

Flexible budget

(100,000 units) VarianceRevenues $100 x 100,000 u. $10,000,000 $100 x 100,000 u. $ 10,000,000 $ 0

Direct mat. $ 11 x 105,000 lbs. $ 1,155,000 $10 x 100,000 lbs. $ 1,000,000 $ 155,000 UDirect labor $ 10 x 210,000 dlh. $ 2,100,000 $12 x 200,000 dlh. $ 2,400,000 $ 300,000 FVariableoverhead - $ 3,400,000 $15 x 200,000 dlh. $ 3,000,000 $ 400,000 UContribution - $ 3,345,000 $36 x 100,000 u. $ 3,600,000 $ 255,000 UFixed overhead - $ 1,400,000 - $ 1,200,000 $ 200,000 UOperatingprofit

-$ 1,945,000

-$ 2,400,000 $ 455,000 U

Note that the firms actual profit exceeds the profit in the firmsoriginal static budget by $ 265,000. The flexible budget, however,indicates that profits should have increased by $ 720,000 because ofthe increase in sales. For this reason, management requires asexplanation for the shortfall of $ 455,000 ($ 720,000 - $ 265,000).The analysis of the source of this variation focuses on the variancecolumn above. In a variable costing framework, the following sevenvariances are usually measured:

A. Prime cost variances:


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1. Materials price variance.

2. Materials efficiency variance.

3. Labor rate variance.

4. Labor efficiency variance.

B. Overhead variances:

5. Variable overhead efficiency variance.

6. Variable overhead spending variance.

7. Fixed overhead spending variance.

In an absorption costing framework, the following additional variance is measured:

8. Fixed overhead volume variance. (The economic interpretation of this variance is

not the same as the interpretation of the other seven variances.)

A. Over-all reconciliation of budgeted and actual amounts:


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Static budget $ 1,680,000 Static budget profit $ 1,680,000

Actual results $ 1,945,000 Sales activity variance(fav)

$ 720,000

Total variance $ 265,000 Flexible budget profit $ 2,400,000Actual profit $ 1,945,000

Flexible budget variance(unfav)

$ 455,000

B. Components of the flexible budget variance:

Item Total Price* Quantity*Direct materials $ 155,000 UNF $ 105,000 UNF $ 50,000 UNF

Direct labor $ 300,000 FAV $ 420,000 FAV $ 120,000 UNF

Variable OH $ 400,000 UNF $ 250,000 UNF $ 150,000 UNFFixed OH $ 200,000 UNF $ 200,000 UNF NA

Total $ 455,000 UNF $ 135,000 UNF $ 320,000 UNF

Fixed overheadvolume variance $ 300,000 FAV

Aggregate $ 155,000 UNF

* For purposes of this table, the terms price, rate and spending variances are used as

synonyms; also, the terms quantity, usage and efficiency are used as synonyms.

C. Calculations of the variances shown in the previous table:

Item Price* Quantity*Materials (11-10)*105,000=$ 105,000 U (105,000-100,000)*10=$ 50,000 ULabor (10-12)*210,000=$ 420,000 F (210,000-200,000)*12=$ 120,000 UVOH Plugged U (210,000-200,000)*15=$ 150,000 U

FOH $ 200,000 over budget U

FOH-Vol 20,000u.*2DLH*$ 7.50=$300,000 F


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Handout 10(b)

Industry and market share

variances

Additional Variances


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In addition to the basic variances

examined on the previous slides, manyfirms develop further disaggregations ofsales activity variances. The total

contribution margin variance is oftendisaggregated into three components:(1) contribution margin per unit, (2)industry and (3) market share variances.These variances are defined as follows:

Additional Variances


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Contribution margin per unit variance: Theimpact of the standard cost variances formaterials, labor and variable overhead.

Industry variance: The impact of the change in

inventory sales, holding market share constant.

Market share variance:The impact of the changein market share percentage, given the actual

level of industry sales.

Note: The sum of the industry and market sharevariances is equal to the sales activity variance.


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Handout 10(b): Partition of the sales activity variance into industry and marketshare variances: The sales activity variance measures the change in the flexible

budget total contribution margin that is due to the difference between the budgetedand actual level of sales. The sales activity variance may be partitioned into theportion due to changes in industry sales, and the portion due to changes in marketshare.

Example: Consider the following information:

Expected industry sales 1,000,000 unitsExpected market share 20%Budgeted contribution margin $ 10 per unitActual industry sales 1,100,000 unitsActual market share 15%

Actual contribution margin $ 12 per unit

Expected industry sales 1,000,000 unitsExpected market share 20%Budgeted contribution margin $ 10 per unit


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Budgeted contribution margin $ 10 per unitActual industry sales 1,100,000 unitsActual market share 15%Actual contribution margin $ 12 per unit

Required: Determine the following amounts:

1. Variation between budgeted and actual total contribution margin.

Budgeted contribution margin: ($10) (20% x 1,000,000u) = $2,000,000Actual contribution margin: ($12) (15% x 1,100,000u) = $1,980,000Variance: $ 20,000UNF



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2. Portion of variation due to change in unit contribution margin.

Total contribution margin variance = (ACMSCM) (AQ)= ($12 - $10) (165,000)

= $ 330,000FAV



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2. Portion of variation due to change in unit contribution margin.

Total contribution margin variance = (ACMSCM) (AQ)

= ($12 - $10) (165,000)= $ 330,000FAV

3. Portion of variation due to change in industry sales

Change in industry sales: + 100,000uImpact on contribution margin: ($10) (20% x 100,000u) = $ 200,000FAV

4. Portion of variation due to change in market share

Impact of change in market share = (SMSAMS) ($10 x 1,100,000u)

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Ch 10 Budgeting