PowerPoint Editor: Anna Boulware Chapter 21 Flexible Budgets and Standard Costs 1 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction

PowerPoint Editor:Anna Boulware

Chapter 21

Flexible Budgetsand Standard Costs

1

Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Wild, Shaw, and ChiappettaFinancial & Managerial Accounting6th Edition

Wild, Shaw, and ChiappettaFinancial & Managerial Accounting6th Edition

Budgetary Control and Reporting

Reviseobjectives

and preparea new

budget.

Management usesbudgets to monitor

and controloperations.

Develop the budgetfrom planned objectives.

Compareactual to

budget andanalyze anydifferences.

Take corrective andstrategic actions.

2

Budgets are an important cost control tool. Actual results are compared with budgets and differences

are investigated and analyzed.

OptelFixed Budget Performance Report

For the Month Ended January 31, 2015

Fixed ActualBudget Results Variances

Sales: In units 10,000 12,000

In dollars 100,000$ 125,000$ 25,000$ F

Cost of goods sold 49,000$ 58,100$ 9,100$ USelling expenses 13,000 15,100 2,100 UGen. & admin. expenses 26,000 26,400 400 UTotal expenses 88,000$ 99,600$ 11,600$ UIncome from operations 12,000$ 25,400$ 13,400$ F

U = Unfavorable varianceActual cost is greaterthan budgeted cost.

F = Favorable varianceActual revenue and income are greater

than budgeted revenue and income.

If unit sales are higher, should we expect costs to be higher?

How much of the higher costs are because of higher unit sales?

Fixed Budget Performance Report

3

A fixed budget, also called a static budget, is based on a singlepredicted amount of sales or other activity measure.

Improve performance evaluation.

May be prepared for any activity level in the relevant range.

Show revenues and expensesthat should have occurred at theactual level of activity.

Reveal variances due to good costcontrol or lack of cost control.

Purpose of Flexible Budgets

4

21-P1: Preparation of Flexible Budgets

5

Preparation of Flexible Budgets

To a budget for different activity levels, we must know how costs behave with changes in activity levels.– Total variable costs change

in direct proportion to changes in activity.

– Total fixed costs remainunchanged within therelevant range.

FixedVaria

ble

P 16

OptelFlexible Budgets


Variable TotalAmount Fixedper Unit Cost 10,000 12,000 14,000

Sales: 10.00$ 100,000$ 120,000$ 140,000$ Total variable costs 4.80 48,000 57,600 67,200 Contribution margin 5.20$ 52,000$ 62,400$ 72,800$

Total fixed costs 40,000$ 40,000 40,000 40,000

Income from operations 12,000$ 22,400$ 32,800$

Flexible Budget for Unit Sales of

Flexible Budget

Variable costs are a constant amount per unit.

Total variable cost = $4.80 per unit × budget level in units

Total Fixed costs do not change within the relevant range.

Preparation of Flexible Budgets

7P 1

OptelFlexible Budget Performance Report


Budget ActualVariable Total for forAmount Fixed 12,000 12,000per Unit Cost Units Units Variances

Sales (12,000 units) 10.00$ 120,000$ 125,000$ 5,000$ FTotal variable costs 4.80 57,600 59,400 1,800 UContribution margin 5.20$ 62,400$ 65,600$ 3,200$ F

Total fixed costs 40,000$ 40,000 40,200 200 U

Income from operations 22,400$ 25,400$ 3,000$ F

Favorable sales variance indicates that the averageselling price was greater than $10.00 per unit.

Unfavorable cost variances indicate costs are greater than expected for 12,000 units.

Favorable variance because favorable sales variance is greater than unfavorable cost variances.

Flexible Budget Performance Report

8P 1

A flexible budget performance report compares actual performance and budgeted performance based on actual sales. In Optel’s case, January’s sales are 12,000 units.

NEED-TO-KNOW 21.1

A manufacturing company reports the fixed budget and actual results for the year as shown below. Thecompany’s fixed budget assumes a selling price of $40 per unit. The fixed budget is based on 20,000 unitsof sales, and the actual results are based on 24,000 units of sales. Prepare a flexible budget performancereport for the year.

Budget assumptions:Selling price per unit $40.00 ($800,000 divided by 20,000 units)Variable cost per unit $8.00 ($160,000 divided by 20,000 units)

Budget Assumptions Flexible Budget(24,000 units)

Sales $40.00 x 24,000 units = $960,000Variable costs $8.00 x 24,000 units = 192,000Fixed costs 500,000

Fixed Budget Actual Results(20,000 units) (24,000 units)

Sales $800,000 $972,000Variable costs 160,000 240,000Fixed costs 500,000 490,000

9P 1

NEED-TO-KNOW 21.1

A manufacturing company reports the fixed budget and actual results for the year as shown below. Thecompany’s fixed budget assumes a selling price of $40 per unit. The fixed budget is based on 20,000 unitsof sales, and the actual results are based on 24,000 units of sales. Prepare a flexible budget performancereport for the year.

Budget Assumptions Flexible Budget(24,000 units)

Sales $40.00 x 24,000 units = $960,000Variable costs $8.00 x 24,000 units = 192,000Fixed costs 500,000

Flexible Budget Actual Results(24,000 units) (24,000 units) Variances

Sales $960,000 $972,000 $12,000 Favorable (F)Variable costs 192,000 240,000 48,000 Unfavorable (U)Contribution margin 768,000 732,000 36,000 Unfavorable (U)Fixed costs 500,000 490,000 10,000 Favorable (F)Net income 268,000 242,000 26,000 Unfavorable (U)

FLEXIBLE BUDGET PERFORMANCE REPORT

Fixed Budget Actual Results(20,000 units) (24,000 units)

Sales $800,000 $972,000Variable costs 160,000 240,000Fixed costs 500,000 490,000

10P 1

21-C1: Standard Costs

11

Benchmarks for measuring performance.

The expected level of performance.

Based on carefullypredetermined amounts.

Used for planning materials, labor, and overhead requirements.

Standard costs are

Standard Costs

12C 1

Standard costs can be used in a flexible budgeting system to enable management to better understand the reasons for variances

Identifying Standard Costs

Engineer

ProductionManager

ManagerialAccountant

HumanResourcesManager

13C 1

Managerial accountants, engineers, personnel administrators, and other managers combine their efforts to set standard costs.

Practical standards should be set at levels that are currently attainable with reasonable and efficient effort.

Ideal standards, that are based on perfection, areunattainable and discouraging to most employees.

Setting Standard Costs

QuantityStandards

PriceStandard

s

Direct Materials

TimeStandards

RateStandards

DirectLabor

ActivityStandards

RateStandards

VariableOverhead

14C 1

Setting Standard Costs

15C 1

The standard costs of direct materials, direct labor, and overhead for one bat, manufactured by ProBat, are

shown below. This is called a standard cost card.

These standard cost amounts are then used to prepare manufacturing budgets for a budgeted level

of production.

21-C2: Cost Variance Analysis

16

A standard cost varianceis the amount by which

an actual cost differs fromthe standard cost.

Cost Variances

ManufacturingOverhead

DirectMaterials Direct

Labor

Standard cost

Type of Product Cost

$ A

mo

un

t

This variance isfavorable (F)

becausethe actual costis less than thestandard cost.

This variance is unfavorable (U) because the actual cost exceeds the standard cost.

17C 2

Cost Variance Analysis

• Variance analysis involves preparing a standard cost performance report and comparing actual costs with standard costs.

• We then investigate variances by asking for explanations and possible causes for the variances.

• We should correct problems that caused unfavorable variances and possibly adopt and reward the practices that resulted in favorable variances.

18C 2

Cost Variance Computation

19C 2

Management needs information about the factors causing a cost variance, but first it must properly compute the variance. In its

most simple form, a cost variance (CV) is computed as:

Cost Variance (CV) = Actual Cost (AC) - Standard Cost (SC)

Actual Cost (AC) = Actual Quantity (AQ) x Actual Price (AP)

Standard Cost (SC) = Standard Quantity (SQ) x Standard Price (SP)

• Actual quantity (AQ) is the input (material or labor) used to manufacture the quantity of output.

• Standard quantity (SQ) is the standard input for the quantity of output.

where:

• Actual price (AP) is the actual amount paid to acquire the input (material or labor).

• Standard price (SP) is the standard price.


Cost Variance

Quantity VariancePrice Variance

The difference betweenthe actual price and the

standard price.

The difference betweenthe actual quantity andthe standard quantity.

20C 2

Two main factors cause a cost variance:

To assess the impacts of these two factors in a cost variance, let’s look at the model on the next slide.

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Cost Variance ComputationStandard quantity is the quantity that should have been used for the actual good output.

Standard price is the amount that should have been paid for the resources acquired.

21C 2

(AP - SP) x AQ (AQ - SQ) x SP

AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity


Price Variance Quantity Variance


22C 2

Actual Cost Standard Cost

21-P2: Computing Materials and Labor Variances

23

G-Max Company makes golf club heads withthe following standard cost information:

Direct materials (0.5 lb. per unit at $20 per lb.) 10.00$ Direct labor (1.0 hrs. per unit at $8 per hr.) 8.00 Total standard direct cost per unit 18.00$

Computing Materialsand Labor Variances

24P 2

During May, G-Max produced 3,500 club heads using1,800 pounds of material. G-Max paid $21.00 per

pound for the material.Compute the material price and quantity variances.

Materials Cost Variances


25P 2

Use this information to compute the material price and quantity variances before you go to the next slide.


1,800 lbs. 1,800 lbs. 1,750 lbs. × × × $21.00 per lb. $20.00 per lb. $20.00 per lb.

$37,800 $36,000 $35,000

SQ = 3,500 units × 0.5 lb. per unit = 1,750 lbs.

Price Variance$1,800 Unfavorable

Quantity Variance$1,000 Unfavorable


26

P 2


$2,800 Total Cost Variance (U)

+

I am not responsible for this unfavorable material

quantity variance.

You purchased cheapmaterial, so my peoplehad to use more of it.

You used too much material because of poorly trained workers and poorly

maintained equipment.

Also, your poor scheduling requires me to rush order material at a higher price, causing unfavorable price variances.


27P 2

Who is responsible for material cost variances??

NEED-TO-KNOW 21.2

A manufacturing company reports the following for one of its products. Compute the direct materials(a) price variance and (b) quantity variance and indicate whether they are favorable or unfavorable.

Direct materials standard 8 pounds @ $6.00 per poundActual direct materials used 83,000 pounds @ $5.80 per poundActual finished units produced 10,000

AQ 83,000 lbs.AP $5.80 per lb.

SQ 80,000 lbs. (10,000 units x 8 lbs. per unit)SP $6.00 per lb.

Materials Price Variance Materials Quantity Variance

$1,400 UnfavorableTotal Direct Materials Variance

$481,400 $498,000 $480,000

$18,000 Unfavorable$16,600 Favorable

AQ X APStandard Cost

SQ x SPAQ x SP83,000 x $5.80 83,000 x $6.00 [10,000 x 8] x $6.00

Actual Cost

28P 2

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate

*Rate Variance *Efficiency Variance

AH(AR - SR) SR(AH - SH)

AH = Actual Hours SR = Standard Rate AR = Actual Rate SH = Standard Hours

Labor Cost Variances

29P 2


Instead of price and quantity, for direct labor we use the terms rate and hours.

*NEW

During May, G-Max produced 3,500 club heads working3,400 hours. G-Max paid an average of $8.30 per

hour for the hours worked.Compute the labor rate and efficiency variances.



30P 2

Use this information to compute the labor rate and efficiency variances before you go to the next slide.

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate

3,400 hours. 3,400 hours 3,500 hours × × × $8.30 per hour. $8.00 per hour. $8.00 per hour.

$28,220 $27,200 $28,000

SQ = 3,500 units × 1.0 hour per unit = 3,500 hours.

Rate Variance$1,020 Unfavorable

Efficiency Variance$800 Favorable


31

P 2


$220 Total Cost Variance (U)

+

High skill,high rate

Low skill,low rate

Using highly paid skilled workers to

perform unskilled tasks results in an unfavorable rate variance.


32P 2

Evaluating Labor Cost VariancesOne possible explanation of G-Max’s labor rate and efficiency

variances is the use of workers with different skill levels.

However, fewer labor hours might be required for the work

resulting in a favorable efficiency variance.

I am not responsible for the unfavorable labor efficiency

variance.

You purchased cheap material, so it took more time to process it.

You used too much time because of poorly

trained workers and poor supervision.


33P 2

Who is responsible for material cost variances??

Production managers who make work assignmentsare generally responsible for labor cost variances.

NEED-TO-KNOW 21.3

Compute the direct labor rate and efficiency variances.

SQ (2,500 units x 2 hrs. per unit = 5,000 standard hrs. )

$16,875 UnfavorableTotal Direct Labor Variance

$625 Unfavorable $16,250 UnfavorableLabor Rate Variance Labor Efficiency Variance

6,250 x $13.10 6,250 x $13.00 (2,500 x 2) x $13.00$81,875 $81,250 $65,000

Actual Cost Standard CostAQ X AR AQ x SR SQ x SR

The following information is available for York Company.

Actual direct labor cost (6,250 hours @$13.10 per hour) $81,875Standard direct labor hours per unit 2.0 hoursStandard rate per hour $13.00Actual production (units) 2,500Budgeted production (units) 3,000

34P 2

21-P3: Computing Overhead Cost Variances

35

Recall that overhead costs are assigned to products and services using a

predetermined overhead rate (POHR):

Estimated total overhead costs

Estimated activity POHR =

Assigned Overhead = POHR × Standard Activity

Overhead Standardsand Variances

36P 3

Standard Overhead

Rate

Contains a variableunit rate which staysconstant at all levels

of activity.

Contains a fixedoverhead rate whichdeclines as activity

level increases.

Function of activity levelchosen to determine rate.

Setting Overhead Standards

Flexible budgets, showing budgeted amount of overhead for various levels of activity, are used to analyze overhead costs.

37P 3

Standard overhead costs are the overhead amounts expected to occur at a certain activity level.

To allocate overhead costs to products or services, management needs to establish the standard overhead cost rate.

G-MaxFlexible Overhead Budgets

For the Month Ended May 31, 2015

Variable Total Flexible Budget at DifferentAmount Fixed Percentages of Monthly Capacityper Unit Cost 70% 80% 90% 100%

Production in units 3,500 4,000 4,500 5,000

Total variable costs 1.00$ 3,500$ 4,000$ 4,500$ 5,000$ Total fixed costs 4,000$ 4,000 4,000 4,000 4,000 Total factory overhead 7,500$ 8,000$ 8,500$ 9,000$

Standard direct labor hours 3,500 4,000 4,500 5,000

Predetermined OH rate per standard direct labor hour 2.14$ 2.00$ 1.89$ 1.80$

Standard overhead rate is: $8,000 ÷ 4,000 DL hours = $2.00 per DL hour

Flexible Overhead Budgets

G-Max predicted an 80 percent activity level.

38P 3

(Flexible budgets for overhead prepared at several levels of activity)

This standard overhead rate will

be used in computing overhead

cost variances.

Computing Overhead Cost Variances

Overhead costvariance

(OCV)

Actual overheadincurred

(AOI)

Standard overheadapplied(SOA)

= –

Ex: During May, G-Max produced 3,500 club heads working 3,400 hours. G-Max budgeted for 4,000 units (80%).

Actual variable overhead was $3,650 and actual fixed overhead was $4,000.

39P 3

When standard costs are used, a company applies overhead to the units produced using the predetermined

standard overhead rate.

The difference between the total overhead cost applied to products and the total overhead cost actually incurred is called an

overhead cost variance. It’s defined as:

Total Overhead Cost Variance

$3,650 + $4,000 3,500 DLH × $2.00 per DLH= –(OCV)

40P 3


(OCV)


(AOI)


= –

Ex: During May, G-Max produced 3,500 club heads working 3,400 hours. G-Max budgeted for 4,000 units (80%).

Actual variable overhead was $3,650 and actual fixed overhead was $4,000.

$7,650 $7,000= –(OCV)

To help identify factors causing the overhead cost variance, let’s analyze this variance separately for

controllable and volume variances.

= (unfavorable ) $650(OCV)

Controllable and Volume Variances

41P 3


(OCV)


(AOI)


= –

Controllable and Volume Variances for G-Max

Actual overhead (given) 7,650$ Applied overhead (from flexible budget) 7,500 Controllable variance (unfavorable) 150$

Budgeted fixed overhead (at predicted capacity) 4,000$ Applied fixed overhead (3,500 DLH × $1.00 per DLH) 3,500 Volume variance (unfavorable) 500$

42P 3

Overhead Controllable Variance

Overhead Volume Variance

NEED-TO-KNOW 21.4

A manufacturing company uses standard costs and reports the information below for January. The companyuses machine hours to allocate overhead, and the standard is two machine hours per finished unit.Predicted activity level 1,500 unitsVariable overhead rate $2.50 per machine hourFixed overhead budgeted $6,000 per month ($2.00 per machine hour at predicted activity level)Actual activity level 1,800 unitsActual overhead costs $15,800

Compute the total overhead cost variance, overhead controllable variance, and overhead volume variancefor January. Indicate whether each variance is favorable or unfavorable.

SQ 3,600 MHs (1,800 units x 2 MHs per unit = 3,600 standard hrs. )SR $4.50 per MH (FOH $2.00 + VOH $2.50 = $4.50 per MH)

$400 FavorableTotal Overhead Variance

Flexible Budget1,800 units

VOH [(1,800 x 2) x $2.50] + FOH $6,000

$800 Unfavorable $1,200 FavorableControllable Variance Overhead Volume Variance

(1,800 x 2) x $4.50$15,800 $15,000 $16,200

Actual Overhead Standard CostSQ x SR

43P 3

Global View

BMW, uses standard costing and variance analysis concepts. Material must meet high quality standards, and the

company sets quantity standards for each of its machine operations.

BMW also sets standards for how much labor time should be used in the assembly of its automobiles and then monitors its employee performance.

44

21-A1: Sales Variances

45

A similar analysis can be applied to sales variances. We will use two additional G-Max products,

Excel golf balls and Big Bert drivers, to illustrate.

Sales Variances

46A 1

Consider the following sales data from G-Max:

47A 1

Computing Sales Variances for G-Max

21A-P4 (Appendix): Expanded Overhead Variances and Standard Cost Accounting

System

48

Appendix 21A: Expanded OverheadVariances and Standard Cost Accounting system

49P 4

AH = Actual Hours of ActivityAVR = Actual Variable Overhead RateSVR = Standard Variable Overhead RateSH = Standard Hours Allowed

Spending Variance

EfficiencyVariance

AH × SVR

AH × AVR SH × SVR

Actual Flexible Budget Applied Variable for Variable Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours

Variable Overhead Variances for G-Max

50P 4

Let’s split the $150 unfavorable

variance into spending and

efficiency variances. . .

During May, G-Max produced 3,500 club heads working3,400 hours. G-Max budgeted for 4,000 units (80%).

Actual variable overhead was $3,650 andactual fixed overhead was $4,000.

Compute the variable overhead spending andefficiency variances

Recall the G-Max information for May:


51P 4


52

3,400 hrs. x $1.00AH × AVR 3,500 hrs. x $1.00

Actual Flexible Budget Applied Variable for Variable Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours

Spending Variance$250 Unfavorable

Efficiency Variance$100 Favorable

$3,650 $3,400 $3,500

P4

Spending Variance

VolumeVariance

AH × SVR

AH × AVR SH × SFR

Actual Budgeted Applied Fixed Fixed Fixed Overhead Overhead Overhead at (Given) (Flexible Budget) Standard Hours

Fixed Overhead Variances for G-Max

53P 4

Let’s split the $500 unfavorable

variance into spending and

volume variances. . .

SFR = Standard Fixed Overhead RateSH = Standard Hours Allowed

During May, G-Max produced 3,500 club heads working3,400 hours. G-Max budgeted for 4,000 units (80%).

Actual variable overhead was $3,650 andactual fixed overhead was $4,000.

Compute the fixed overheadspending and volume variances.

Recall the G-Max information for May:

Fixed Overhead Variance for G-Max

54P 4

AH × SVR

AH × AVR 3,500 hrs × $1.00

Actual Budgeted Applied Fixed Fixed Fixed Overhead Overhead Overhead at (Given) (Flexible Budget) Standard Hours

Fixed Overhead Variances for G-Max

55P 4

Spending Variance$0

Volume Variance$500 Unfavorable

$4,000 $4,000 $3,500

VolumeFixed overhead

applied to products

4,000 Expected

Units

3,500ActualUnits

$4,000 expected fixed OH

$3,500 applied fixed OH{$500

Volume Variance

Unfavorable

3,500 units × $1.00 fixed overhead rateCost

Fixed Overhead Cost Variances

56P 4

Spending Variance Efficiency VarianceResults from paying moreor less than expected foroverhead items and from

excessive usage ofoverhead items.

A function of the selected cost driver. It

does not reflect overhead control.

Variable Overhead

Spending Variance Volume VarianceResults from paying moreor less than expected for

fixed overhead items.

Results from the inabilityto operate at the activity

level planned for the period.It has no significance for

cost control.

Fixed Overhead

Variable and Fixed Overhead Variances

57P 4

21A-P5 (Appendix): Standard Cost Journal Entries

58

Standard Cost Accounting System

Recording G-Max material costs for May

* Many companies record the materials price variance when materials are purchased. For simplicity, we record both the materials price and quantity variances when materials are issued to production.

59P 5

Standard cost systems also record costs and variances in accounts. The entries in the next few slides briefly illustrate the important

aspects of this process for G-Max’s standard costs and variances for May.

Standard Cost Accounting System

Recording G-Max labor costs for May

60P 5

The difference between standard and actual labor costs is explained by two variances. The direct labor rate variance is unfavorable and is debited to that account. The direct labor efficiency variance is favorable and that account is

credited.

Standard Cost Accounting system

Recording G-Max overhead costs for May

61P 5

When Factory Overhead is applied to Goods in Process Inventory, the actual amount is credited to the Factory Overhead account. To account

for the difference between actual and standard overhead costs, the entry includes a $500 debit to the Volume Variance, a $250 debit to the

Variable Overhead Spending Variance, and a $100 credit to the Variable Overhead Efficiency Variance.

NEED-TO-KNOW 21.5

A company uses a standard cost accounting system. Prepare the journal entry to record these direct materials variances:

Direct materials cost actually incurred $73,200Direct materials quantity variance (favorable) 3,800Direct materials price variance (unfavorable) 1,300

Debit CreditWork in Process Inventory 75,700Direct Materials Price Variance 1,300

Direct Materials Quantity Variance 3,800Raw Materials Inventory 73,200

General Journal

62P 4

End of Chapter 21

63

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PowerPoint Editor: Anna Boulware Chapter 21 Flexible Budgets and Standard Costs 1 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction