Flexible Budgets, Standard Costs, and Variances Analysis Chapter 8 Introduction to Managerial Accounting Brewer, Garrison,Noreen Power Points from website -adapted by Cynthia Fortin, CPA, CMA http://highered.mheducation.com/sites/0078025419/student_view0/chapter8/index.html

Want to compare what actually happened with what should have happened

Management Control Develop Planning budgets before a period begins Adjust budgets to reflect actual level of activity => Flexible budget Compare Actual revenue and spending to flexible budgets => Evaluate performance Compute variances => Highlight significant problems Take corrective action to solve problems

Flexible Budget Computes what revenues and costs would have been given the actual level of activity

Flexible budget assumption All costs are either variable or fixed with respect to level of activity

Develop flexible budget Start with Master budget or Planned budget Income Statement Compute per unit Budget sales price (BSP) , Variable expenses (BV) Identify Fixed expenses Determine Actual quantities (AQ) of output Compute Flexible Revenue = BSP * AQ Compute Flexible Variable expenses = BV * AQ Use Budget Fixed expenses Compute Net Operating Income

Develop flexible budget Start with Master budget or Planned budget Income Statement Compute per unit Budget sales price (BSP) , Variable expenses (BV) Identify Fixed expenses Determine Actual quantities (AQ) of output Compute Flexible Revenue = BSP * AQ Compute Flexible Variable expenses = BV * AQ Use Budget Fixed expenses Compute Net Operating Income

Variances The Revenue variance = Actual Revenue – Flexible Budget Revenue The Spending variance = Actual spending - Flexible budget spending.

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Standard costs Benchmark measure performance Developed at all levels during the planning process DM (weight, units, length, price per unit of measure) DL (wages, taxes, benefits, mix of workers, rate per hour, labor time) Variable manufacturing OH (rates, allocation basis)

Setting standards Direct Materials standard cost Price includes delivery Allowed Quantity per unit produced Amount of material required for each unit of finished product including waste

Setting standards Direct Labour standard cost RATE includes employee benefits, taxes and the mix of workers based on skills and seniority Allowed Quantity per unit produced Number of hours required to complete 1 unit, by clocking the time required for each task, includes breaks, personal needs, cleanup and machine downtime.

Standard Costing Examples: Standard quantity of materials = 2 kg. per unit Standard price of materials = $8 per kg. Standard cost of materials = $16 per unit

Webb’s standard cost per jacket Direct materials: 2sq metres at $30 per sq metre = $60 per jacket Direct mfg labour: 0.8 mfg labour-hours of input allowed per output unit manufactured at $20 standard cost per hours = $16 per jacket manufactured. Direct marketing labour: 0.25 marketing labour-hour of input allowed per output unit sold at $24 standard cost per hour: $6 per jacket sold.

Variable mfg o/h: Allocated based on 1 Variable mfg o/h: Allocated based on 1.20 machine-hours per output unit mfg at $10 standard cost per machine-hour: $12 per unit manufactured. Variable marketing overhead: Allocated based on 0.125 direct marketing l-h per output unit sold at $40 standard cost per hour: $5 per output unit sold.

A General Model for Variance Analysis applicable to Materials, Labor and Variable Overhead Standard Quantity Actual Quantity of input Actual Quantity of input allowed X actual output × × × Standard Price Standard Price Actual Price Efficiency Variance Price Variance

Material spending Variance A General Model for Variance Analysis Applied for Materials when Bought and Used are the same Quantity – Standard Quantity input Actual Quantity of input Actual Quantity of allowed X actual output × input × × Standard Price Standard Price Actual Price 2 m2 x 10,000 jackets 22,200 m2 22,200 m2 × × × $30 /m2 $30 /m2 $31 / m2 $600,000 $666,000 $688,200 $66,000U $22,200U Efficiency Variance Price Variance $88,200U Material spending Variance Actuals Webb purchased and used 22,200 m2 at $31 per m2 for 10,000 jackets

Price and Efficiency Variance — Materials Actual Budget Direct 22,200 m2 20,000 m2 (2 * 10000) materials $31 per m2 $30 per m2 Price variance = (Actual price – Budgeted price) x Actual quantity used = ($31 – $30) x 22,200 = $22,200 U Efficiency (Usage) variance = (Actual quantity used – Budgeted quantity used) x Budgeted price = (22,200 – 20,000) x $30 = $66,000 U

Price and Efficiency Variance — Labour I Actual Budget Manufacturing 9,000 hours 8,000 hours (0.8 x 10,000) labour $22 per hour $20 per hour Price (or rate) variance = (Actual price – Budgeted price) x Actual quantity used = ($22 – $20) x 9,000 = $18,000 U Efficiency variance = (Actual quantity used – Budgeted quantity used) x Budgeted price = (9,000 – 8,000) x $20 = $20,000 U

Direct Labour Variances Higher rates than expected Overtime due to rework or poor material Unfavorable Price Variance Poorly maintained equipment Employee mix with more experienced staff

Price and Efficiency Variance — Labour II Actual Budget Marketing 2,304 hours 2,500 hours (0.25 X 10,000) labour $25 per hour $24 per hour Price (or rate) variance = (Actual price – Budgeted price) x Actual quantity used = ($25 – $24) x 2,304 = $2,304 U Efficiency variance = (Actual quantity used – Budgeted quantity used) x Budgeted price = (2,304 – 2,500) x $24 = $4,704 F

Direct Labour Variances Poorly maintained equipment Poorly trained workers Poor quality materials Poor supervision of workers Unfavorable Efficiency Variance

Possible reasons for efficiency variances Webb’s personnel manager hired under-skilled workers or their training was inadequate. Webb’s production process is being reorganized or a new machine has been installed, creating addition direct manufacturing time per jacket while the workers learn the new process, etc.

AN IMPORTANT DETAIL IN THE MATERIALS VARIANCES Most companies use the quantity of materials purchased to compute the materials price variance and the quantity of materials used in production to compute the materials quantity variance. Why? Because Purchasing Manager is responsible for the price of materials and Production Manager is responsible for the quantity used for one reason.

Materials variance when quantity of materials used and purchased is different Price variance is calculated on quantity of materials purchased and not quantity of materials used. The Actual input is restated using the quantity of materials purchased then multiplied by the standard price and compared to the quantity of materials purchased multiplied by the actual price. The total efficiency variance and price variance will not balance with the spending variance of materials because the quantities of materials are different.

Materials when quantity of materials used and purchased is different Standard Quantity Actual Quantity of input Actual Quantity allowed X actual output X Materials purchased × Standard Price Standard Price x Actual Price Materials Quantity Variance Price Variance Actual Quantity Materials purchased X Standard Price

Evaluating Performance Variances Used to evaluate performance Indicate that something was different than expected Critical to understand why ( the causes) significant variances arise and use this knowledge to promote learning and continuous improvement

Effectiveness The degree to which organization’s predetermined goals are met Efficiency How well inputs were used in relation to a given level of output

Multiple causes of variances 1. Always consider possible interdependencies among variances; do not interpret them in isolation. 2. Use broad perspective of actions taken in the supply chain of organizations (supply chain: flow of goods, services, and information from beginning to end of a product or service). 3. Note that improvements in early stages of supply chain can sizably reduce magnitude of variances in subsequent stages.

Understand why variances arise and use knowledge to promote learning and continuous improvement –most important task in variance analysis. Emphasize total organizational objectives by design of performance measurement and reward system by top management. Use cost-benefit test to decide when and which variances should be investigated. Realize that the standard is a range of possible acceptable outcomes.

Variance Analysis Cycle Query ‘material’ variances Corrective actions implemented Develop explanations Determine and analyze variances Prepare report to management and new Budget Conduct next period’s operations Begin