1. © 2007 Pearson Education Canada Slide 12-1 Flexible Budgets and Variance Analysis 12

2. © 2007 Pearson Education Canada Slide 12-2 Static and Flexible Budgets Static Budget Master budget Carefully forecasted sales and operating targets Flexible Budget Budget that adjusts for changes in volume and other cost driver activities May be prepared for any level of activity Provides a basis for comparison with actual results Flexible Budgets Units Per Unit7,0008,000 Sales$31.00$217,000$248,000 Variable costs: Manufacturing$21.00$147,000$168,000 Shipping.604,2004,800 Administrative.20 1,400 1,600 Total variable$21.80$152,600$174,400 Contribution margin$9.20$64,400$73,600 Fixed costs: Manufacturing$37,000$37,000 Sell & Admin33,00033,000 Total fixed costs$70,000$70,000 Operating income (loss)$(5,600)$3,600

3. © 2007 Pearson Education Canada Slide 12-3 Evaluation of Financial Performance Subdivision of total difference between master or static budget and actual results to evaluate performance FlexibleSales Actual BudgetFlexibleActivityMaster ResultsVariancesBudgetVariancesBudget Units7,0007,0002,000 U9,000 Sales$217,000$217,000$62,000 U$279,000 Variable costs158,2705,670 U152,60043,600 F196,200 Contribution Margin58,7305,670 U64,40018,400 U82,800 Fixed costs70,300 300 U70,00070,000 Operating income$(11,570)$5,970 U$(5,600)$18,400 U$12,800

4. © 2007 Pearson Education Canada Slide 12-4 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 Units7,0008,0009,000 Activity Centres 1. Processing Cost driver – machine hours14,00016,00018,000 Variable costs$147,000$168,000$189,000 Fixed costs13,00013,00013,000 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)

5. © 2007 Pearson Education Canada Slide 12-5 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

6. © 2007 Pearson Education Canada Slide 12-6 Standard Costs Standard Cost Cost that is most likely to be attained and should be attained Standard Price$2.00 per kg. Standard Quantity3 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

7. © 2007 Pearson Education Canada Slide 12-7 Investigation & Use of Variances Variances show that something was different than expected Variances are attention directors, not problem solvers VarianceXInterpretation VarianceDeterminationEvaluation of Causeof Reaction ControllerManagerSupervisor 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

8. © 2007 Pearson Education Canada Slide 12-8 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

9. © 2007 Pearson Education Canada Slide 12-9 Direct Material Variances Actual CostsFlexible BudgetFlexible Budget Actual Inputs xActual Inputs xStandard Inputs x Actual PricesStandard PricesStandard Prices Direct material 36,800 kg36,800 kg35,000 kg x $1.90 / kg x $2.00 / kgx $2.00 / kg = $69,920= $73,600= $70,000 Price Variance $3,680 F Usage Variance $3,600 U Flexible Budget Variance $80 F

10. © 2007 Pearson Education Canada Slide 12-10 Direct Labour Variances Actual CostsFlexible BudgetFlexible Budget Actual Inputs xActual Inputs xStandard Inputs x Actual PricesStandard PricesStandard Prices Direct labour 3,750 hours3,750 hours3,500 hours x $16.40 / hourx $16.00 / hourx $16.00 / hour = $61,500= $60,000= $56,000 Price Variance $1,500 U Usage Variance $4,000 U Flexible Budget Variance $5,500 U

11. © 2007 Pearson Education Canada Slide 12-11 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

12. © 2007 Pearson Education Canada Slide 12-12 Overhead Subdivision Actual CostsFlexible BudgetFlexible Budget Actual Inputs xActual Inputs xStandard Inputs x Actual PricesStandard PricesStandard Prices Variable Overhead 3,750 hours3,500 hoursx $1.20 / hour $4,700= $4,500= $4,200 Fixed Overhead $14,700$14,400 Spending Variance $200 U Efficiency Variance $300 U Flexible Budget Variance $500 U Flexible Budget Variance $300 U

13. © 2007 Pearson Education Canada Slide 12-13 Subdividing The Total Variance Revenue$1,200 Variable COGS850 Contribution Margin350 Fixed Costs220 Operating Income$ 130 Revenue$1,000 Variable COGS700 Contribution Margin300 Fixed Costs200 Operating Income$ 100 Sales Price Variance Sales Activity Variance Variable Cost Flexible Budget Variance Fixed Cost Flexible Budget Variance Sales Quantity Variance Sales Mix Variance Price Variance Usage Variance Market Share Variance Market Size Variance Master BudgetActual Results

14. © 2007 Pearson Education Canada Slide 12-14 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