flexible budgets and variance analysis
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Flexible Budgets and Variance Analysis. Management Cycle, Standard Costing and Variance Analysis. Use standard costs to prepare budgets and establish goals for product costing. Use standard costs to account for operations and managers’ performance. - PowerPoint PPT PresentationTRANSCRIPT
Flexible Budgets and Variance
Analysis
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Management Cycle, Standard Costing and Variance AnalysisManagement Cycle, Standard
Costing and Variance AnalysisUse standard costs to prepare budgets and establish goals for product
costing.
Apply dollar, time, and
quantity standards to work.
Use standard costs to account for operations and managers’
performance.
Calculate variances between standard and
actual costs, determine their causes, identify inefficient
operations, and take corrective action.
Use variances to evaluate managers’ performance.
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Standard CostsStandard Costs
A standard cost (predetermined cost) indicates what it should cost to provide an
activity or produce one batch or unit of product under planned and efficient operating
conditions.
A standard cost (predetermined cost) indicates what it should cost to provide an
activity or produce one batch or unit of product under planned and efficient operating
conditions.
Flexible budgets are based on standard costs. Flexible budgets are based on standard costs.
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Standard CostsStandard Costs
• To determine the unit standard cost for a particular input, 2 decisions must be made: The amount of input that should be used per
unit of output (quantity standard) The amount that should be placed for the
quantity of the input to be used (pricing standard)
Unit Standard cost = Quantity Standard x Price Standard
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Standard CostsStandard Costs• How standards are developed
Historical experience Engineering studies Input from operating personnel
• Types of standards Ideal standards
Demand maximum efficiency and can be achieved only if everything operates perfectly
Currently attainable standards Can be achieved under efficient operating conditions, with
allowance for normal breakdowns, interruptions, etc.
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Standard CostsStandard Costs
• Why standard cost systems are adopted Planning and Control
– Unit standards are a fundamental requirement for a flexible budgeting system
– Budgetary control systems compare actual costs with budgeted costs by comparing variances
– By developing unit price standards and quantity standards, an overall variance can be decomposed into a price variance/spending variance and a usage variance/efficiency variance
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Standard CostsStandard Costs
• Why standard cost systems are adopted Product Costing
– Comparison of costing systems
DM DL OHActual Actual Actual ActualNormal Actual Actual BudgetedStandard Standard Standard Standard
Manufacturing Costs
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Standard CostsStandard Costs
– Advantages of standard costingGreater capacity for control over product
costProvide readily available unit cost
information that can be used for pricing decisions
If a process costing system uses standard costing, there is no need to compute a unit cost for each equivalent unit of DM, DL and MOH
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Standard CostsStandard Costs
Product cost (to illustrate use of standard cost in process costing):
Input Required Cost Cost Inputs per ‘X’
Direct materials $2.00/lb. 20 $40.00
Direct labor $5.00/dlh. 3 15.00
Fixed MOH $2.00/dmh. 3 6.00
Variable MOH $3.00/dmh. 3 9.00
Total unit cost. . . . . . . . . . . . . . . . $70.00
Product cost (to illustrate use of standard cost in process costing):
Input Required Cost Cost Inputs per ‘X’
Direct materials $2.00/lb. 20 $40.00
Direct labor $5.00/dlh. 3 15.00
Fixed MOH $2.00/dmh. 3 6.00
Variable MOH $3.00/dmh. 3 9.00
Total unit cost. . . . . . . . . . . . . . . . $70.00
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Standard CostsStandard CostsExample of DM standards calculationStandard price of corn = $0.006 per ounce
Standard usage of per bag = 18 ounces
Standard cost per bag = $0.108
If the budgeted number of bags is 800 bags:• Standard quantity for 800 bags = 14,400 ounces
• Standard cost for budgeted level of activity (a.k.a static budget)
= 0.006 x 14,400 = $86.40
If the actual number of bags produced is 1,000 bags:• Standard quantity allowed for 1,000 bags = 18,000 ounces
• Standard cost for actual level of activity (a.k.a flexible budget)
= 0.006 x 18,000 = $108
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Manufacturing BudgetManufacturing BudgetMcMillan CompanyManufacturing Budgetfor the Month of JulyManufacturing costs:
Unit level:Direct materials (10,000 x 2 pounds X $5) $100,000Assembly (10,000 x 0.25 hours x $24) 60,000Waterproofing and Inspection (10,000 x $8) 80,000
Batch level:Setup (10 batches x $400) 4,000Test run (10 batches x $100) 1,000
Product level 20,000Facility level 32,000
Total $297,000
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Static BudgetStatic BudgetMcMillan CompanyProduction Department Performance Reportfor the Month of July Original Static Budget
Actual Budget Variance Volume 11,000 10,000
Unit level:Direct materials $108,000 $100,000 $ 8,000 UAssembly 70,000 60,000 10,000 UWaterproofing and Inspection 81,000 80,000 1,000 U
Batch costs:Setup 4,000Test runs 1,000
Continued on next slideContinued on next slide
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Batch costs:Total 5,600 5,000 600 U
Fixed overhead:Product 22,000 20,000 2,000 UFacility 31,000 32,000 1,000 F
Totals $317,600 $297,000 $20,600 U
McMillan CompanyProduction Department Performance Reportfor the Month of July Original Static Budget
Actual Budget Variance Volume 11,000 10,000
Static BudgetStatic Budget
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Flexible BudgetFlexible Budget
Volume 11,000 11,000
Unit level:Direct materials $108,000 $110,000 $ 2,000 FAssembly 70,000 66,000 4,000 UWaterproofing and Inspection 81,000 88,000 7,000 F
Batch costs:Setup 4,400Test runs 1,100
McMillan CompanyProduction Department Performance Reportfor the Month of July Flexible Flexible Budget
Actual Budget Variance
Continued on next slideContinued on next slide
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Batch costs:Total 5,600 5,500 100 U
Fixed overhead*:Product 22,000 20,000 2,000 UFacility 31,000 32,000 1,000 F
Totals $317,600 $321,500 $3,900 F
McMillan CompanyProduction Department Performance Reportfor the Month of July Flexible Flexible Budget
Actual Budget Variance Volume 11,000 11,000
Flexible BudgetFlexible Budget
* For fixed overheads, there is no difference between static budget and flexible budget because fixed overheads do not vary with output.
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Variance AnalysisVariance Analysis
• A flexible budget can be used to identify the costs that should have been incurred for the actual level of activity.
• Flexible budget is tailored after the fact to actual production levels.
• Flexible budget variance =
Actual costs – Flexible budget cost
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Variance AnalysisVariance Analysis
• Flexible budget variance
= Actual costs – Flexible budget cost
• Dichotomizing flexible budget variance Total flexible budget variance
= (AP x AQ) – (SP x SQ) Total flexible budget variance
= (AP x AQ) – (SP x SQ)
= (AP x AQ) – (SP x AQ) + (SP x AQ) – (SQ x SP)
= (AP – SP)AQ + (AQ – SQ)SP
= Price Variance + Efficiency variance
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Variance AnalysisVariance Analysis
• Variance analysis Identifies the general causes for the total
flexible budget variance by breaking it down into separate price and quantity variances for each production resource
2 possible reasons why actual cost may differ from flexible budget cost for a given amount of output produced:
– Difference between actual price and standard price
– Difference between actual quantity and standard quantity
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Variance AnalysisVariance Analysis• Unfavorable and favorable variances
Unfavorable variances occur whenever the actual prices or usage of inputs are greater than standard prices or usages (variances are + ve)
AP > SP, AQ > SQ
Favorable variances occur whenever the actual prices or usage of inputs are less than standard prices or usages (variances are – ve)
AP < SP, AQ < SQ
Favorable and unfavorable variances are not equivalent to good or bad variances. Must investigate underlying reasons for variances.
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Variance AnalysisVariance Analysis
• Why separate total variances into price and quantity variances? Separate variances that are subjected to a
manager’s direct influence from those that are not
• Excessive focus on variances can lead to dysfunctional behavior
• Decision to investigate Rarely will actual performance exactly meet
established standards
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Variance AnalysisVariance Analysis Management should develop an acceptable range of
performance. – When variances are within this range, they are
assumed to be caused by random factors.– When variances are outside this range, they are
assumed to be caused by nonrandom factors and these variances should be investigated.
Controllable: Corrective actions/Affirmative actionsUncontrollable: Revise standards
Management should also consider costs and benefits of investigating variances.
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Variance Analysis: DMVariance Analysis: DM
Actual Quantity of Input at Actual Price
AQ x AP
Actual Quantity ofInput at Standard Price
AQ x SP
Standard Quantity ofInput at Standard Price
SQ x SP
PriceVariance
AQ x (AP - SP)
UsageVariance
SP x (AQ - SQ)
BudgetVariance
(AQ x AP) - (SQ x SP)
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Variance Analysis: DMVariance Analysis: DM• Possible causes for DM Price Variance
Inaccurate or outdated price standards Quality of DM Quantity discounts Market price fluctuations
• Possible causes for DM Usage Variance Inaccurate or outdated usage standards Quality of DM Level of scrap, waste or rework
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Variance Analysis: DLVariance Analysis: DL
Actual Hours of Input at Actual Rate
AH x AR
Actual Hours ofInput at Standard Rate
AH x SR
Standard Hours ofInput at Standard Rate
SH x SR
Labor RateVariance
AH x (AR - SR)
Labor EfficiencyVariance
SR x (AH - SH)
BudgetVariance
(AH x AR) - (SH x SR)
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Variance Analysis: DLVariance Analysis: DL• Possible causes for DL Rate Variance
Inaccurate or outdated labor rate standards Increase or decrease in the pay of workers Use of highly or lowly skilled workers in the
production• Possible causes for DL Efficiency Variance
Inaccurate or outdated quantity standards Training of employees Quality of machinery Quality of materials Level of supervision
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Variance Analysis: VMOHVariance Analysis: VMOH
Actual Hours of Input xActual Variable OH Rate
AH x AVOH rate
Actual Hours of Input xStd Variable OH Rate
AH x SVOH rate
Std Hours of Input xStd Variable OH Rate
SH x SVOH rate
Spending Variance
AH x (AVOR – SVOR)
EfficiencyVariance
SVOR x (AH - SH)
Total Variance(AVOR x AH) – (SVOR x SH)
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Variance Analysis: VMOHVariance Analysis: VMOH• Possible causes for VMOH Spending Variance
Inaccurate or outdated VMOH rate standards Changes in the price of the variable overhead items
Efficiency in the use (in terms of quantity) of the variable overhead items
• Possible causes for VMOH Efficiency Variance Inaccurate or outdated quantity standards for allocation
base Efficiency in the use of the cost allocation base
– If the cost allocation base is direct labor hours, the reasons for direct labor efficiency variance will be the reason for VMOH efficiency variance
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Variance Analysis: FMOHVariance Analysis: FMOH
Actual Fixed OHAH x AFOR rate
Budgeted Fixed OHBH x SFOR
Applied Fixed OHSH x SFOR for
actual work done
Spending Variance Volume Variance
Total Variance
Impt: Note that budgeted hours is used instead of actual hours because FMOH does not vary with the number of units
[Note: Variance formulas for DM, DL and VMOH are not applicable for computing spending variance and volume variance of FMOH]
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Variance Analysis: FMOHVariance Analysis: FMOH• Spending variance = Actual FMOH cost – Static FMOH
budget [Note: Spending variance = Flexible budget variance = Static budget variance]
• Volume variance = Static FMOH budget – “Flexible” FMOH budget
• “Flexible” FMOH budget =
Static FMOH budget +
Static FMOH budget x % change in number of units sold• In fact, the volume variance is just (negative of) Static
FMOH budget x % change in number of units sold
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Variance Analysis: FMOHVariance Analysis: FMOH• Possible causes for FMOH Spending Variance
Inaccurate or outdated budgets for FMOH Changes in the price and quantity of the FMOH
items Note: Many FMOH items are not subject to
change in the short run, consequently fixed overhead costs are often beyond the immediate control of management
• Cause for FMOH Volume Variance Changes in the level of output
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Variance Analysis: TRVariance Analysis: TR
Actual Price x Actual Volume
AP x AQ
Budgeted Price xActual Volume
BP x AQ
Budgeted Price xBudgeted Volume
BP x BQ
Sales Price Variance
AQ x (AP - BP)
Sales VolumeVariance
BP x (AQ - BQ)
RevenueVariance
(AP x AQ) - (BP x BQ)
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Variance Analysis: TRVariance Analysis: TR
Flexible budget variance
= Actual revenue – Flexible budget revenue
Example
FAS budget 2001 ticket sales at $70,000 per home game, which represent the sale of an estimated 10,000 tickets at a selling price of $7. In July’s first game, actual gate ticket revenue was $66,000, creating a total unfavorable revenue variance of $4,000. The actual sales consisted of 12,000 tickets at $5.50.
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Variance Analysis: TRVariance Analysis: TR
Actual Price x Actual Volume12,000 x 5.50
Budgeted Price xActual Volume
7 x 12,000
Budgeted Price xBudgeted Volume
7 x 10,000
Sales Price Variance
12,000 x (5.50 - 7)18,000U
Sales VolumeVariance
7 x (12,000 – 10,000)14,000F
RevenueVariance
(66,000) - (70,000)4,000U
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Variance Analysis: TRVariance Analysis: TR• Possible causes for TR Price Variance
Inaccurate or outdated price standards Changes in the market price of the product
• Possible causes for TR Volume Variance Inaccurate or outdated quantity standards Changes in the level of demand for the product
• Note: For TR variance only, variance favorable if AP > SP, AQ > SQ
(In contrast with cost variances)
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Summary of Variance Analysis Summary of Variance Analysis
• Variance analysis in general Deviation of an actual amount from the
expected (standard) or budgeted amount.
“Unfavorable” or “Favorable” means nothing
Provide clues to the causes of performance i.e. attention directors, not problem solvers
Requires a drill down into the organization to have a better understanding of the variances
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Summary of Variance Analysis Summary of Variance Analysis
• Benefits of variance analysis Useful for control purposes. For example, when the
figures in the master budgets are not achieved, investigations and appropriate actions can be undertaken.
Communicates information to management.
– Highlights possible organizational difficulties – management cannot fix what they do not know about.
– Affects the actions of organization management.
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Summary of Variance Analysis Summary of Variance Analysis
• Trade-Offs Among Variances As the operations of organizations are linked,
the level of performance in one area of operations will affect performance in another.
Improvements in one area could lead to improvements in others and vice versa.
Substandard performance in one area may be balanced by superior performance in others.