1. Copyright © 2003 Pearson Education Canada Inc. Slide 7-76 Chapter 7 Flexible Budgets, Variances and Management Control: I

2. Copyright © 2003 Pearson Education Canada Inc. Slide 7-77 Static and Flexible Budgets Static budget a budget based on a single level of output Flexible budget a budget which is adjusted for the actual level of output, revenue, or cost driver Standard cost a carefully predetermined amount representing what management thinks a cost should be Examples Standard quantity of materials = 2 kg. per unit Standard cost of materials = $8 per kg. Standard cost of materials= $16 per unit Page 236

3. Copyright © 2003 Pearson Education Canada Inc. Slide 7-78 Variances represent the difference between the cost that was incurred and the budgeted cost Actual cost > Budgeted cost = Unfavourable variance Budgeted cost > Actual cost = Favourable variance Variances Static ActualVarianceBudget Volume10,0002,000 U12,000 Revenue$1,850,000$310,000 U$2,160,000 Variable Costs1,120,000 68,000 F1,188,000 Contribution Margin730,000242,000 U972,000 Fixed costs705,000 5,000 F 710,000 Operating income$25,000$237,000 U$262,000 Pages 236 - 238 Static budget variance difference between actual results achieved and the original static budget

4. Copyright © 2003 Pearson Education Canada Inc. Slide 7-79 Static ActualBudget Volume10,00012,000 Revenue$1,850,000$2,160,000 Variable Costs1,120,0001,188,000 Contribution Margin730,000972,000 Fixed costs705,000 710,000 Operating income$25,000$262,000 Using A Flexible Budget Pages 238 - 240 $75,000 U Flexible budget variance $162,000 U Sales volume variance $237,000 U Total static budget variance Flexible Budget 10,000 $1,800,000 900,000 810,000 710,000 $100,000 Sales Volume Variance 2,000 U $360,000 U 198,000 F 162,000 U $162,000 U Flexible Budget Variances 0 $50,000 F 130,000 U 80,000 U 5,000 F $75,000 U

5. Copyright © 2003 Pearson Education Canada Inc. Slide 7-80 Selling Price Variance Variance analysis used to evaluate performance separate measures of effectiveness and efficiency Selling price variance = =($185 - $180) x 10,000 units = $50,000 F Pages 240 - 241 Actual selling price Budgeted selling price Actual units sold x -

6. Copyright © 2003 Pearson Education Canada Inc. Slide 7-81 Sales Volume Variance Effectiveness degree to which the organization’s goals were met measured by the Sales volume variance Sales volume variance = =(10,000 - 12,000) x $81 = $162,000 U Pages 240 - 241 Actual units sold Budgeted units sold Budgeted contribution margin per unit x - Note: This variance can be read as the difference between the contribution margin in the flexible and static budgets

7. Copyright © 2003 Pearson Education Canada Inc. Slide 7-82 Price and Efficiency Variances Price variance is the difference between the actual price and the budgeted price multiplied by the actual quantity of inputs used Efficiency variance is the difference between the actual quantity of inputs used and the budgeted quantity of inputs that should have been used, multiplied by the budgeted price Static Budget Variance Flexible Budget VarianceSales Volume Variance Price VarianceEfficiency Variance Pages 241 - 242

8. Copyright © 2003 Pearson Education Canada Inc. Slide 7-83 Price and Efficiency Variance - Materials ActualBudget Direct22,200 sq metres20,000 sq metres materials$31 per metre$30 per metre Price variance = (Actual price - Budgeted price) x Actual quantity used =($31 - $30) x 22,200 = $22,200 U Efficiency variance =(Actual quantity used - Budgeted quantity used) x Budgeted price =(22,200 - 20,000) x $30 = $66,000 U Pages 243 - 247

9. Copyright © 2003 Pearson Education Canada Inc. Slide 7-84 Price and Efficiency Variance – Labour I ActualBudget Manufacturing9,000 hours8,000 hours 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 Pages 243 - 247

10. Copyright © 2003 Pearson Education Canada Inc. Slide 7-85 Price and Efficiency Variance – Labour II ActualBudget Marketing2,304 hours2,500 hours 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 $25 = $4,704 F Pages 243 - 247

11. Copyright © 2003 Pearson Education Canada Inc. Slide 7-86 Price and Efficiency Variances Material Pages 243 - 247 Flexible Budget Variance $88,200 U Price Variance $22,200 U Efficiency Variance $60,000 U Manufacturing Labour Flexible Budget Variance $38,000 U Price Variance $18,000 U Efficiency Variance $20,000 U

12. Copyright © 2003 Pearson Education Canada Inc. Slide 7-87 Price and Efficiency Variances (Continued) Pages 243 - 247 Flexible Budget Variance $2,400 F Price Variance $2,304 U Efficiency Variance $4,704 F Marketing Labour

13. Copyright © 2003 Pearson Education Canada Inc. Slide 7-88 Evaluating Performance Variances are used to evaluate performance Effectiveness – the degree to which organization’s predetermined goals were met Efficiency - how well inputs were used in relation to a given level of output Variances indicate that something was difference than expected What is critical is to understand why variances arise and use this knowledge to promote learning and continuous improvement Most companies investigate only significant variances Pages 248 - 250

14. Copyright © 2003 Pearson Education Canada Inc. Slide 7-89 Continuous Improvement and Variances Using continuous improvement budgeted costs is another way to control variances Budgeted cost is successively reduced over succeeding time periods Signals importance of reducing costs Pages 250 - 251 Prior Month’sReduction inRevised MonthBudgeted AmountBudgeted AmountBudgeted Amount April--$60.00 May$60.00$0.600 (1% x $60.00)59.40 June59.40 $0.594 (1% x $59.40) 58.81 July58.81 $0.588 (1% x $58.81) 58.22

15. Copyright © 2003 Pearson Education Canada Inc. Slide 7-90 Benchmarking and Variance Analysis Can think of budgeted amounts as benchmarks (points of reference from which comparisons may be made) Benchmarking refers to the continual process of measuring products, services and activities against the best levels of performance May use internal or external benchmarks\ Key Questions to Ask Why are the cost levels different between units? How can best practices be transferred from more efficient to less efficient units? Pages 256 - 258