flexible budgets and standard costs

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter 23

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Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.2

Prepare a flexible budget for the incomestatement

Prepare an income statement performancereport

Identify the benefits of standard costs andlearn how to set standards

Compute standard cost variances for directmaterials and direct labor


Analyze manufacturing overhead in a standard cost system

Record transactions at standard cost andprepare a standard cost income statement


Budget variance—the difference between an actual amount and a budgeted figure

Managers use variances to operate a businessImportant to know why actual amounts differ from the budgetEnables managers to identify problems and decide upon actions to take

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Prepare a flexible budget for the income statement

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Static budgetPrepared for one level of sales volumeDoes not change after developed

Variances classification Favorable (F) if an actual amount increases operating incomeUnfavorable (U) if an actual amount decreases operating income

Flexible budgetPrepared for several different volume levels within a relevant rangeSeparates fixed and variable costs

Variable costs put the “flex” in the flexible budget

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Need to know:Selling price per unitVariable cost per unit Total fixed costs Different volume levels within the relevant range

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Consider the following definitions. Give the cost term to the correct definition—Flexible Budget, Flexible Budget Variance, Sales Volume Variance, Static Budget, and Variance1.A summarized budget for several levels of volume that separates variable costs from fixed costs.

2. The budget prepared for only one level of sales volume.

3. The difference between an actual amount and the budget.

4. The difference arising because the company actually earned more or less revenue, or incurred more or less cost, than expected for the actual level of output.5. The difference arising only because the number of units actually sold differs from the static budget units.

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Flexible Budget

Static Budget

Variance

Flexible Budget Variance

Sales Volume Variance


Prepare an income statement performance report

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Managers need to know why variance occurredTo pinpoint problemsTo take corrective action

Managers divide the static budget variance into two broad categories

Flexible budget varianceOccurs because sales price per unit, variable cost per unit, and/or fixed cost was different than planned

Sales volume varianceArises because actual number of units sold differs from the amount in the static budget

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Computations

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Moje, Inc., manufactures travel locks. The budgeted selling price is $19 per lock, the variable cost is $8 per lock, and budgeted fixed costs are $15,000.1. Prepare a flexible budget for output levels of 4,000 locks and 7,000 locks for the month ended April 30, 2012.

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Moje, Inc.Flexible Budget

Month Ended April 30, 2012Flexible Budget Output Units (Locks)per Output Unit 4,000 7,000

Sales revenue $19 $76,000 $133,000

Variable expenses $ 8 32,000 56,000

Contribution margin 44,000 77,000

Fixed expenses 15,000 15,000

Operating income (loss) $ 29,000 $62,000


Identify the benefits of standard costs and learn how to set standards

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Budget for a single unitEach unit has standards for price and quantityInputs:

Direct materialsPrice – per unit cost of materials in each productQuantity – amount used to make each product

Direct LaborPrice – wage rate for employees involved in making the productQuantity – time used to make each product


Price StandardsPrice Standards

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Determine cost standards for materials, labor, and overheadDirect materials price standard for vinyl:

Purchase price, net of discounts $1.90 per square footDelivery, receiving, and inspection 0.10 per square footTotal standard cost per square foot of vinyl $2.00 per square foot

Direct labor (DL) price (or rate) standard:Hourly wage $ 8.00 per direct labor hourPayroll taxes and fringe benefits 2.50 per direct labor hourTotal standard cost per direct labor hour $10.50 per direct labor hour

Variable overhead price (or rate) standard

Fixed overhead price (or rate) standard:

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= = $2.00 per DL hourEstimated variable overhead cost $6,400 Estimated quantity of allocation base 3,200 DL hours

= = $3.00 per DL hourEstimated fixed overhead cost $9,600 Estimated quantity of allocation base 3,200 DL hours


Helps managers:Prepare the master budgetSet target levels of performance (static budget)Identify performance standards (standard quantities and standard costs)Set sales prices of products and servicesDecrease accounting costs

Requires upfront cost to develop standards:Save accounting costs in the futureAvoids LIFO, FIFO and average cost computations

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Once established, use the standard cost to assign costs to productionOnce a year, compare actual production costs to standard costs to locate variancesVariance Relationships

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How well material and labor prices are kept within standards

How well a company uses its materials or human resources


Measures how well the business keeps unit costs within standardsDifference in price of an input, multiplied by the actual quantity used.

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Measures how well the business uses its materials or human resourcesIt is the difference in quantities multiplied by the standard price per unit

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The Relationships Among Price, Efficiency, Flexible Budget, Sales Volume, and Static Budget Variances

This table illustrates two points:First, the price and efficiency variances add up to the flexible budget varianceSecond, static budgets play no role in the price and efficiency variances

The static budget is used to compute the sales volume variance24


Compute standard cost variances for direct materials and direct labor

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Main concern: The $4,000 unfavorable flexible budget variance

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Identify fixed and variable costsRecall standard cost (computed earlier)

Materials - $2.00 per square foot of vinylLabor - $10.50 per direct labor hour

OverheadVariable overhead price (or rate) standard is $2.00 per direct labor hourFixed overhead price (or rate) standard is $3.00 per direct labor hour

Identify the cost of one unit of productionMaterials = 1 square foot per DVD = $2.00Labor = .40 hours per DVD = $4.20Variable Overhead = .40 hours per DVD = $0.80

Actual Sales Results = 10,00027


To compute variances, use the cost computed for the flexible budget and actual resultsFollow the direct materials variance of $2,800

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Two types of direct materials variances:Direct materials price variance

Direct materials efficiency variance

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To compute variances, use the cost computed for the flexible budget and actual resultsFollow the direct labor variance of $ 200

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Two types of direct labor variances:Direct labor price (rate) variance

Direct labor efficiency variance

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Johnson, Inc., is a manufacturer of lead crystal glasses. The standard materials quantity is 0.8 pound per glass at a price of $0.30 per pound. The actual results for the production of 6,900 glasses was 1.1 pounds per glass, at a price of $0.40 per pound.1.Calculate the materials price variance and the materials efficiency variance.Materials Price Variance = (AP – SP) x AQ = ($0.30 per pound – $0.40 per pound) x 6,900 glasses x 1.1 lb = (– $0.10 per pound) x 7,590 pounds = – $759 unfavorableDirect Materials Efficiency Variance = (AQ – SQ) x SP

= (7,590 – 5,520) x $0.30 per pound = (2,070) x $0.30 per pound = $621 unfavorable

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Johnson, Inc., manufactures lead crystal glasses. The standard direct labor time is 0.3 hour per glass, at a price of $13 per hour. The actual results for the production of 6,900 glasses were 0.2 hour per glass, at a price of $10 per hour.

1. Calculate the labor price variance and the labor efficiency variance.

Direct Labor Price Variance = (AP – SP) x AH= ($10.00 – $13.00) x 1,380 hours= ($3.00) x 1,380 hours= $4,140 favorable

Direct Labor Efficiency Variance = (AH – SH) x SP = (1,380 hours – 2,070 hours) x $13.00 per hour = (690 hours) x $13.00 per hour = $8,970 favorable

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Analyze manufacturing overhead in a standard cost system

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Total overhead variance—the difference between actual overhead cost and standard overhead allocated to production

Allocating Overhead in a Standard Cost System

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To compute variances, use the cost computed for the flexible budget and actual resultsFollow the variable overhead variance of $1,000

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Two types of variable overhead variances:Variable overhead spending (price) variance

Variable overhead efficiency variance

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To compute variances, use the cost computed for the flexible budget and actual resultsFollow the fixed overhead variance of $2,700

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Two types of variable overhead variancesFixed overhead spending variance

Fixed overhead volume variance

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Refer to the data from Johnson, Inc., in S23-6 and S23-7. The following information relates to the company’s overhead costs:

Static budget variable overhead $ 9,000Static budget fixed overhead $ 4,500Static budget direct labor hours 1,800 hoursStatic budget number of glasses 6,000

Johnson allocates manufacturing overhead to production based on standard direct labor hours. Last month, Johnson reported the following actual results: actual variable overhead, $10,200; actual fixed overhead, $2,830.1.Compute the standard variable overhead rate and the standard fixed overhead rate.

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Standard overhead rate = Budgeted overhead costBudgeted direct labor hours

Standard variable = $9,000 / 1,800 hours = $5 per DL hour

Standard fixed = $4,500 / 1,800 hours = $2.50 per DL hour


Refer to the Johnson data in S23-6, S23-7, and S23-9.Compute the variable and fixed overhead variances. Use Exhibits 23-11 and 23-12 as guides.

VOH Spending Variance =(AP x AH) - (SP x AH) = 10,200 – (1,380 x $5) = $3,300 (U)

VOH Efficiency Variance = (AH – SH) x SP = (1,380 – 2,070) x $5 = $3,450 (F)FOH Spending Variance = Actual fixed overhead – Budgeted fixed

overhead = $2,830 – (1,800 x $2.50) = $1,670 (F)

FOH Volume Variance = Actual fixed overhead – Applied fixed overhead = (1,800 x $2.50) – (2,070 x $2.50) = $675 (F)42


Record transactions at standard cost and prepare a standard cost income statement

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Records variances from standards as soon as possibleRecords direct materials price variances when materials are purchased

Work in process inventory is debited at standard input quantities and standard prices

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Manufacturing wages is debited at standard prices for direct labor hours actually used

Work in process inventory is debited for the standard cost per direct labor hour that should have been used

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Record actual overhead cost for June

Record the overhead allocated to Work in process inventory computed

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Record the transfer of the standard cost of the DVDs completed from Work in process inventory to Finished goods

Record the transfer of the cost of sales of the 10,000 DVDs sold at standard cost

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Closes the Manufacturing overhead account and records the overhead variances

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The master budget is a static budget, which means it is prepared for only one level of sales volume. A variance is the difference between an actual amount and a budgeted amount. A flexible budget summarizes costs and revenues for several different volume levels within a relevant range.An income statement performance report is prepared at the end of the period to measure actual results against the flexible and static budgets. A static budget variance occurs because actual activity differed from what was expected in the static budget.

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The static budget variance is divided into two variances: The flexible budget variance arises because the company had different revenues and/or costs than expected for the actual level of units sold. The sales volume variance arises because the actual number of units sold differed from the number of units on which the static budget was based.Most companies use standard costs to develop their flexible budgets. Standard cost is a budget for a single unit of materials, labor, and overhead. Price variances measure the difference in actual and standard prices. Efficiency variances measure the difference in actual and standard quantities used.

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Standard cost variances for direct materials and direct labor are each split between the price variance and efficiency variance. The price variance measures the difference between actual and standard price for direct materials and labor used. The efficiency variance measures the difference between actual and standard usage for direct materials and labor based on standard prices. In analyzing each variance, management must consider the overall effect of each decision and how it affected overall results for the production period.

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When companies utilize standard costs, journal entries are made using standard costs, and variances are recorded at the same time. The variances are then shown on a standard costing income statement to highlight variances to management for more efficient decision making.

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Copyright

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flexible budgets and standard costs

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