1. Flexible Budgets, Variances, and Management Control: I
Chapter 7

2. Learning Objective 1
Distinguish
a static budget
from a flexible budget.

3. Static and Flexible Budgets
Planned level of
output at start of
the budget period
Static Budget
Based on
Budgeted revenues
and cost based on
actual level of output
Flexible Budget
Based on

4. Static Budget Example Assume that Pasadena Co. manufactures
and sells dress suits.
Budgeted variable costs per suit are as follows:
Direct materials cost $ 65
Direct manufacturing labor
Variable manufacturing overhead
Total variable costs $115

5. Static Budget Example Budgeted selling price is $155 per suit.
Fixed manufacturing costs are expected
to be $286,000 within a relevant range
between 9,000 and 13,500 suits.
Variable and fixed period costs are ignored.
The static budget for year 2004 is based
on selling 13,000 suits.
What is the static-budget operating income?

6. Static Budget Example Revenues (13,000 × $155) $2,015,000
Less Expenses:
Variable (13,000 × $115) ,495,000
Fixed ,000
Budgeted operating income $ 234,000
Assume that Pasadena Co. produced and sold
10,000 suits at $160 each with actual variable
costs of $120 per suit and fixed manufacturing
costs of $300,000.

7. What was the actual operating income?
Static Budget Example
What was the actual operating income?
Revenues (10,000 × $160) $1,600,000
Less Expenses:
Variable (10,000 × $120) 1,200,000
Fixed ,000
Actual operating income $ 100,000

8. Static-Budget Variance Example
What is the static-budget variance of
operating income?
Actual operating income $100,000
Budgeted operating income ,000
Static-budget variance of
operating income $134,000 U
This is a Level 0 variance analysis.

9. Static-Budget Variance Example
Static-Budget Based Variance Analysis
(Level 1) in (000)
Static Budget Actual Variance
Suits U
Revenue $2,015 $1,600 $415 U
Variable costs 1, , F
Contribution margin $ $ $120 U
Fixed costs U
Operating income $ $ $134 U

10. Develop a flexible budget and compute flexible-budget
Learning Objective 2
Develop a flexible budget
and compute flexible-budget
variances and sales-volume
variances.

11. Steps in Developing Flexible Budgets
Determine budgeted selling price, variable
cost per unit, and budgeted fixed cost.
Budgeted selling price is $155,
variable cost is $115 per suit, and
the budgeted fixed cost is $286,000.

12. Steps in Developing Flexible Budgets
Determine the actual quantity of output.
In the year 2004, 10,000 suits were
produced and sold.
Step 3:
Determine the flexible budget for revenues.
$155 × 10,000 = $1,550,000

13. Steps in Developing Flexible Budgets
Determine the flexible budget for costs.
Variable costs: 10,000 × $115 = $1,150,000
Fixed costs ,000
Total costs $1,436,000

14. Variances Level 2 analysis provides information
on the two components of the
static-budget variance.
1. Flexible-budget variance
2. Sales-volume variance

15. Flexible-Budget Variance
(Level 2) in (000)
Flexible
Budget Actual Variance
Suits
Revenue $1,550 $1,600 $ 50 F
Variable costs , , U
Contribution margin $ $ $ 0
Fixed costs U
Operating income $ $ $ 14 U

16. Flexible-Budget Variance
Actual quantity sold: 10,000 suits
Actual results
operating income
$100,000
Flexible-budget
variance
$14,000 U
Flexible-budget
operating income
$114,000

17. Flexible-Budget Variance
Total flexible-budget variance
= Total actual results
– Total flexible budget for actual sales level

18. Flexible-Budget Variance
Actual Budgeted
Amount Amount
Selling price $ $155
Variable cost
Contribution margin $ $ 40

19. Flexible-Budget Variance
Why is the flexible-budget variance $14,000 U?
Selling-price variance $50,000 F
Actual variable costs exceeded
flexible budget variable costs 50,000 U
Actual fixed costs exceeded
flexible budget fixed costs ,000 U
Total flexible-budget variance $14,000 U

20. Sales-Volume Variance
(Level 2) in (000)
Flexible Static Sales-Volume
Budget Budget Variance
Suits U
Revenue $1,550 $2,015 $465 U
Variable costs 1, , F
Contr. margin $ $ $120 U
Fixed costs
Operating income $ $ $120 U

21. Sales-Volume Variance
Actual quantity sold: 10,000 suits
Flexible-budget
operating income
$114,000
Sales-volume
variance
$120,000 U
Static-budget
operating income
$234,000

22. Sales-Volume Variance
Actual sales unit – Master budgeted sales units
13,000 – 10,000 = 3,000 ×
Budgeted contribution margin per unit $40 =
Total sales-volume variance $120,000 U

23. Budget Variances Level 1 Static-budget variance $134,000 U Level 2
Flexible-budget
variance
$14,000 U
Sales-volume
variance
$120,000 U

24. Explain why standard costs are often used in variance analysis.
Learning Objective 3
Explain why standard costs are
often used in variance analysis.

25. × Standards Pasadena’s budgeted cost for each variable
direct cost item is computed as follows:
Standard input
allowed for
one output unit ×
Standard cost
per input unit

26. Standards 4.00 square yards allowed per output unit
at $16.25 standard cost per square yard.
Standard cost per output unit
4.00 × $16.25 = $65.00

27. Standards 2.00 manufacturing labor-hours of input
allowed per output unit at $13.00 standard
cost per hour.
Standard cost per output unit
2.00 × $13.00 = $26.00

28. Compute price variances and efficiency variances
Learning Objective 4
Compute price variances
and efficiency variances
for direct-cost categories.

29. Actual Data Direct materials purchased and used:
42,500 square yards at $15.95
Cost of direct materials = $677,875
Labor hours: 21,500 at $12.90
Cost of direct manufacturing labor = $277,350

30. Price Variance Example
Direct-material price variance
Actual price – Budgeted price
Actual
quantity × =
($15.95 – $16.25) × 42,500 = $12,750 F =

31. Price Variance Example
Direct-labor price variance
Actual price – Budgeted price
Actual
quantity × =
($12.90 – $13.00) × 21,500 = $2,150 F =

32. Price Variance Example
What is the journal entry when the materials price
variance is isolated at the time of purchase?
Materials Control ,625
Direct-Materials Price Variance ,750
Accounts Payable Control ,875
To record direct materials purchased

33. Efficiency Variance Example
Direct-material efficiency variance
Actual quantity – Standard quantity
Standard
price × =
(42,500 – 40,000) × $16.25 = $40,625 U =

34. Efficiency Variance Example
Direct-labor efficiency variance
Actual quantity – Standard quantity
Standard
price × =
(21,500 – 20,000) × $13.00 = $19,500 U =

35. What is the journal entry to record materials used?
Efficiency Variance
What is the journal entry to record materials used?
Work in Process Control ,000
Direct-Materials Efficiency Variance 40,625
Materials Control ,625
To record direct materials used

36. Price and Efficiency Variance
What is the journal entry for direct manufacturing labor?
Work in Process Control 260,000
Direct Manufacturing
Labor Efficiency Variance 19,500
Direct-Manufacturing
Labor Price Variance ,150
Wages Payable ,350
To record liability for direct manufacturing labor

37. Flexible Budget Material Variance Example
Actual
Cost
$677,875
AQ × BP
42,500 × $16.25
$690,625
BQ × BP
40,000 × $16.25
$650,000
$12,750 F
$40,625 U
$27,875 U

38. Flexible Budget Labor Variance Example
Actual
Cost
$277,350
AQ × BP
21,500 × $13.00
$279,500
BQ × BP
20,000 × $13.00
$260,000
$2,150 F
$ 19,500 U
$17,350 U

39. Variance Analysis Level 1 Static-budget variance Materials $167,125 F
Labor ,650 F
Total $227,775 F
Level 2
Level 2
Flexible-budget variance
Materials $27,875 U
Labor 17,350 U
Total $45,225 U
Sales-volume variance
Materials $195,000 F
Labor ,000 F
Total $273,000 F

40. Flexible-budget variance
Variance Analysis
Level 2
Flexible-budget variance
Materials $27,875 U
Labor 17,350 U
Total $45,225 U
Level 3
Level 3
Price variance
Materials $12,750 F
Labor ,150 F
Total $14,900 F
Efficiency variance
Materials $40,625 U
Labor 19,500 U
Total $60,125 U

41. Explain why purchasing performance measures should
Learning Objective 5
Explain why purchasing
performance measures should
focus on more factors than
just price variances.

42. Performance Measurement Using Variances
Effectiveness is the degree to which a
predetermined objective or target is met.
Efficiency is the relative amount of inputs
used to achieve a given level of output.
Variances should not solely be used to
evaluate performance.

43. When to Investigate Variances
When should variances be investigated?
Subjective judgments
Rules of thumb as “investigate all variances
exceeding $10,000 or 25% of expected cost,
whichever is lower.”

44. into variance analysis.
Learning Objective 6
Integrate continuous
improvement
into variance analysis.

45. Continuous Improvement
Assume that the budgeted direct materials cost for
each suit that Pasadena Co. manufactures is $65.
Pasadena Co. wants to implement continuous
improvement budgets based on a target 1%
materials cost reduction each period.
What should the budgeted cost be for the
next 3 subsequent periods?

46. Continuous Improvement
Prior Period Reduction Revised
Budgeted in Budgeted
Amount Budget Amount
This Period: – – $65.00
Period 1: $ $ $64.35
Period 2: $ $ $63.71
Period 3: $ $ $63.07

47. Perform variance analysis in activity-based costing systems.
Learning Objective 7
Perform variance analysis in
activity-based costing systems.

48. Flexible Budgeting and Activity-Based Costing
Materials costs and direct manufacturing labor
costs are examples of output-unit level costs.
Batch-level costs are resources sacrificed
on activities that are related to a group of
units of product(s) or service(s) rather than
to each individual unit of product or service.

49. Flexible Budgeting and Activity-Based Costing
Denver Co. produces metal planters (MP).
Assume that material-handling labor costs vary
with the number of batches produced rather
than the number of units in a batch.
Material-handling labor costs are direct batch
level costs that vary with the number of batches.

50. Flexible Budgeting and Activity-Based Costing
Static Actual
Budget Amounts
Units produced and sold 18,000 15,660
Batch size
Number of batches
Material-handling
labor-hours per batch

51. Flexible Budgeting and Activity-Based Costing
Static Actual
Budget Amounts
Total labor-hours
Cost per material-handling
labor-hour $ $14.50
Total material-handling
labor cost $7,000 $6,786

52. Flexible Budgeting and Activity-Based Costing
How many batches should have been employed
to produce the actual output units?
15,660 units ÷ 180 units per batch = 87 batches
How many material-handling hours
should have been used?
87 batches × 5 hours/batch = 435 hours

53. Flexible Budgeting and Activity-Based Costing
What is the flexible budget for
material-handling labor-hours?
435 hours × $14.00/labor-hour = $6,090
Flexible-budget costs $6,090
Actual costs ,786
Flexible-budget variance $ U

54. Price and Efficiency Variances
Price variance = ($14.50 – $14.00) × = $234 U
Efficiency variance = (468 – 435) × $14.00 = $462 U
Total variance $696 U

55. Describe benchmarking
Learning Objective 8
Describe benchmarking
and how it is used
in cost management.

56. Benchmarking It refers to the continuous process of
measuring products, services, and activities
against the best levels of performance.

57. End of Chapter 7