1. 24 - 1©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Flexible Budgets and Standard Costs Chapter 24

2. 24 - 2©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Objective 1 Prepare a flexible budget for the income statement.

3. 24 - 3©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Oasis Pools Comparison of Actual Results with Static Budget For the Month Ended May 31, 2002 Actual Static Results Budget Variance Pools 10 8 2 F Revenues$150,000$120,000$30,000 F Expenses 119,000 95,000$24,000 U Income$ 31,000$ 25,000$ 6,000 F Static versus Flexible Budgets

4. 24 - 4©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Static versus Flexible Budgets Expected Output Volume Only Static Budget (8 Pools)

5. 24 - 5©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Static versus Flexible Budgets Range of Output Volumes Flexible Budget (5 Pools)(8 Pools)(10 Pools)

6. 24 - 6©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Flexible Budgets What are the flexible budgets for Oasis Pools when expected volume is 5, 8, and 10 pools? Budgeted sales price per pool is $15,000. Budgeted variable expenses per pool are $10,375. Total budgeted fixed cost is $12,000.

7. 24 - 7©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Flexible Budgets Oasis Pools Flexible Budgets Units 5 8 10 Sales revenue$75,000$120,000$150,000 Variable expenses 51,875 83,000 103,750 Fixed expenses 12,000 12,000 12,000 Operating income$11,125$ 25,000$ 34,250

8. 24 - 8©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Graphing the Flexible Budget Formula $115,750 $95,000 $63,875 $12,000 Variable cost $10,375 per pool installed Fixed cost $12,000 per month Total cost line

9. 24 - 9©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Graphing the Flexible Budget Formula The flexible budget graph shows budgeted expenses for 10 pools. Variable expenses$103,750 Fixed expenses 12,000 Total expenses$115,750 May actual expenses were $119,000. They exceeded the budgeted by $3,250.

10. 24 - 10©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Objective 2 Prepare an income statement performance report.

11. 24 - 11©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Oasis Pools Performance Report Actual Flexible Static Results Budget Budget Pools 10 10 8 Revenues$150,000$150,000$120,000 Variable expenses 105,000 103,750 83,000 Fixed expenses 14,000 12,000 12,000 Total expenses 119,000 115,750 95,000 Income$ 31,000$ 34,250$ 25,000

12. 24 - 12©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Oasis Pools Performance Report Flexible Budget Variance Sales Volume Variance Actual Results $31,000 Static Budget $25,000 Flexible Budget $34,250 $3,250 U $9,250 F

13. 24 - 13©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Oasis Pools Performance Report Static Budget Variance Actual Results $31,000 Static Budget $25,000 $6,000 U

14. 24 - 14©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber The Flexible Budget and Variance Analysis n The flexible budget variance is the difference between what the company spent at the actual level of output and what it should have spent to obtain the actual level of output. n It highlights the difference between actual costs and flexible budget costs.

15. 24 - 15©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber The Flexible Budget and Variance Analysis n Oasis Pools actually incurred $105,000 of variable costs to install the 10 pools. n This was $1,250 more than the $103,750 budgeted variable cost for 10 pools. n Oasis Pools also spent $2,000 more than budgeted on fixed expenses ($14,000 – $12,000).

16. 24 - 16©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Objective 3 Identify the benefits of standard costs.

17. 24 - 17©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Benefits of Standard Costs n Standard costs are carefully predetermined costs. n They help managers plan by providing the unit amounts, which are the building blocks of budgeting. n They help simplify record keeping. n Standard quantity often is referred to as the quantity that should have been used.

18. 24 - 18©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Objective 4 Compute standard cost variances for direct materials and direct labor.

19. 24 - 19©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Direct Material and Direct Labor Variances 1 Price, or rate, which measures how well the business keeps unit prices of materials and labor within standards. 2 Efficiency, or quantity, which measures whether the quantity of materials or labor used to make the actual number of outputs is within the budget.

20. 24 - 20©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Price Variance... – is the difference between the actual price and standard price of inputs used multiplied by the actual quantity of inputs. n Price variance = (Actual quantity × Actual price) – (Actual quantity × Standard price) or... n Actual quantity × (AP – SP)

21. 24 - 21©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Efficiency Variance... – is the difference between the actual and standard quantity of inputs allowed multiplied by the standard price of input. n Efficiency variance = (Actual quantity × Standard price) – (Standard quantity × Standard price) or... n Standard price × (AQ – SQ)

22. 24 - 22©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Variance analysis begins with a total variance to be explained – in this example, $3,250. Actual variable expenses$105,000 Flexible budget–103,750 Difference 1,250 Actual fixed expenses were $2,000 more than budgeted. Example of Standard Costing

23. 24 - 23©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Materials Variances Direct materials cost was $3,575 per cubic foot. SQ of materials allowed (gunite) was 1,000 cubic feet per pool. Standards Actual Results (10 pools were built) AP paid per cubic foot = $3.00 AQ of materials used = 12,000 cubic feet

24. 24 - 24©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Price variance: 12,000($3.00 – $3.575) = $6,900 favorable Efficiency variance: $3.575(12,000 – 10,000) = $7,150 unfavorable Flexible budget variance: $6,900 – $7,150 = $250 unfavorable Materials Variances

25. 24 - 25©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Materials Variances n Actual cost incurred: (Actual inputs × Actual price) = 12,000 × $3 = $36,000 n Standard cost of actual inputs: (Actual inputs × Standard price) = 12,000 × $3.575 = $42,900 n Flexible budget: (Standard inputs × Standard price) = 10,000 × $3.575 = $35,750

26. 24 - 26©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Labor Variances Standards Actual Results (10 pools were built) Direct labor cost was $6,000 per pool. SP (rate) was $15 per hour. Standard hours per pool was 400. AP (actual rate) was $16.10 per hour. AQ (actual hours) was 3,800.

27. 24 - 27©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Labor Variances Price (or rate) variance: 3,800($16.10 – $15.00) = $4,180 unfavorable Efficiency variance: $15.00(3,800 – 4,000) = $3,000 favorable Flexible budget variance: $4,180 – $3,000 = $1,180 unfavorable

28. 24 - 28©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Labor Variances n Actual cost incurred: (Actual inputs × Actual price) = 3,800 × $16.10 = $61,180 n Standard cost of actual inputs: (Actual inputs × Standard price) = 3,800 × $15 = $57,000 n Flexible budget: (Standard inputs × S tandard price ) = 4,000 × $15 = $60,000

29. 24 - 29©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Flexible Budget Variances for Materials and Labor Flexible budget variance for materials$ 250 U Flexible budget variance for labor 1,180 U Total variances$1,430 U Total flexible budget variance$3,250 U Materials and labor variances 1,430 U Flexible budget overhead variances$1,820 U

30. 24 - 30©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Objective 5 Analyze manufacturing overhead in a standard cost system.

31. 24 - 31©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Manufacturing Overhead Variances n The flexible budget variance for manufacturing overhead shows whether managers are keeping total overhead costs within the budgeted amount for the actual production of the period. n The production volume variance arises when actual production differs from the level in the static budget.

32. 24 - 32©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Allocating Overhead to Production n Oasis Pools allocates manufacturing overhead to production based on standard direct labor hours for the actual number of outputs. n The static budget, which is based on expected output of 8 pools, is known at the beginning of the period.

33. 24 - 33©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Allocating Overhead to Production Standards Actual Results (10 pools were built) Variable overhead cost was $800 per pool. Standard hours per pool were 400. Fixed overhead cost was $12,000. Actual variable overhead was $7,820. Actual hours were 3,800, fixed overhead was $14,000, and total overhead was $21,820.

34. 24 - 34©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Allocating Overhead to Production n In a standard cost system, manufacturing overhead is allocated to production based on a predetermined overhead rate. n Most companies base their predetermined overhead rates on amounts from the static (master) budget which is known at the beginning of the year.

35. 24 - 35©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Allocating Overhead to Production Oasis Pools Budget Data for the Month Ended May 30, 2002 Budget type Static Flexible Pools 8 10 Standard direct labor hours 3,200 4,000 Overhead cost: Variable$ 6,400$ 8,000 Fixed 12,000 12,000 Total$18,400$20,000

36. 24 - 36©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Allocating Overhead to Production Standard variable overhead rate per hour: $6,400 ÷ 3,200 = $2.00 Standard fixed overhead rate per hour: $12,000 ÷ 3,200 = $3.75

37. 24 - 37©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Total Manufacturing Overhead Variance... – is the amount of underallocated or overallocated manufacturing overhead. n This is the difference between actual manufacturing overhead and allocated manufacturing overhead.

38. 24 - 38©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Total Manufacturing Overhead Variance How much standard overhead is allocated to production? 4,000 × $2.00$ 8,000 variable 4,000 × $3.75 15,000 fixed Total$23,000 Total manufacturing overhead cost variance: $23,000 – $21,820 = $1,180 favorable

39. 24 - 39©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Total Manufacturing Overhead Variance n The total manufacturing overhead variance is split into the manufacturing flexible budget variance and the production volume variance. n Flexible budget overhead for actual production = $12,000 + (4,000 × $2) = $20,000.

40. 24 - 40©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Overhead Flexible Budget Variance Oasis Pools – a comparison of actual results with the flexible budget overhead for actual production: Actual Results Flexible Budget Variance Pools 10 10 Overhead cost: Variable$ 7,820$ 8,000 $ 180 F Fixed 14,000 12,000 $2,000 U Total$21,820$20,000 $1,820 U Overhead flexible variance is $1,820 unfavorable.

41. 24 - 41©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Variable Overhead Variances n Actual cost incurred: (Actual inputs × Actual price) = $7,820 n Standard cost of actual inputs: (Actual inputs × Standard price) = $7,600 n Flexible budget: (Standard inputs × Standard price) = $8,000

42. 24 - 42©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Production Volume Variance... – is the difference between the fixed overhead cost in the flexible budget for actual production and the standard fixed overhead allocated to production. n 4,000 × $3.75 = $15,000 allocated n How much is the volume variance? n $12,000 – $15,000 = $3,000 favorable volume variance

43. 24 - 43©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Flexible budget variance$1,820 U Volume variance 3,000 F Total$1,180 F Total Overhead Variances

44. 24 - 44©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Flexible Budget Variance Flexible budget variance: $3,250 U Materials$ 250 U Labor 1,180 U Flexible budget for overhead 1,820 U Total$3,250 U

45. 24 - 45©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Total Variances n Why was actual income $3,250 less than the flexible budget for 10 pools? n Variable costs exceeded the flexible budget by $1,250 and actual fixed costs exceeded the static budget by $2,000.

46. 24 - 46©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Record transactions at standard cost. Objective 6

47. 24 - 47©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber What is the entry to record the purchase of 12,000 cubic feet of materials (actual price paid was $3.00 per cubic foot and the standard being $3.575/cubic foot)? Standard Costs in the Accounts Materials Inventory42,900 Direct Materials Price Variance 6,900 Accounts Payable36,000 To record purchases of direct materials

48. 24 - 48©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber What is the entry to record the transfer of 12,000 actual cubic feet of materials to work in process inventory? Standard Costs in the Accounts Work in Process Inventory35,750* Direct Materials Efficiency Variance 7,150 Materials Inventory42,900 To record use of materials *10,000 SQ × $3.575 SP

49. 24 - 49©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Standard Costs in the Accounts n Notice that in these entries direct materials price variance is recorded at the time of purchase. n An unfavorable variance has a debit balance which increases the expense. n A favorable variance has a credit balance in the accounts and is a reduction in expenses.

50. 24 - 50©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Standard Costs in the Accounts Manufacturing Overhead21,820 Accounts Payable, Accumulated Depreciation, and Other accounts21,820 To record actual overhead costs incurred

51. 24 - 51©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Standard Costs in the Accounts What is the entry to record allocated manufacturing overhead? Work in Process Inventory23,000 Manufacturing Overhead23,000 To allocate overhead

52. 24 - 52©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Other Entries Finished Goods Inventory118,750 Work in Process Inventory118,750 To record completion of 10 pools Cost of Goods Sold118,750 Finished Goods Inventory118,750 To record sale of 10 pools

53. 24 - 53©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Closing Variances Unfavorable Variances Favorable Variances Materials price$ 6,900 Labor efficiency 3,000 Production volume 3,000 Total$12,900 Materials efficiency$ 7,150 Labor rate 4,180 Flexible budget 1,820 Total$13,150

54. 24 - 54©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Closing Variances $13,150 unfavorable – $12,900 favorable = $250 unfavorable Income Summary250 Net Variance250 To close various variances This entry increases the cost of goods sold.

55. 24 - 55©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Prepare a standard cost income statement for management. Objective 7

56. 24 - 56©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Standard Cost Income Statement for Management Standard Costing Revenues$150,000 Cost of goods sold 118,750 Unadjusted income$ 31,250 Actual Costing Revenues$150,000 Cost of goods sold 119,000 Unadjusted income$ 31,000

57. 24 - 57©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Standard Cost Income Statement for Management n Closing the $250 net unfavorable variance to income summary increases the cost of goods sold to $119,000. n This produces the $31,000 income figure.

58. 24 - 58©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber End of Chapter 24