YANBU UNIVERSITY COLLEGE
Management Science Department
ACCT 315
COST ACCOUNTING
MODULE 2
Flexible Budgets, Direct-Cost Variances and Management
Control
(Chapter 7)
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Learning Objectives For This Module
• Understand static budgets and static-budget
variances
• Examine the concept of a flexible budget and learn
how to develop one
• Calculate flexible-budget variances and sales-
volume variances
• Explain why standard costs are often used in
variance analysis
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Learning Objectives For This Module
• Compute price variances and efficiency variances
for direct cost categories
• Understand how managers use variances
• Describe benchmarking and explain its role in cost
management
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What is a Static Budget and a Static Budget Variance?
• The static (master) budget is based on the level of
output planned at the start of the budget period.
• A static budget variance is the differences between
the actual result and the correspondence budgeted
amount in the static budget.
• Favorable variance (F)—has the effect of increasing
operating income relative to the budget amount
• Unfavorable variance (U)—has the effect of
decreasing operating income relative to the budget
amount
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What is a Static Budget and a Static Budget Variance?
• Variances lie at the point where planning and
control functions come together.
• Variances assist managers in implementing their
strategies by enabling Management by exception.
• Management by Exception is the practice of
focusing attention on areas not operating as
expected (budgeted).
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Variances
• Variance can be calculated at multiple levels.
• Variances may start out “at the top” with a Level 0
analysis.
• This is the highest level of analysis, a super-macro
view of operating results.
• The Level 0 analysis is nothing more than the
difference between actual and static-budget
operating income.
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Variances
• Further analysis decomposes (breaks down) the
Level 0 analysis into progressively smaller and
smaller components.
– Answers: “How much were we off?”
• Levels 1, 2, and 3 examine the Level 0 variance into
progressively more-detailed levels of analysis.
– Answers: “Where and why were we off?”
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Level 0 Analysis, Illustrated
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What is a Flexible Budget?
• A flexible budget calculates budgeted revenues and
budgeted costs based on the actual output in the
budget period.
• Prepared at the end of the period, after managers
know the actual output
• Flexible budget—shifts budgeted revenues and
costs up and down based on actual operating
results (activities)
• Represents a blending of actual activities and
budgeted dollar amounts
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What is a Flexible Budget?
• In a flexible budget, the selling price is the same as
the static budget, the budgeted unit variable cost is
the same, and, within the relevant range, total
fixed costs are the same.
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How can we develop a flexible budget?
• Step 1 – Identify the Actual Quantity of Output
• Step 2 – Calculate the Flexible Budget for Revenue
based on Budgeted Selling Price and Actual Quantity of
Output.
• Step 3 – Calculate the Flexible Budget for Costs based
on Budgeted Variable Costs per output unit, Actual
Quantity of output and Budgeted Fixed Costs.
• The flexible budget will allow for a more detailed
analysis of the static budget variance.
• Will allow for preparation of Level 2 and 3 variances
– Answers the question: “Why were we off?”
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Level 2 Analysis
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What is a flexible budget variances?
• The flexible budget variance is the difference
between an actual result and the corresponding
flexible budget amount.
• The sales volume variance is the difference
between a flexible budget amount and the
corresponding static budget amount.
• Sales Volume Variance arises solely from the
differences between the actual volume from the
static budget volume
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Reasons for Sales Volume Variance
• An unfavorable sales volume variance may occur
for many possible reasons:
1. Failure to execute the sales plan
2. Weaker than anticipated demand
3. Aggressive competitors taking market share
4. Unanticipated market preference away from the
product
5. Quality problems
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Illustration on Level 2
FLEXIBLE BUDGET AND STATIC BUDGET – ILLUSTRATION
Brabham Enterprise manufactures tires for the Formula 1 motor
racing circuit. For August 2012, it budgeted to manufacture and
sale 3000 tires at a variable costs of $74 per tire and total fixed
costs of $54000. The budgeted selling price was $110 per tire.
Actual results in August 2012, were 2800 tires manufactured and
sold at a selling price of $112 per tire. The actual total variable
costs were $229,600 and the actual total fixed costs were $50,000.
Required:
• Prepare a performance report that uses a flexible budget and a
static budget
• Comment on the results in (a)
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Flexible Budget Variance (Level 3)
• Level 3 variances provide even more detailed
information than we get from Level 2.
• All product costs can have Level 3 variances.
• Level 3 variances provide details of our level 2
flexible budget variances.
• The info from these variances helps managers to
better understand past performance and take
corrective actions to implement superior strategies
in the future
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Price Variance and Efficiency variance for Direct Cost Input
• Instead of simply identifying the difference
between actual material costs and (flexible)
budgeted costs, we can break that variance down
into a price variance component and an efficiency
component.
• Managers have control more on efficiency that
price as efficiency is from inside factors whereas
price is outside market force.
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Price Variance and Efficiency variance for Direct Cost Input
• A) Price variance – that reflects the difference
between an actual input price and a budgeted
input price
• B) Efficiency Variance – that reflects the difference
between an actual input quantity and a budgeted
input quantity.
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Flexible Budget Variances— Formulas
(Materials and Direct Labor)
Price Variance formula =
{Actual Price of Budgeted Price of x Actual Quantity of
Input – Input} Input
Efficiency Variance formula =
{Actual Quantity Budgeted Quantity x Budgeted Price of
of Input Used – of Input Allowed for Input
Actual Output}
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Level 3 Analysis
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Illustration on Level 3 – Direct Costs (Material)
• PRICE AND EFFICIENCY VARIANCE – MATERIALS
• Peterson Foods manufactures pumpkin scones. For
January2012, it budgeted to purchase and use 15000 pounds
of pumpkin at $0.89 a pound. Actual purchases and usage for
January 2012 were 16000 pounds at $0.82 a pound. Peterson
budgeted for 60,000 pumpkin scones. Actual output was
60800 pumpkin scones.
• Required:
• Compute the flexible budget variance
• Compute the price and efficiency variances.
• Comment on the results requirements 1 & 2 and provide a
possible explanation
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Illustration on Level 3 – Direct Costs (Labor)
PRICE AND EFFICIENCY VARIANCE – LABOR
Luxon manufactures statutes of famous historical figures. All statutes are the same
size. Each unit requires same amount of resources. The following information is from
the static budget of 2016
• Expected production and sales 6000units
• Direct Manufacturing Labor 21000 hours
The following are the standard quantities, standard price, and standard unit costs for
direct manufacturing labor:
• Standard Quantity Standard Price Standard Unit Cost
• Direct manufacturing labor 3.5 hours $50 per hour $175
During 2016, actual number units produced and sold was 5500. Total direct
manufacturing labor hours actually used were 18,500 at the rate of $51.50 per hour.
As a result, actual direct manufacturing labor costs were $ 952,750.
Required:
• Compute price and efficiency variances for direct manufacturing labor.
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Variance Summary
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Obtaining Budgeted Input Prices and Input Quantities
• Budgeted input prices and budgeted input
quantities can be obtained from a number of
sources, including actual input data from past
periods, data from other companies that have
similar processes and standards developed by the
firm itself
• A standard is a carefully determined price, cost, or
quantity that is used as a benchmark for judging
performance.
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Variances and Journal Entries
• Each variance may be journalized.
• Each variance has its own account.
• Favorable variances are credits; unfavorable
variances are debits.
• Variance accounts are generally closed into cost of
goods sold at the end of the period, if immaterial.
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What is a standard Cost system and why it is used in variance analysis?
• A standard cost system is a method of setting cost
targets and evaluating performance.
• Targets or expected costs are set based on a variety
of criteria, and actual performance relative to
expected targets is measured.
• Significant differences between expectations and
actual results are investigated.
• Standard cost systems are a means of helping
managers with decision making and control.
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Standard Costing as a useful tool
• Targets or standards are established for direct
material and direct labor.
• The standard costs are recorded in the accounting
system.
• Actual price and usage amounts are compared to
the standard and variances are recorded.
• Price and efficiency variances provide feedback to
initiate corrective actions.
• Standards are used to control costs.
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MANAGEMENT USES OF VARIANCE
• TO EVALUATE PERFORMANCE AFTER DECISIONS ARE
IMPLEMENTED
– CAUSES OF VARIANCE
• POOR DESIGN OF PRODUCT OR PROCESSES
• POOR WORK ON PRODUCTION LINE
• INAPPROPRIATE ASSIGNMENT OF LABOR OR MACHINE
• CONGESTION DUE TO SCHEDULING LARGE NUMBER OF ORDERS
– WHEN TO EVALUATE
– PERFORMANCE MEASUREMENT
• EFFECTIVENESS
• EFFICIENCY
• TO TRIGGER ORGANIZATION LEARNING
• CONTINOUS IMPROVEMENT
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Benchmarking and Variances
• Benchmarking is the continuous process of
comparing the levels of performance in producing
products and services against the best levels of
performance in competing companies.
• Variances can be extended to include comparison
to other entities.
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Benchmarking Example: Airlines
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END OF LECTURE
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