Flexible Budgets, Direct-Cost Variances, and Management Control

CHAPTER 7
Flexible Budgets, Direct-Cost Variances, and Management Control
Income Statement Budget compared to the
actual Revenues, Costs, and Expenses Deviations of actual figures from budgeted are called Variances Variance analysis helps managers to improve performance
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright 2006 by Pearson Education. All rights reserved.
7-2
Basic Concepts
Static (Master) Budget is based on the
output planned at the start of the budget period Actual performance Variance difference between an actual and an expected (budgeted) amount Management by Exception the practice of focusing attention on areas not operating as expected (budgeted)
7-3
Basic Concepts
Static-Budget Variance (Level 0) the difference
between the actual result and the corresponding static budget amount Favorable Variance (F) has the effect of increasing operating income relative to the budget amount Unfavorable Variance (U) has the effect of decreasing operating income relative to the budget amount
7-4
Variances
Variances may start out at the top with a
Level 0 analysis This is the highest level of analysis, a supermacro view of operating results The Level 0 analysis is nothing more than the difference between actual and static-budget operating income
7-5
Variances
Further analysis decomposes (breaks down)
the Level 0 analysis into progressively smaller and smaller components
Answers: How much were we off?
Levels 1, 2, and 3 examine the Level 0
variance into progressively more-detailed levels of analysis
Answers: Where and why were we off?
7-6
A Simple Example
Operating Indicators:
Indicator Units Sold Selling Price
Actual Results 100 $
Static Budget 90 30 6 10 6 700

7-7
35 $ 7 $ 10 $ 5 $ 600 $
Direct Material Cost per Unit $ Direct Labor Cost per Unit $ Variable Manufacturing Overhead per Unit $ Fixed Costs $
A Simple Example
Actual Results Units Sold Revenues $ Variable Costs: Direct Materials Direct Labor Variable Factory Overhead Contribution Margin Fixed Costs Operating Income $
Level 0 Analysis
Static-Budget Variances 10 F 800 F 160 U 100 U (40) F 580 F (100) F 680 F
Static Budget 90 $ 2,700 540 900 540 720 700 $ 20
100 3,500 $ 700 1,000 500 1,300 600 700 $
Level 1 Analysis
7-8
Evaluation
Level 0 tells the user very little other than how much
Contribution Margin was off from budget: a $680 F variance in this case
Level 0 answers the question: How much were we off in total?
Level 1 gives the user a little more information: it
shows which line-items led to the total Level 0 variance
Level 1 answers the question: Where were we off?
7-9
Flexible Budget
Flexible Budget shifts budgeted revenues
and costs up and down based on actual operating results (activities) Represents a blending of actual activities and budgeted dollar amounts Will allow for preparation of Levels 2 and 3 variances
Answers the question: Why were we off?
7-10
A Flexible-Budget Example
Actual Results Units Sold Revenues $ Variable Costs: Direct Materials Direct Labor Variable Factory Overhead Contribution Margin Fixed Costs Operating Income $ 100 3,500 $ 700 1,000 500 1,300 600 700 $ Flexible-Budget Variances N/A $ Flexible Budget 100 3,000 $ 600 1,000 600 800 700 $ 100 $ Sales-Volume Variances 10 F 300 F 60 U 100 U 60 U 80 F N/A $ $ Static Budget 90 2,700 540 900 540 720 700 20
500 F 100 U N/A (100) F 500 F (100) F 600 F
80 F
Level 3 Variances will explore these figures in detail
Level 2 Variances: Flexible-Budget
Level 2 Variances: Sales-Volume
Level 1 Variance: Static-Budget
7-11
Level 3 Variances
All Product Costs can have Level 3
Variances. Direct Materials and Direct Labor will be handled next. Overhead Variances are discussed in detail in a later chapter Both Direct Materials and Direct Labor have both Price and Efficiency Variances, and their formulae are the same
7-12
Level 3 Variances
Price Variance formula:
Price Variance
Actual Price Of Input
Budgeted Price Of Input
}X
Actual Quantity Of Input
Efficiency Variance formula:
Efficiency Variance
Actual Quantity Of Input Used
Budgeted Quantity of Input Allowed for Actual Output
}X
Budgeted Price Of Input
7-13
Variances and Journal Entries

Each variance may be journalized
Each variance has its own account

Favorable variances are credits; Unfavorable
variances are debits Variance accounts are generally closed into Cost of Goods Sold at the end of the period, if immaterial
7-14
Standard Costing
Budgeted amounts and rates are actually
booked into the accounting system These budgeted amounts contrast with actual activity and give rise to Variance accounts
7-15
Standard Costing
Reasons for implementation:
Improved software systems Wide usefulness of variance information
7-16
Management Uses of Variances

To understand underlying causes of
variances Recognition of inter-relatedness of variances Performance Measurement
Managers ability to be Effective Managers ability to be Efficient
7-17
Activity-Based Costing and Variances

ABC easily lends itself to budgeting and
variance analysis Budgeting is not conducted on the departmental-wide basis (or other macro approaches) Instead, budgets are built from the bottom-up with activities serving as the building blocks of the process
7-18
Benchmarking and Variances

Benchmarking is the continuous process of
comparing the levels of performance in producing products and services against the best levels of performance in competing companies Variances can be extended to include comparison to other entities
7-19

Flexible Budgets, Direct-Cost Variances, and Management Control

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CHAPTER 7

Flexible Budgets, Direct-Cost Variances, and Management Control

Income Statement Budget compared to the

the Level 0 analysis into progressively smaller and smaller components

Answers: How much were we off?

Levels 1, 2, and 3 examine the Level 0

variance into progressively more-detailed levels of analysis

Answers: Where and why were we off?

Indicator Units Sold Selling Price

Actual Results 100 $

Static Budget 90 30 6 10 6 700

Static-Budget Variances 10 F 800 F 160 U 100 U (40) F 580 F (100) F 680 F

Static Budget 90 $ 2,700 540 900 540 720 700 $ 20

100 3,500 $ 700 1,000 500 1,300 600 700 $

Level 0 answers the question: How much were we off in total?

Level 1 gives the user a little more information: it

shows which line-items led to the total Level 0 variance

Level 1 answers the question: Where were we off?

Answers the question: Why were we off?

500 F 100 U N/A (100) F 500 F (100) F 600 F

Level 3 Variances will explore these figures in detail

Level 2 Variances: Flexible-Budget

Level 2 Variances: Sales-Volume

Level 1 Variance: Static-Budget

Actual Price Of Input

Budgeted Price Of Input

Actual Quantity Of Input

Efficiency Variance formula:

Actual Quantity Of Input Used

Budgeted Quantity of Input Allowed for Actual Output

Budgeted Price Of Input

Variances and Journal Entries

Each variance has its own account

Improved software systems Wide usefulness of variance information

Management Uses of Variances

variances Recognition of inter-relatedness of variances Performance Measurement

Managers ability to be Effective Managers ability to be Efficient

Activity-Based Costing and Variances

Benchmarking and Variances

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