1. MSE608C – Engineering and Financial Cost Analysis Budgeting and Variance Analysis

2. A Monthly Budget Variance Report

3. Positive and Negative Variances Definition –Positive Variances = increase profits They are sometimes called Credit Variances –Negative Variances = decrease profits They are sometimes called Debit Variances –Positive Variances are not necessarily good for a company and a Negative Variance is not necessarily bad.

4. Variance Analysis There are two sources of Variance between BUDGETS and ACTUALS. –Spending differences Variance due to the COST paid for resources (price or rate) AQ (AP – SP) –Volume differences Variance in the QUANTITY used (volume or level of activity) SP (AQ – SQ)

5. The Variance Format AQ = Actual Quantity or Actual Volume or Actual Hours AP = Actual Price or Actual Rate SQ = Standard Quantity or Standard Volume or Standard Hours SP = Standard Price or Standard Rate ACTUAL QUANTITY AT ACTUAL PRICE (ACTUALS) AQ x A P ACTUAL QUANTITY AT STANDARD PRICE AQ x SP STANDARD QUANTITY AT STANDARD PRICE SQ x S P 123 1 – 2 = PRICE VARIANCE AQ(AP-SP) 2 – 3 = QUANTITY VARIANCE SP(AQ-SQ) TOTAL VARIANCE (1 - 2) + (2 - 3) Negative Variances are Favorable (a credit to Overhead Variance) Positive Variances are Unfavorable (a debit to Overhead Variance)

6. Where is the information found? 123 1 - 2 SPENDING VARIANCE 2 - 3 VOLUME VARIANCE TOTAL VARIANCE (1 - 2) + (2 - 3) ACTUAL COSTS (PROVIDED BY ACCOUNTING) ACTUAL AMOUNT OF RESOURCE AT STANDARD PRICE (CALCULATED) BUDGETED COSTS (PROVIDED BY ACCOUNTING) (1) Actual $$$ given on monthly Variance Analysis report (3) Budgeted $$$ given on monthly Variance Analysis report (2) Calculated by getting AQ and SP from Accounting or other source of budget information = AQ x AP = AQ x SP = SQ x SP

7. Graphical Analysis Budgeted VolumeActual Volume Budgeted $$ Expected $$ @ Actual volume Actual $$ OH $$ Activity Level Spending Variance due to Price (rate) Volume Variance due to activity (quantity) Budgeted Resource ($$ per unit resource) 1 2 3

8. A Monthly Budget Variance Report

9. Overhead Variances under Full- absorption Costing Variation for Y = mx + b Where Y = applied overhead m = Variable Overhead rate (budgeted) x = actual quantity of overhead vehicle (i.e. hours) b = Fixed Overhead expenses (budgeted) ACTUAL QUANTITY AT ACTUAL PRICE (ACTUALS) AQ x A P ACTUAL QUANTITY AT STANDARD PRICE Y = mx + b STANDARD QUANTITY AT STANDARD PRICE SQ x S P 123 1 – 2 = PRICE VARIANCE AQ(AP-SP) 2 – 3 = QUANTITY VARIANCE SP(AQ-SQ) TOTAL VARIANCE (1 - 2) + (2 - 3) 2

10. Full-absorption Overhead Variance Analysis Budgeted Volume Actual Volume Budgeted OH $$ Applied (Absorbed) Volume-adjusted OH $$ Activity Level Variance due to Price (rate) Variance due to Volume (quantity) ALLOCATED OVERHEAD BUDGETED OVERHEAD Y=mx + b 1 2 3 Actual Overhead Spending

11. Fixed (Static) vs.Flexible Budgets Fixed (Static) Budgets –Geared to one level of activity. –Costs are always based on this one level. Flexible Budgets –Separates Fixed and Variable Expenses –Considers different levels of business activity –More accurate and effective for managing profits.

12. Fixed (Static) Budget

13. Flexible (Volume Adjusted) Budget

14. Example of a Flexible Budget

15. Assessment What is the difference between Fixed (static) and Flexible budgets? The equation that represents budgeted Full- absorption Overhead is __________ ? Budgeted and allocated (absorbed) Overhead can only intersect at one point. True or False?