Flexible Budgets andStandard CostsChapter 11

Objective 1Prepare a flexible budgetfor planning purposes

Static Budget

E11-18: Flexible Budget$440,000$550,000$770,000200,000250,000350,000400,000450,000600,000$40,000$100,000$170,000

E11-19: Graph Flexible Budget CostsFixedVariable

Chart3

200000200000

200000500000

250000550000

250000650000

Fixed

Total

Units (in thousands)

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QFixedTotal

0$200,000$200,000

60$200,000$500,000

60$250,000$550,000

80$250,000$650,000

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00

00

00

00

Fixed

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Units (in thousands)

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Objective 2Use sales volume variance and flexible budget variance to explain why actual results differ from the master budget

Static Budget VariancesSales Volume VarianceFlexible Budget VarianceActual ResultsFlexible Budgetbased on actualnumber of outputsStatic Budgetbased on expected number of outputsStatic Budget Variance

Sales Volume VarianceStatic Budget(for the # units expected to be sold)minusFlexible Budget(for the # units actually sold)

Flexible Budget VarianceFlexible Budget(for the # units actually sold)minusActual Results

E11-22: Compute Sales Volume and Flexible Budget Variances145140140$1,160$1,120$1,330319308322400400420719708742$441$412$588$40 U$210 F5 U-0-11 F14 U-0-20 U11 F34 U$29 U$176 F

E11-22: Compute Sales Volume and Flexible Budget Variances$441$412$588$29 U$176 FStatic Budget Variance$147,000 F

Objective 3Identify the benefitsof standard costs and learn how to set standards

Standard Costs

Budget for a Single UnitQuantity StandardPrice Standard

Quantity Standards ComponentsDirect materials product specifications allowing for spoilageDirect labor time requirements to produce product as well as level of experience needed to do specific tasksManufacturing overhead determine resources needed for support activities

Price Standards ComponentsDirect materials purchase price (after early-pay discount) + freight-in + receiving costsDirect labor basic pay rates + payroll taxes + fringe benefitsManufacturing overhead determine resources needed for support activities and determine appropriate allocation base

The Benefits of Standard CostsStandards help managers plan by providing unit amounts for budgetingStandards help managers control by setting target levels of performanceStandards motivate employees by serving as performance benchmarksStandards provide unit costs managers can use to set sale prices of products or servicesStandards simplify recordkeeping and reduce clerical costs

Objective 4Compute standard cost variancesfor direct materials and direct labor

Variance ComponentsEfficiency VariancePrice VarianceActual Price X Actual QuantityStandard PriceXActual QuantityStandard PriceXStandard QuantityTotal Cost Variance

Price VarianceMeasures how well the business keeps unit costs within standards:(Actual Price x Actual Quantity) (Standard Price x Actual Quantity)or(Actual Price Standard Price) x Actual Quantity(AP SP) x AQ

Efficiency VarianceEfficiency variance measures how well the business uses its materials or human resources:(Standard Price x Actual Quantity) (Standard Price x Standard Quantity)or(Actual Quantity Standard Quantity) x Standard Price(AQ SQ) x SP

VariancesSales Volume VarianceFlexible Budget VarianceActual ResultsFlexible Budgetbased on actualnumber of outputsStatic Budgetbased on expected number of outputsStatic Budget VarianceEfficiency VariancePrice Variance

E11-27: Calculate Materials and Labor VariancesTotal Cost Variance for Direct Materials:Static budget$1.10 x 7 x 200,000 fenders$1,540,000Actual cost $1.05 x ?1,522,500$17,500 FHint: What is the correct quantity to use to compute Actual Cost of Materials in this variance?

E11-27: Calculate Materials Price VarianceMaterials price variance: Actual Quantity = 1,450,000 feetActual Price = $1.05Standard Price = $1.10(Actual Price Standard Price) x Actual Quantity($1.05 - $1.10) x 1,450,000 feet = $72,500 F

E11-27: Calculate Materials Efficiency VarianceMaterials efficiency variance: Actual Quantity = 1,450,000Standard Quantity = 200,000 fenders x 7 = 1,400,000Standard Price = $1.10(Actual QuantityStandard Quantity) x Standard Price(1,450,000-1,400,000) x $1.10 = $55,000 U

E11-27: Calculate Cost Variance for Direct LaborTotal Cost Variance for Direct Labor:Static budget$13 x .025 hrs x 200,000 fenders$65,000Actual cost $14 x ?63,000$2,000 FHint: What is the correct quantity of hours to use in computing the cost variance for direct labor?

E11-27: Calculate Labor Price VarianceLabor price variance: Actual Quantity = 4,500 hoursActual Price = $14.00Standard Price = $13.00(Actual Price Standard Price) x Actual Quantity($14 - $13) x 4,500 hours = $4,500 U

E11-27: Calculate Labor Efficiency VarianceLabor efficiency variance: Actual Quantity = 4,500 hrs.Standard Quantity = 200,000 fenders x .025 = 5,000 hrs.Standard Price = $13.00(Actual QuantityStandard Quantity) x Standard Price(4,500 5,000) x $13 = $6,500 F

Objective 5Compute manufacturing overhead variances

Total Overhead VarianceActual Overhead CostStandardOverhead Allocated to Production

Allocating Overhead in a Standard Cost System

Predetermined overhead rate x Standard quantity of allocation base allowed for actual outputs

E11-30: Compute Manufacturing Overhead VarianceManufacturing overhead variance:Standard overhead costs:33,000 gallons x $? $49,500Actual overhead costs:$16,200 + $32,500 48,700$800 F

Hint: What is the correct rate to use for computing standard overhead costs?

Total Overhead VarianceProduction VolumeVarianceOverhead FlexibleBudget VarianceActual overhead costStandardoverhead costFlexible budgetoverhead for actual outputs

Manufacturing Overhead VariancesOverhead flexible budget variance how well managers controlled overhead costsProduction volume variance - when actual production differs from expected production

E11-30: Compute Flexible Budget VarianceOverhead flexible budget variance:Actual overhead cost$48,700Flexible budget overhead ($.50 x 33,000) + $30,00046,500Total overhead flexible budget variance$2,200 U

E11-30: Compute the Production Volume VarianceProduction volume variance:Flexible budget overhead$46,500Standard overhead allocated to actual production (33,000 x $1.50)49,500Total production volume variance$3,000 F

Objective 6 (Appendix)Record transactions at standard cost and prepare a standard cost income statement

Standard Cost Accounting SystemsEach variance has GL account:Debit balance unfavorableCredit balance favorableStandard costs (not actual costs) are used to record manufacturing costs put into inventory accountsVariance accounts are closed to cost of goods sold at end of period

E11-37: Record Materials and Labor Transactions using Standard Cost AccountingMaterials inventory (1,450,000 x $1.10)1,595,000Direct materials price variance72,500Accounts payable (1,450,000 x $1.05)1,522,500

GENERAL JOURNALDATEDESCRIPTIONREFDEBITCREDIT

E11-37: Record Materials and Labor TransactionsWork in process inventory (1,400,000 x $1.10)1,540,000Direct materials efficiency variance55,000Materials inventory (1,450,000 x $1.10)1,595,000

GENERAL JOURNALDATEDESCRIPTIONREFDEBITCREDIT

E11-37: Record Materials and Labor TransactionsManufacturing wages (4,500 x $13)58,500Direct labor price variance4,500Wages payable (4,500 x $14)63,000

GENERAL JOURNALDATEDESCRIPTIONREFDEBITCREDIT

E11-37: Record Materials and Labor TransactionsWork in process inventory (5,000 x $13)65,000Direct labor efficiency variance6,500Manufacturing Wages (4,500 x $13)58,500

GENERAL JOURNALDATEDESCRIPTIONREFDEBITCREDIT

E11-39 Prepare a Standard Cost Income StatementWestern Outfitters, Inc.Standard Cost Income StatementFor the Month Ended April 30Sales revenue $560,000Cost of goods sold at standard cost 342,000Manufacturing cost variances: Direct materials price variance$(2,000) Direct materials efficiency variance(6,000) Direct labor price variance4,000 Direct labor efficiency variance(2,000) Overhead flexible budget variance3,500 Production volume variance (8,000)Total manufacturing variances (10,500)Cost of goods sold at actual cost 331,500Gross profit $228,500

End of Chapter 11

Chapter 11 reviews Flexible Budgets. Master budgets are based on estimated volumes of production and sales. What if actual volume differs from the budgeted amount? This is called a static budget. A flexible budget is one which is designed to change as volume of levels change. It is a valuable management tool for planning and control.Learning Objective 1 show us how to prepare a flexible budget for planning purposes.Remember Exercise10-21 in the previous chapter? The actual operating income for cell phones was higher than budgeted. You might assume that the cell phone division is doing quite well. But what if the actual sales volume was double the budgeted sales volume, do you still think the cell phone division is doing so well? It is very important to know why the variance occurred to identify problem areas and fix them or to identify areas that are doing well and encourage it to continue.A flexible budget shows budgeted sales and revenues at various levels of activity. It is based on the assumption that cost behavior is either fixed or variable. Here we see how to graph the flexible budget total cost line for Logiclik using data from Exercise 11-18. Learning Objective 2 discusses how to use sales volume variance and flexible budget variance to explain why actual results differ from the master budget.

There are two static budget variances.1. The sales volume variancenumber of units actually sold differs from static budget units2. The flexible budget varianceentity actually earned more or less revenue than expected for actual level of output

A variance is labeled as favorable if it increases income. A variance is labeled as unfavorable if it decreases income.The sales volume variance is the difference between the static (master) budget and the flexible budget (for the actual number of outputs). The variance arises only because the number of units actually sold differs from the volume originally planned for in the master budget.As the name suggests, the flexible budget variance is the difference between the flexible budget and the actual results.In Exercise 11-22, the variance contributing most to the years excellent results is the favorable flexible budget variance for sales revenue. This variance resulted from selling the companys product at a higher-than-expected prices.Pinpointing the cause of variances is important. Sometimes a manager has no control over the cause of the variance such as increased gas prices causing the cost of materials to rise. Other times, the manager can do something about inefficiencies perhaps a process can be improved to reduce the amount of waste when converting raw materials.Learning Objective 3 identifies the benefits of standard costs and teaches how to set standards.Think of a standard cost as a budget for a single unit. In a standard cost system, each manufacturing input has both a quantity standard and a price standard. Engineers and production managers set direct material and direct labor quantity standards, usually allowing for unavoidable waste and spoilage. Accountants help managers set direct material price standards after considering the base purchase price of materials, early-payment discounts, receiving costs, and freight-in.Quantity standards components include:

Direct materialsproduct specifications allowing for spoilageDirect labortime requirements to produce product as well as level of experience needed to do specific tasksManufacturing overheaddetermine resources needed for support activitiesPrice standards components include:

Direct materialspurchase price (after early-pay discount) + freight-in + receiving costsDirect laborbasic pay rates + payroll taxes + fringe benefitsManufacturing overheaddetermine resources needed for support activities and determine appropriate allocation baseThe benefits of standard costs include:1. helping managers plan by providing unit amounts for budgeting.2. helping managers control by setting target levels of performance.3. motivating employees by serving as performance benchmarks.4. providing unit costs managers can use to set sale prices of products or services.5. simplifying recordkeeping and reduce clerical costs.

Learning Objective 4 shows us how to compute standard cost variances for direct materials and direct labor.

In order to analyze a flexible budget variance, the flexible budget variance must be separated into price and efficiency components. Static (master) budgets play no role in computing the flexible budget variance or how it is split into price and efficiency variances.A price variance measures how well the business keeps unit prices of material and labor inputs between standards. The price variance is the difference in prices (actual price per unit standard price per unit) of an input, multiplied by the actual quantity of the input.The efficiency variance measures whether the firm meets its quantity standards. It measures whether the quantity of materials actually used to make the actual number of outputs is within the standard allowed for that number of outputs. The efficiency variance is the difference in quantities (actual quantity of input usedstandard quantity of input allowed for the actual number of outputs) multiplied by the standard price per unit of the input.Here we show the relationship of the components of the static budget variance the flexible budget variance and the sales volume variance.

Exercise E11-27 reviews the calculation of Materials and Labor Variances by separating each variance into its price and efficiency variances.To find the Materials Price Variance, use the difference in actual price and standard price multiplied by the actual quantity used.The materials efficiency variance is computed by calculating the difference between actual quantity used and standard quantity, and multiplying it by the standard price.

The large $72,500 favorable direct materials price variance combined with the large $55,000 unfavorable direct materials efficiency variance suggests that managers may have used cheaper, lower-quality materials that resulted in more waste. The net effect is favorable ($72,500F + $55,000U = $17,500F), so this appears to have been a wise decision if quality is maintained. To find the Cost Variance for Direct Labor, use the difference between the static budget and the actual cost.

The labor price variance is calculated by determining the difference between actual and standard price for labor, and multiplying that result by the actual quantity of hours used.To calculate the labor efficiency variance determine the difference between actual quantity and standard quantity and multiplying the result by the standard price of labor.

The unfavorable direct labor price variance combined with the favorable direct labor efficiency variance suggests that managers may have used higher-paid, more skilled workers who performed more efficiently. Again the net effect is positive ($4,500U + $6,500F = $2,000F), so this appears to have been a wise tradeoff.Learning Objective 5 reviews how to compute manufacturing overhead variances.A companys total manufacturing overhead variance is the difference between the actual overhead incurred and the standard overhead allocated to production. In other words, this is the amount by which manufacturing overhead has been over-allocated, or under-allocated to production.The overhead flexible budget variance is computed in the same manner as the flexible budget variances for direct materials and direct labor. It is the difference between actual overhead costs and the flexible budget overhead for the actual number of outputs.In Exercise E11-30, we use the actual variable and fixed overhead provided in the exercise, and compare the total of these amounts to the ACTUAL number of outputs multiplied by the standard unit cost for manufacturing overhead.Total Overhead Variance is composed of the overhead flexible budget variance and the production volume variance.Manufacturing overhead variances have two components: Overhead flexible budget variances a measure of how well managers control overhead costsProduction volume variances occur when actual production differs from expected production.In Exercise 11-30, the flexible budget variance is computed by comparing the actual overhead cost to the flexible budget overhead for the actual number of outputs.The production volume variance is the difference between the flexible budget overhead and the standard overhead allocated to production. This variance arises when actual production volume differs from expected production volume.Objective 6 (Appendix) shows us how to record transactions at standard cost and prepare a standard cost income statement.Many companies integrate standards directly into their general ledger accounting by recording inventory related costs at standard cost, rather than actual cost. This method of accounting is called standard costing or standard cost accounting. Standard costing not only saves on bookkeeping costs, but also isolates price and efficiency variances as soon as they occur.Using calculations from Exercise11-27, prepare journal entries to record the purchase and use of direct materials and direct labor made by Dock Guard. The journal entry shown records the direct materials price variance.Continue using the calculations from Exercise11-27 to prepare the appropriate journal entries to show the direct materials efficiency variance. Using calculations from Exercise11-27, continue to prepare the appropriate journal entries for the direct labor price variance.

Next, prepare journal entries to record the direct labor efficiency variance.The standard cost income statement highlights the variances of manufacturing cost components. The statement shows sales revenue at standard adds any flexible budget sales revenue variance, and then shows cost of goods sold at standard cost. The manufacturing cost variances are separately listed to arrive at the cost of goods sold at actual cost to arrive at the gross profit amount.Are there any questions?