12

Flexible Budgets
and Variance Analysis

© 2007 Pearson Education Canada Slide 12-1

 Static and Flexible Budgets
Static Budget Flexible Budgets
• Master budget Units Per Unit 7,000 8,000
• Carefully forecasted
Sales $31.00 $217,000 $248,000
sales and operating
targets Variable costs:
Manufacturing $21.00 $147,000 $168,000
Flexible Budget Shipping .60 4,200 4,800
• Budget that adjusts for Administrative .20 1,400 1,600
changes in volume and Total variable $21.80 $152,600 $174,400
other cost driver Contribution margin $9.20 $64,400 $73,600
activities
• May be prepared for Fixed costs:
any level of activity Manufacturing $37,000 $37,000
Sell & Admin 33,000 33,000
• Provides a basis for
Total fixed costs $70,000 $70,000
comparison with actual
results Operating income (loss) $(5,600) $3,600

© 2007 Pearson Education Canada Slide 12-2

 Evaluation of Financial Performance
• Subdivision of total difference between master or static
budget and actual results to evaluate performance

Flexible Sales
Actual Budget Flexible Activity Master
Results 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
Contribution
Margin 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

© 2007 Pearson Education Canada Slide 12-3

 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)
© 2007 Pearson Education Canada Slide 12-4
 Variance Analysis
Variance 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

© 2007 Pearson Education Canada Slide 12-5

 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 unit
Standard 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

© 2007 Pearson Education Canada Slide 12-6

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

Variance X Interpretation

Variance Determination Evaluation

of 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

© 2007 Pearson Education Canada Slide 12-7

 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
© 2007 Pearson Education Canada Slide 12-8
 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 kg
x $1.90 / kg x $2.00 / kg x $2.00 / kg
= $69,920
Price Variance= $73,600 Usage Variance= $70,000
$3,680 F $3,600 U

Flexible Budget Variance $80 F

© 2007 Pearson Education Canada Slide 12-9

 Direct Labour Variances

Actual Costs Flexible Budget Flexible

Budget
Actual Inputs x Actual Inputs x Standard Inputs
x
Actual Prices Standard Prices Standard Prices

Direct labour
3,750 hours 3,750 hours 3,500 hours
x $16.40 / hour x $16.00 / hour x $16.00 / hour
= $61,500
Price Variance= $60,000Usage Variance= $56,000
$1,500 U $4,000 U

Flexible Budget Variance $5,500 U

© 2007 Pearson Education Canada Slide 12-10

 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

© 2007 Pearson Education Canada Slide 12-11

 Overhead Subdivision
Actual Costs Flexible Budget Flexible Budget
Actual Inputs x Actual Inputs x Standard Inputs x
Actual Prices Standard Prices Standard Prices

Variable Overhead
3,750 hours 3,500 hours
x $1.20 / hour x $1.20 / hour
$4,700 = $4,500 = $4,200
Spending Variance Efficiency Variance
$200 U $300 U

Flexible Budget Variance $500 U

Fixed Overhead
$14,700 $14,400
Flexible Budget Variance $300 U

© 2007 Pearson Education Canada Slide 12-12

 Subdividing The Total Variance
Actual Results Master Budget
Revenue $1,200 Revenue $1,000
Variable COGS 850 Variable COGS 700
Contribution Margin 350 Contribution Margin 300
Fixed Costs 220 Fixed Costs 200
Operating Income $ 130 Operating Income $ 100

Sales Sales Variable Cost Fixed Cost

Price Activity Flexible Budget Flexible Budget
Variance Variance Variance Variance

Sales Mix Sales Quantity

Variance Variance Price Usage
Variance Variance

Market Share Market Size

Variance Variance

© 2007 Pearson Education Canada Slide 12-13

 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

© 2007 Pearson Education Canada Slide 12-14