1. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 1 Chapter 8 - Flexible Budgets and Variance Analysis Distinguish between flexible budgets and master (static) budgets. Learning Objective 1

2. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 2 Static Budgets l Static budget is really just another name for master budget. l A master budget is prepared for only one level of a given type of activity. l All actual results are compared with the original budgeted amounts, even if sales volume is less than originally planned.

3. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 3 Performance Report Performance report is a generic term that usually means a comparison of actual results with some budget. Variance is a deviation of an actual amount from the expected or budgeted amount.

4. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 4 Master Budget Variance: Revenue Actual Budget Variance $400,000 $380,000 $20,000 F $370,000 $380,000 $10,000 U The variances of actual results from the master budget are called master (static) budget variances.

5. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 5 Master Budget Variance: Expenses Actual expenses that are less than budgeted expenses result in favorable expense variances. Actual expenses that exceed budgeted expenses result in unfavorable expense variances.

6. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 6 Objective 2 Use flexible-budget formulas to construct a flexible budget based on the volume of sales.

7. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 7 Flexible Budget l A flexible budget (variable budget) is a budget that adjusts for changes in sales volume and other cost-driver activities.

8. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 8 Flexible Budget Formulas The flexible budget is based on the same assumptions of revenue and cost behavior (within the relevant range) as is the master budget. The flexible budget incorporates effects on each cost and revenue caused by changes in activity.

9. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 9 E.g. of Flexible Budgets

10. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 10 Objective 3 Understand the performance evaluation relationship between master (static) budgets and flexible budgets.

11. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 11 Performance Evaluation Using Flexible Budgets Comparing the flexible budget to actual results accomplishes an important performance evaluation purpose.

12. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 12 Performance Evaluation Using Flexible Budgets l There are basically two reasons why actual results might differ from the master budget. 1 Sales and other cost-driver activities were not the same as originally forecasted. 2 Revenue or variable costs per unit of activity and fixed costs per period were not as expected.

13. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 13 Performance Evaluation Using Flexible Budgets The intent of using the flexible budget for performance evaluation is to isolate unexpected effects on actual results that can be corrected if adverse or enhanced if beneficial.

14. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 14 Objective 4 Compute flexible-budget variances and sales-activity variances.

15. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 15 Flexible-Budget Variances Flexible Budget Variances Actual Results Flexible Budget

16. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 16 Flexible-Budget Variances Activity-Level Variances Flexible Budget Master Budget

17. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 17 Distinguish Between Effectiveness and Efficiency Effectiveness is the degree to which a goal, objective, or target is met. Efficiency is the degree to which inputs are used in relation to a given level of outputs.

18. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 18 Isolating the Causes of Variances l Managers use comparisons among actual results, master budgets, and flexible budgets to evaluate organizational performance. l Performance may be effective, efficient, both, or neither.

19. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 19 Flexible-Budget Variances Total flexible-budget variance = Total actual results – Total flexible budget for actual sales activity level

20. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 20 Sales-Activity Variances Total sales-activity variance = Actual sales unit – Master budgeted sales units × Budgeted contribution margin per unit

21. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 21 Objective 6 Compute and interpret price and usage variances for inputs based on cost-driver activity.

22. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 22 Expectations, Standard Costs, and Standard Cost Systems l Expectations or standard costs are the building blocks of a planning and control system.

23. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 23 Expectations, Standard Costs, and Standard Cost Systems l An expected cost is the cost that is most likely to be attained. l A standard cost is a carefully developed cost per unit that should be attained. l Standard cost systems are accounting systems that value products according to standard costs only.

24. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 24 Perfection Standards... – or ideal standards, are expressions of the most efficient performance possible under the best conceivable conditions, using existing specifications and equipment. l No provision is made for waste, spoilage, machine breakdowns, and the like.

25. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 25 Currently Attainable Standards... – are standards based on levels of performance that can be achieved by realistic levels of effort. l Allowances are made for normal defects, spoilage, waste, and nonproductive time.

26. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 26 Trade-Offs Among Variances l Improvements in one area could lead to improvements in others and vice versa. l Likewise, substandard performance in one area may be balanced by superior performance in others.

27. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 27 When to Investigate Variances When should variances be investigated? Knowing exactly when to investigate is difficult. Many organizations have developed such rules of thumb as “investigate all variances exceeding $5,000 or 25% of expected cost, whichever is lower”.

28. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 28 Flexible-Budget Variance Example Standard per unit of output: DirectDirect MaterialLabor Std. inputs expected5 pounds½ hour Std. price expected$ 2$16 Std. cost expected$10$ 8

29. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 29 Flexible-Budget Variance Example Actual results for 7,000 units produced: Direct material Pounds purchased and used: 36,800 Price/pound: $1.90 Total actual cost: $69,920 Direct labor Hours used: 3,750 Actual price (rate): $16.40 Total actual cost: $61,500

30. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 30 Flexible-Budget Variance Example Flexible budget (or total standard cost allowed) Units of good output achieved Input allowed per unit of output Standard unit price on input × × =

31. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 31 Flexible-Budget Variance Example Flexible budget (or total standard cost allowed): $70,000 Units of good output achieved: 7,000 Input allowed per unit of output: 5 pounds Standard unit price on input: $2 per pound × × = Standard Direct-Materials Cost Allowed

32. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 32 Flexible-Budget Variance Example Direct material flexible budget variance = $80 F Actual Cost $69,920 Flexible Budget $70,000

33. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 33 Flexible-Budget Variance Example Flexible budget (or total standard cost allowed): $56,000 Units of good output achieved: 7,000 Input allowed per unit of output: ½ hour Standard unit price on input: $16 per hour × × = Standard Direct-Labor Cost Allowed

34. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 34 Flexible-Budget Variance Example Direct labor flexible budget variance = $5,500 U Actual Cost $61,500 Flexible Budget $56,000

35. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 35 Price Variance Computations Direct-material price variance Actual price – Standard price × Actual quantity ($1.90 – $2.00) per pound × 36,800 pounds = $3,680 favorable = =

36. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 36 Price Variance Computations Direct-labor price variance Actual price – Standard price × Actual quantity ($16.40 – $16.00) per hour × 3,750 hours = $1,500 unfavorable = =

37. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 37 Price Variance Computations Direct-material usage variance Actual quantity – Standard quantity × Standard price [36,800 – (7,000 × 5)] pounds × $2.00 per pound = $3,600 unfavorable = =

38. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 38 Price Variance Computations Direct-labor usage variance Actual quantity – Standard quantity × Standard price [3,750 – (7,000 × ½)] hours × $16 per hour = $4,000 unfavorable = =

39. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 39 Favorable or Unfavorable Variance? l To determine whether a variance is favorable or unfavorable, use logic rather than memorizing a formula.

40. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 40 Effects of Inventories l What if production does not equal sales? l The sales-activity variance then is the difference between the static budget and the flexible budget for the number of units sold. l In contrast, the flexible-budget cost variances compare actual costs with flexible-budgeted costs for the number of units produced.

41. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 41 Objective 7 Compute variable overhead spending and efficiency variances.

42. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 42 Variable Overhead Variances Spending variance Efficiency variance

43. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 43 Variable-Overhead Efficiency Variance When actual cost-driver activity differs from the standard amount allowed for the actual output achieved, a variable-overhead efficiency variance will occur.

44. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 44 Variable-Overhead Spending Variance... – is the difference between the actual variable overhead and the amount of variable overhead budgeted for the actual level of cost-driver activity.

45. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 45 Flexible-Budget Variance Example Standard variable overhead rate per unit of output: $0.60 per unit or $1.20 per direct labor hour ½ hour is allowed per unit of output Suppose that Dominion Company’s cost of supplies, a variable-overhead cost, is driven by direct-labor hours.

46. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 46 Flexible-Budget Variance Example Actual variable overhead = $4,700 Variable overhead allowed = $.60 × 7,000 units = $4,200 $500 unfavorable variance

47. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 47 Price Variance Computations Variable-overhead efficiency variance Actual direct labor hours – Standard hours × Standard rate per hour (3,750 actual hours – 3,500 standard hours allowed) × $1.20 per hour = $300 unfavorable = =

48. ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 8 - 48 Price Variance Computations Variable-overhead spending variance Actual variable overhead – Expected rate per hour × Actual direct-labor hours used ($4,700 – ($1.20 × 3,750 hours) = $200 unfavorable = =