1. Budgeting and Variances
Uses of budgets
Production variances

2. Agenda Discussion of budgeting Discussion of variances
Materials
Labor
Overhead
Demonstration problems
Thursday’s class
Group work

3. Master Budget
Budget = quantitative expression of a firm’s strategic plan of action
Master budget = prepared before the accounting period begins
Also static budget
Standard costs

4. Preparing the budget Project sales Plan production activity level
Sales prediction
Current finished goods inventory
Desired ending finished goods inventory
Plan purchases, employment
Estimate fixed costs
Prepare estimated income statements and balance sheets

5. Uses of budgets Planning Performance evaluation Control
Operational plans (short-term)
Capital budgets (long-term)
Company strategy
Performance evaluation
Variances
Responsibility centers
Control

6. Behavioral aspects of budgeting:
Participative budgeting
Better information
Better cooperation
Budgetary slack
Dysfunctional responses
Compulsion to spend all discretionary funds
Short-run emphasis on budget only
Questionable actions designed only to balance the budget

7. Flexible budget:
Flexible budget = the master budget you would have prepared if you had known before the accounting period started how much you would actually produce during the period.
Flexible budget = “standard cost allowed for good output achieved”

8. Flexible budgets and performance evaluation:

9. Variances
“unfavorable variance” = NI is reduced from the budgeted expectation
“favorable variance” = NI is increased from budgeted expectation
Note: Do not interpret directly as “bad” or “good” behavior on the part of management.

10. Variances

11. Variable cost variances
Direct materials
price variance: usage price variance
purchase price variance
(actual price - std. price) x actual usage
(actual price - std. price) x actual purchases
quantity variance: based on usage
(actual usage - std. usage) x std. price
actual usage = total actual materials used
standard usage = std. allowed per unit x actual units

12. Variable cost variances
Direct labor
rate variance: (actual price - std. price) x actual usage
efficiency variance:
(actual usage - std. usage) x std. price
actual usage = total actual labor hrs. used
standard usage = std. allowed per unit x actual units

13. Example: Chemical, Inc.
Chemical, Inc., has set up the following standards for materials and direct labor:
Materials: 10 $3 $30 per batch
Direct labor: .5 $20/hr. $10 per batch
The number of finished units budgeted for the period
was 10,000. The number of actual batches produced
was 9,810. During the month, purchases amounted to 100,000 lbs. at a total cost of $310,000. The actual price paid for labor was $21 per hour. Price variances are
isolated upon purchase. Actual inputs used were: 98,073 lbs. of material and 4,900 hours of labor.

14. Direct material price variances
What might cause a direct material price variance?
Price change in market
Purchase discounts
Transportation costs
Grade of materials
Therefore, purchasing department

15. Direct material quantity variance
What could cause a direct material efficiency variance?
Defect in material
Inexperienced workers
Poor supervision
Poor scheduling
Therefore, production department

16. DM variance computations
Direct material purchase price variance: U
$310,000 - ($3 x 100,000) = $10,000
Or: ($ $3.00) x 100,000 = $10,000
Direct material quantity variance:
[98,073 - (10 lbs. x 9,810 batches)]x $3 = $81 F
Or: ( ) x 9,810 batches x $3 = $82

17. (9,810 batches - 10,000 batches) x $3 x 10 lbs. = $5,700
DM activity variance
(actual output - budgeted output) x standard price per unit of direct material x standard quantity of direct material per unit of output
(9,810 batches - 10,000 batches) x $3 x 10 lbs. = $5,700
F?????

18. Direct labor variances
What would cause a direct labor rate variance?
The actual rate = approximately average wage paid, including fringes
Experience of workers
Union contract
Overtime
Change in fringes
Therefore, human resources or management

19. Direct labor variances
What would cause a direct labor efficiency variance?
Skill
Motivation
Supervision/scheduling
Quality of materials
Late time
Therefore, production, human resources, purchasing

20. Labor variance computations
Rate variance:
($21 - $20) x 4,900 hours = $4,900 U
Efficiency variance:
(4,900 hours - (9,810/2)) hours) x $20 = $100 F
Activity variance:
(9,810 batches - 10,000 batches) x $20 x .5 = $1,900 F

21. Overhead variances
1. By definition, fixed overhead does not vary with the level of planned production.
Flexible budget FOH = Master budget FOH
2. By definition, fixed overhead is incurred as a lump sum expenditure and there are no partial input-output relationships.
Therefore, the “Std. Input” column is undefined.

22. Overhead variances: FOH
FOH budget variance = Actual FOH - Budgeted FOH
FOH efficiency variance =
Is undefined
FOH applied =
(Predetermined rate/unit) x actual units
Production volume variance = Applied FOH - Budgeted FOH

23. Overhead variances: VOH
VOH spending variance = Actual VOH - “Std. Input” col.
VOH efficiency variance =
“Std. Input” - Flexible Budget
VOH activity variance = Flexible Budget - Master Budget
Or: VOH applied - Master Budget

24. Overhead variances Over- or underapplied overhead =
Actual overhead spending - Overhead applied Or
The net of all the variances computed

25. Example: Murray Manufacturers
VOH Rate = $3 per DL hour
FOH Rate = $4 per DL hour
One unit requires 2 hours of labor
Denominator volume is 1,000 units of output
Actual production was only 800 units.
Actual costs were $5,800 for variable overhead and $8,130 for fixed overhead; 1,590 DL hrs. were worked.

26. Example: Murray Manufacturers
$5,800 - ($3 x 1,590 hrs.)
VOH spending variance = U
$1,030
VOH efficiency variance =
(1,590 hr. - (2x800)hrs)
x $3 = $30 F
VOH activity variance =
(800 units units)
x 2 hrs. x $3 = $1,200 F

27. Example: Murray Manufacturers
FOH budget variance =
$8,130 - $8,000 = $130 U
FOH production volume variance =
(800 units x 2 hrs. x $4) - $8,000
= $1,600 U

28. Example: The Vanguard Company
The Vanguard Company manufactures one product. Its standard cost system incorporates flexible budgets and
assigns indirect costs on the basis of standard DL hrs.
At denominator activity, the standard cost per unit is:
Direct materials, 3 $ $15.00
Direct labor, .4 $
Variable indirect costs, .4 $
Fixed indirect costs, .4 $
Total $27.00

29. Example: The Vanguard CompanyDM DL
VOH
FOH

30. Example: The Vanguard Company
Direct materials were quoted at $5.50 per pound through-
out September and October to all suppliers. There was no purchase-price variance for materials in October; the price variance shown relates solely to the materials used
during October.
Wage standards were set in accordance with an annual
union contract, but a shortage of workers in the local
areas has resulted in rates higher than standard.
There were no beginning or ending inventories of work in process.

31. Example: The Vanguard Company
1. How many units were produced?
Use the standard cost column.
All the units manufactured cost $243,000
One unit at standard costs $27.00
Units produced = $243,000 / $27.00 = 9,000 units

32. Example: The Vanguard Company
2. What were the actual number of direct labor hours used?
Efficiency variance = (actual hrs./unit - std. hrs./unit) x actual units x std. price
= [actual DL hrs. - (.4 x 9,000)] x $20
$4,000 = actual DL hrs. x $20 - $72,000
$76,000 = actual DL hrs. x $20
3,800 = actual DL hrs.

33. Example: The Vanguard Company
3. What was the actual wage rate?
Labor price variance = (actual rate - std. rate) x actual labor hours
$1,900 = (actual wage rate - $20.00) x 3,800 hrs.
$1,900 = actual wage rate x 3,800 hrs - $76,000
$77,900 = actual wage rate x 3,800 hrs
$20.50 = actual wage rate

34. Example: The Vanguard Company
4. What was the budget for fixed indirect costs.
FOH budget variance = Budgeted FOH - Actual FOH
$200 = Budgeted FOH - $15,800
Actual FOH < Budgeted FOH
$16,000 = Budgeted FOH

35. Example: The Vanguard Company
5. Denominator activity expressed in direct labor hours.
Denominator Volume = 4,000 DL hrs.

36. Example: The Vanguard Company
6. How many pounds of direct materials were used?
DM quantity variance = (actual quantity used std. quantity for output) x standard price
$5,000 = (actual quantity used - (3 lbs. x 9,000) x $5.00
$5,000 = actual quantity used x $ $135,000
$140,000 = actual quantity used x $5.00
28,000 lbs. = actual quantity used

37. Thursday Review overhead variances Compute sales revenue variances
sales price
sales activity (measured via contribution margin)
sales mix
sales volume
market size
market share
Variance reconciliation

38. Group exercise
Use example company: Look at the numbers and determine what they all mean.
Compute
Direct material price, quantity and activity variances
Direct labor rate, quantity and activity variances
Overhead variances: spending/budget, efficiency (if applicable), and PVV