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Flexible Budgets, Direct-Cost Variances, and Management Control

Basic Concepts
Variancedifference between an actual and an

expected (budgeted) amount. Management by exceptionthe practice of focusing attention on areas not operating as expected (budgeted). Static (master) budget is based on the output planned at the start of the budget period.

Basic Concepts
Static-budget variance (Level 0)the difference

between the actual result and the corresponding static budget amount 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

Variances
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.

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?

Level 1 Analysis, Illustrated

Evaluation
Level 0 tells the user very little other than how much

contribution margin was off from budget.


Level 0 answers the question: How much were we off in

total?

Level 1 gives the user a little more information: it

shows which line-items led to the total Level 0 variance.


Level 1 answers the question: Where were we off?

Flexible Budget
Flexible budgetshifts budgeted revenues and costs

up and down based on actual operating results (activities) Represents a blending of actual activities and budgeted dollar amounts Will allow for preparation of Level 2 and 3 variances
Answers the question: Why were we off?

Level 2 Analysis, Illustrated

Level 3 Analysis, Illustrated

Level 3 Variances
All product costs can have Level 3 variances. Direct

materials and direct labor will be handled next. Overhead variances are discussed in detail in a later chapter. Both direct materials and direct labor have both price and efficiency variances, and their formulae are the same.

Variance Summary

Level 3 Variances
Price variance formula:
Price Variance

Actual Price Of Input

Budgeted Price Of Input

} X

Actual Quantity Of Input

Efficiency variance formula:


Efficiency Variance

Actual Quantity Of Input Used

Budgeted Quantity of Input Allowed for Actual Output

}X

Budgeted Price Of Input

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.

Standard Costing
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.

Standard Costs can be a Useful Tool


Price and efficiency variances provide feedback to

initiate corrective actions. Standards are used to control costs. Managers use variance analysis to evaluate performance after decisions are implemented. Part of a continuous improvement program.

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.

Benchmarking Example: Airlines

The textbook discusses three levels of variances, Level 0, Level 1, Level 2, and Level 3. Briefly explain the meaning of each of those levels and provide an example of a variance at each of those levels.
A Level 0 variance is simply the difference between actual operating income and planned operating income in the static budget. A Level 1 variance would be any of the differences between the static budget and the actual results that make up operating income. Examples of such differences could include the following items: Units sold (Static budget - actual) Revenues (Static budget - actual) Material costs (Static budget - actual) Direct manufacturing labor (Static budget - actual) Variable manufacturing overhead (Static budget - actual) Contribution margin (Static budget - actual) Fixed costs (Static budget - actual) A Level 2 variance subdivides the level 0 variance (which is the total of the Level 1 variances) into a sales volume variance and a flexible-budget variance. The sales volume variance is the difference between the flexible budget amount and the corresponding static budget amount. The flexible budget variance is an actual result and the corresponding flexible budget amount based on the actual output level in the budget period. Specific examples of Level 2 variances could include any of the items shown in the list of Level 1 variances. A Level 3 variance would include price variances that reflect the difference between the actual input price and a budgeted input price, such as the direct material price variance, the direct labor rate variance, and the variable overhead rate variance. Level 3 variances would also include efficiency variances that reflect the difference between an actual input quantity and a budgeted input quantity. Examples would include material quantity variances, labor efficiency variances, and variable overhead efficiency variances.

Question1.
Bowden Corporation used the following data to evaluate their current operating system. The company sells items for $20 each and used a budgeted selling price of $20 per unit. Actual Budgeted Units sold 46,000 units 45,000 units Variable costs $225,400 $216,000 Fixed costs $47,500 $50,000 A) What is the static-budget variance of revenues?

Explanation: A) (46,000 units $20) - (45,000 units $20) = $20,000 F


B) What is the static-budget variance of variable costs?

Explanation: B) $225,400- $216,000 = $9,400 U


C) What is the static-budget variance of operating income? C)
Actual Results Units sold 46,000 Static Budget 45,000 Static-budget Variance

Revenues Variable costs Contribution margin Fixed costs Operating income

$920,000 225,400 $694,600 47,500 $647,100

$900,000 216,000 $684,000 50,000 $634,000

$20,000 9,400 10,600 (2,500) $13,100

F U F F F

Question2.
Caan Corporation used the following data to evaluate their current operating system. The company sells items for $20 each and used a budgeted selling price of $20 per unit. Actual Budgeted Units sold 200,000 units 203,000 units Variable costs $1,250,000 $1,500,000 Fixed costs $ 925,000 $ 900,000 What is the static-budget variance of revenues?

Explanation: B) (200,000 units $20) - (203,000 units $20) = $60,000 U


What is the static-budget variance of variable costs?

Explanation: C) $1,250,000 - $1,500,000= $250,000 F


Static-budget Static-budget
Variance

What is the static-budget variance of operating income? Actual Static Actual Static Results Budget Results Budget Units sold 200,000 203,000
Units sold 200,000 203,000

Variance

Revenues Revenues Variable costs Variable costs Contribution margin Contribution margin Fixed costs Fixed costs Operating income
Operating income

$4,000,000 $4,000,000 1,250,000 1,250,000 $2,750,000 $2,750,000 925,000 925,000 $1,825,000


$1,825,000

$4,060,000 $4,060,000 1,500,000 1,500,000 $2,560,000 $2,560,000 900,000 900,000 $1,660,000


$1,660,000

$(60,000) U $(60,000) U (250,000) F (250,000) FF 190,000 190,000 25,000 FU 25,000 $165,000 U F


$165,000 F

Question3.

Everclean Filter Corporation used the following data to evaluate their current operating system. The company sells items for $10 each and had used a budgeted selling price of $11 per unit.
Actual 306,000 units $965,000 $ 53,000 Budgeted 300,000 units $950,000 $ 50,000

Units sold Variable costs Fixed costs

What is the static-budget variance of revenues? Explanation: (306,000 units $10) - (300,000 units $11) = $30,000 F What is the static-budget variance of variable costs? Explanation: $965,000 - $950,000= $15,000 U What is the static-budget variance of operating income? $12,000 favorable

Question5.
The president of the company, Gregory Peters, has come to you for help. Use the following data to prepare a flexible budget for possible sales/production levels of 10,000, 11,000, and 12,000 units. Show the contribution margin at each activity level. Sales price $24 per unit Variable costs: Manufacturing $12 per unit, Administrative $ 3 per unit, Selling $ 1 per unit Fixed costs: Manufacturing $60,000, Administrative $20,000 Answer: Flexible Budget for Various Levels of Sales/Production Activity

Units Sales Variable costs: Manufacturing Administrative Selling Total variable costs Contribution margin Fixed costs: Manufacturing Administrative Operating income/(loss)

10,000 11,000 12,000 $240,000 $264,000 $288,000 120,000 30,000 10,000 160,000 80,000 60,000 20,000 $ -0132,000 33,000 11,000 176,000 88,000 60,000 20,000 $ 8,000 144,000 36,000 12,000 192,000 96,000 60,000 20,000 $ 16,000

Question6.
Nicholas Company manufacturers TVs. Some of the company's data was misplaced. Use the following information to replace the lost data:
Actual Results 112,500 $42,080 (C) $8,280 $17,740 Flexible Variances $1,000 F $200 U $860 F (D) Flexible Budget 112,500 (A) $15,860 $9,140 $16,080 SalesVolume Variances $1,400 U $2,340 F (E) Static Budget 103,125 (B) $18,200 $9,140 $15,140

Required: a. What are the respective flexible-budget revenues (A)? b. What are the static-budget revenues (B)? c. What are the actual variable costs (C)? d. What is the total flexible-budget variance (D)? e. What is the total sales-volume variance (E)? f. What is the total static-budget variance?

Analysis Units Sold Revenues Variable Costs Fixed Costs Operating Income

a. $42,080 - $1,000 = $41,080

b. $41,080 + $1,400 = $42,480

c. $15,860 + $200 = $16,060 d. $17,740 - $16,080 = $1,660 favorable e. $2,340 favorable + $1,400 unfavorable = $940 favorable f. $17,740 - $15,140 = $2,600 favorable

Question7.

Bach Table Company manufactures tables for schools. The 2011 operating budget is based on sales of 40,000 units at $50 per table. Operating income is anticipated to be $120,000. Budgeted variable costs are $32 per unit, while fixed costs total $600,000. Actual income for 2011 was a surprising $354,000 on actual sales of 42,000 units at $52 each. Actual variable costs were $30 per unit and fixed costs totaled $570,000. Required: Prepare a variance analysis report with both flexible-budget and sales-volume variances.

Answer:

Bach Table Company Variance Analysis


Actual Results 42,000 $2,184,000 1,260,000 $924,000 570,000 $354,000 Flexible Variances $84,000 84,000 $168,000 30,000 $198,000 F F F F F Flexible Budget 42,000 $2,100,000 1,344,000 $756,000 600,000 $156,000 SalesVolume Variances Static Budget 40,000 $100,000F $2,000,000 64,000U 1,280,000 $36,000F $720,000 0 600,000 $36,000F $120,000

Units sold Sales Variable costs Contribution margin Fixed costs Operating income

Total flexible-budget variance = $198,000 favorable. Total sales-volume variance = $36,000 favorable.

Question8.
Diana Industries, Inc. (DII), developed standard costs for direct material and direct labor. In 2010, DII estimated the following standard costs for one of their major products, the 10-gallon plastic container. Budgeted quantity Budgeted price Direct materials 0.10 pounds $30 per pound Direct labor 0.05 hours $15 per hour During June, DII produced and sold 10,000 containers using 980 pounds of direct materials at an average cost per pound of $32 and 500 direct manufacturing labor-hours at an average wage of $15.25 per hour.

June's direct material efficiency variance is: Explanation: B) $30 (980 - 1,000) = $600 F June's direct material flexible-budget variance is: Explanation: C) (980 $32) - (10,000 0.10 $30) = $1,360 U June's direct material price variance is: Explanation: A) 980 ($32 - $30) = $1,960 U June's direct manufacturing labor price variance is: Explanation: A) 500 dlh ($15.25 - $15.00) = $125 U June's direct manufacturing labor efficiency variance is: Explanation: D) [500 dlh (10,000 0.05)] $15 = Zero

Question9.
Apple Valley Orchards, Inc. (AVO), developed standard costs for direct material and direct labor. In 2011, AVO estimated the following standard costs for one of their most well loved products, the AVO classic Grandma's large apple pie which had a brown sugar coating on the top of the crust as well as including cranberry and mince ingredients in addition to the apples. Budgeted quantity Budgeted price Direct materials 1.5 pounds $7.25 per pound Direct labor 0.25 hours $14.00 per hour During September, AVO produced and sold 1,200 pies using 1,875 pounds of direct materials at an average cost per pound of $7.00 and 280 direct labor hours at an average wage of $14.25 per hour. September's direct material flexible-budget variance is:

Explanation: C) (1,875 $7.00) - (1,200 1.5 $7.25) = $75.00 U


September's direct material price variance is:

Explanation: A) 1,875 ($7.00 - $7.25) = $468.75 F


September's direct material efficiency variance is:

Explanation: D) $7.25 [1,875 - (1,200 1.5)] = $543.75 U


September's direct labor flexible-budget variance is:

Explanation: A) (280 $14.25) - (1,200 0..25 $14) = $210.00 F


September's direct labor price variance is:

Explanation: C) 280 dlh ($14.25 - $14.00) = $70 U


September's direct labor efficiency variance is:

Explanation: A) [280 dlh - (1,200 0.25)] $14 = $280 F

7-20 Flexible budget and sales volume variances, market-share and market-size variances.
Performance Report for Marron, Inc., June 2009 Flexible Budget Variances (2) = (1) (3) U U U Static Budget Variance (6) = (1) (5) 25,000 F $110,000 F 140,000 U $ 30,000 U Static Budget Variance as % of Static Budget (7) = (6) (5) 5.0% 3.4% 8.0% 2.0%

Units (pounds) Revenues Variable mfg. costs Contribution margin

Actual (1) 525,000

Flexible Budget (3) 525,000 $3,412,500a 1,837,500b $1,575,000

Sales Volume Variances (4) = (3) (5) 25,000 F $162,500 F 87,500 U $ 75,000 F

Static Budget (5) 500,000 $3,250,000 1,750,000 $1,500,000

$3,360,000 $ 52,500 1,890,000 52,500 $1,470,000 $105,000

$105,000U Flexible-budget variance

$30,000 U Static-budget variance a Budgeted selling price = $3,250,000 500,000 lbs = $6.50 per lb. Flexible-budget revenues = $6.50 per lb. 525,000 lbs. = $3,412,500
b Budgeted

$ 75,000 F Sales-volume vriance

variable mfg. cost per unit = $1,750,000 500,000 lbs. = $3.50 Flexible-budget variable mfg. costs = $3.50 per lb. 525,000 lbs. = $1,837,500

3. The selling price variance, caused solely by the difference in actual and budgeted selling price, is the flexible-budget variance in revenues = $52,500 U.

4. The flexible-budget variances show that for the actual sales volume of 525,000 pounds, selling prices were lower and costs per pound were higher. The favorable sales volume variance in revenues (because more pounds of ice cream were sold than budgeted) helped offset the unfavorable variable cost variance and shored up the results in June 2009. Levine should be more concerned because the small static-budget variance in contribution margin of $30,000 U is actually made up of a favorable sales-volume variance in contribution margin of $75,000, an unfavorable selling-price variance of $52,500 and an unfavorable variable manufacturing costs variance of $52,500. Levine should analyze why each of these variances occurred and the relationships among them. Could the efficiency of variable manufacturing costs be improved? Did the sales volume increase because of a decrease in selling price or because of growth in the overall market? Analysis of these questions would help Levine decide what actions he should take.

7-22 Materials and manufacturing labor variances.


Actual Costs Incurred (Actual Input Qty. Actual Price) Direct Materials Actual Input Qty. Budgeted Price Flexible Budget (Budgeted Input Qty. Allowed for Actual Output Budgeted Price)

$200,000
$14,000 F Price variance

$214,000

$225,000

$11,000 F Efficiency variance $25,000 F

Flexible-budget variance
Direct Mfg. Labor $90,000 $86,000 $80,000 $4,000 U $6,000 U Price variance Efficiency variance $10,000 U Flexible-budget variance

7-24 Price and efficiency variances, journal entries. 1. Direct materials and direct manufacturing labor are analyzed in turn:

Actual Costs Incurred (Actual Input Qty. Actual Price) Direct Materials (100,000 $465,000 $4.65a)

Actual Input Qty. udgeted Price Purchases (100,000 $4.50) $450,000 Usage (98,055 $4.50) $441,248

Flexible Budget (Budgeted Input Qty. Allowed for Actual Output Budgeted Price) (9,850 10 $4.50) $443,250

15,000 U Price variance


(4,900 $31.5b) $154,350 (4,900 $30) $147,000

$2,002 Efficiency variance


(9,850 0.5 $30) or (4,925 $30) $147,750

Direct Manufacturing Labor

$7,350 U Price variance

$750 F Efficiency variance

2. Direct Materials Control

450,000 Direct Materials Price Variance 15,000 Accounts Payable or Cash Control Work-in-Process Control 443,250 Direct Materials Control Direct Materials Efficiency Variance Work-in-Process Control 147,750 Direct Manuf. Labor Price Variance 7,350 Wages Payable Control Direct Manuf. Labor Efficiency Variance

465,000 441,248 2,002

154,350 750

3. Some students comments will be immersed in conjecture about higher prices for materials, better quality materials, higher grade labor, better efficiency in use of materials, and so forth. A possibility is that approximately the same labor force, paid somewhat more, is taking slightly less time with better materials and causing less waste and spoilage. A key point in this problem is that all of these efficiency variances are likely to be insignificant. They are so small as to be nearly meaningless. Fluctuations about standards are bound to occur in a random fashion. Practically, from a control viewpoint, a standard is a band or range of acceptable performance rather than a single-figure measure.

7-25 Continuous improvement (continuation of 7-24). 1. Standard quantity input amounts per output unit are:

January February (Jan. 0.988) March (Feb. 0.988)

Direct Materials (pounds) 10.000 9.880 9.761

Direct Manufacturing Labor (hours) 0.500 0.494 0.488

7-25 Continuous improvement (continuation of 7-24)

2. The answer is the same as that for requirement 1 of Question 7-24, except for the flexible-budget amount.
Actual Costs Incurred (Actual Input Qty. Actual Price) Direct Materials (100,000 $465,000 $4.65a) (100,000 $4.50) $450,000 (98,055 $4.50) $441,248 Actual Input Qty. udgeted Price Purchases Usage (9,850 9.761 $4.50) $432,656 Flexible Budget (Budgeted Input Qty. Allowed for Actual Output Budgeted Price)

15,000 U

$8,592

Price variance
(4,900 $31.5b) $154,350 (4,900 $30) $147,000

Efficiency variance
(9,850 0.488 $30) or (4,925 $30) $144,204

Direct Manufacturing Labor

$7,350 U

$2796 F

Price variance Efficiency variance Using continuous improvement standards sets a tougher benchmark. The efficiency variances for January (from Exercise 7-24) and March (from Exercise 7-25) are: January March Direct materials $2,002 F $8,592 U Direct manufacturing labor $ 750 F $2,796 U Note that the question assumes the continuous improvement applies only to quantity inputs. An alternative approach is to have continuous improvement apply to the total budgeted input cost per output unit ($45 for direct materials in January and $15 for direct manufacturing labor in January).

7-26

Materials and manufacturing labor variances, standard costs.

1.

Direct Materials
Actual Input Qty. Budgeted Price Flexible Budget (Budgeted Input Qty. Allowed for Actual Output Budgeted Price) (2,000 2 $5.00) (4,000 sq. yds. $5.00) $20,000 $1,500 F

Actual Costs Incurred (Actual Input Qty. Actual Price) (3,700 sq. yds. $5.10) $18,870

(3,700 sq. yds. $5.00) $18,500 $370 U

Price variance Efficiency variance $1,130 F Flexible-budget variance The unfavorable materials price variance may be unrelated to the favorable materials efficiency variance. For example, (a) the purchasing officer may be less skillful than assumed in the budget, or (b) there was an unexpected increase in materials price per square yard due to reduced competition. Similarly, the favorable materials efficiency variance may be unrelated to the unfavorable materials price variance. For example, (a) the production manager may have been able to employ higher-skilled workers, or (b) the budgeted materials standards were set too loosely. It is also possible that the two variances are interrelated. The higher materials input price may be due to higher quality materials being purchased. Less material was used than budgeted due to the high quality of the materials

Direct Manufacturing Labor

Actual Costs Incurred (Actual Input Qty. Actual Price)


(900 hrs. $9.80) $8,820

Actual Input Qty. Budgeted Price

Flexible Budget (Budgeted Input Qty. Allowed for Actual Output Budgeted Price) (2000 0.5 $10.00) (1,000 hrs. $10.00) $10,000

(900 hrs. $10.00) $9,000

$180 F
Price variance $1,180 F Flexible-budget variance

$1,000 F
Efficiency variance

The favorable labor price variance may be due to, say, (a) a reduction in labor rates due to a recession, or (b) the standard being set without detailed analysis of labor compensation. The favorable labor efficiency variance may be due to, say, (a) more efficient workers being employed, (b) a redesign in the plant enabling labor to be more productive, or (c) the use of higher quality materials.

1. Direct materials and direct manufacturing labor are analyzed in turn: 2.


Actual Costs Incurred (Actual Input Qty. Actual Price) (6,000 sq. yds. $5.10) $30,600 Actual Input Qty. Budgeted Price Purchases (6,000 sq. yds. $5.00) $30,000 Usage (3,700 sq. yds. $5.00) $18,500 Flexible Budget (Budgeted Input Qty. Allowed for Actual Output Budgeted Price) (2,000 2 $5.00) $20,000

Direct Materials

$ 600U

$1500 F

Price variance

Efficiency variance

Direct manufacturing labor variances are the same as in requirement 1.

7-27

Journal entries and T-accounts (continuation of 7-26).


Direct Materials Control Direct Materials Price Variance Accounts Payable Control To record purchase of direct materials. 18,500 370 18,870

For requirement 1 from Exercise 7-26:

b.

c.

Work-in-Process Control 20,000 Direct Materials Efficiency Variance 1,500 Direct Materials Control 18,500 To record direct materials used. Work-in-Process Control 10,000 Direct Manufacturing Labor Price Variance 180 Direct Manufacturing Labor Efficiency Variance 1,000 Wages Payable Control 8,820 To record liability for and allocation of direct labor costs.

For requirement 2 from Exercise 7-26: when 6,000 sq. yds. of direct materials are purchased: a1. Direct Materials Control 30,000 Direct Materials Price Variance 600 Accounts Payable Control To record direct materials purchased. a2. Work-in-Process Control 20,000 Direct Materials Control Direct Materials Efficiency Variance To record direct materials used.

30,600

18,500 1,500

7-28 Flexible budget (Refer to data in Exercise 7-26). A more detailed analysis underscores the fact that the world of variances may be divided into three general parts: price, efficiency, and what is labeled here as a sales-volume variance. Failure to pinpoint these three categories muddies the analytical task. The clearer analysis follows (in dollars): Actual Costs Incurr Actual Input Flexible Budget (Budgeted Input (Actual Input Qty. Qty. Budge. Qty. Allowed for Actual Output Budgeted Price) Actual Price Price Direct Materials $18,870 $18,500 $20,000 Static Budget

$25,000

(a) $370 U

(b) $1,500 F

(c) $5,000 F

Direct Manuf. Labor

$8,820
(a) $180 F

$9,000
(b) $1,000 F

$10,000

$12,500

(c) $2,500 F

(a)Price variance (b)Efficiency variance (c)Sales-volume variance

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