Flexible Budgets and Direct-Cost Variances

Basic Concepts
Variance () difference between an actual and an expected (budgeted) amount. Management by Exception the 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.

Static-Budget Variance
Static-Budget Variance () the difference between the actual result and the corresponding static budget amount.
Static-budget variance for operating income

Actual result

Static-budget amount

Static-Budget Variance
Static-Budget Variance 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. Exhibit 7-1 (P.211)

Evaluation
Level 0 tells the user very little other than how much Contribution Margin was off from budget: a $93,100 U variance in this case.
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 Budget () shifts budgeted revenues and costs up and down based on actual operating results (activities). The flexible budget is prepared at the end of the period. Represents a blending of actual activities and budgeted dollar amounts. The only difference is that the static budget is prepared for the planned output, whereas the flexible budget is based on the actual output.

Flexible Budget
Flexible Budget will allow for preparation of Levels 2 and 3 variances. Exhibit 7-2 (P.213)
Answers the question: Why were we off?

Variance Analysis
Actual Actual Results Results Flexible Flexible Budget Budget Static Static Budget Budget

Flexible-budget variance

Sales-volume variance

Static-budget variance

Sales-Volume Variance
Sales-volume Flexible-budget variance for amount operating income Budgeted contribution margin per unit Static-budget amount

Actual units Static-budget sold units sold

Budgeted selling priceBudgeted variable cost per unit

Flexible-Budget Variance
Flexible-budget variance Actual result Flexible-budget amount

() Selling-price Actual units Actual Budgeted variance selling price Selling price sold Flexible-budget variance for revenue

Flexible Budget
Exercise 7-16
Actual Results (1) 2,800 $313,600a 229,600 84,000 50,000 $ 34,000 FlexibleBudget Variances (2) = (1) (3) 0 $ 5,600 F 22,400 U 16,800 U 4,000 F $12,800 U $12,800 U a. b. c. d. e. $112 2,800 = $313,600 $110 2,800 = $308,000 $110 3,000 = $330,000 $74 2,800 = $207,200 $74 3,000 = $222,000 Total flexible-budget variance Flexible Budget (3) 2,800 $308,000b 207,200d 100,800 54,000 $ 46,800 Sales-Volume Variances (4) = (3) (5) 200 U $22,000 U 14,800 F 7,200 U 0 $ 7,200 U $ 7,200 U Total sales-volume variance Static Budget (5) 3,000 $330,000c 222,000e 108,000 54,000 $ 54,000

Units sold Revenues Variable costs Contribution margin Fixed costs Operating income

$20,000 U Total static-budget variance

Level 3 Variances
All Product Costs can have Level 3 Variances. Both Direct Materials and Direct Labor have both Price and Efficiency Variances, and their formulae are the same. Overhead Variances are discussed in detail in a later chapter.

Level 3 Analysis (Direct Materials)

Actual costs Incurred Actual costs Incurred
(Actual Input Quantity (Actual Input Quantity Actual Price) Actual Price) Actual Input Quantity (Budgeted Input Quantity Allowed Actual Input Quantity (Budgeted Input Quantity Allowed Budgeted Price for Actual Output Budgeted Price for Actual Output
Budgeted price) Budgeted price)

Flexible Budget Flexible Budget

Level 3

Price variance

Efficiency variance

Level 2

Flexible-budget variance

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

Level 3 Variances
Exercise 7-21
Actual Costs Incurred (Actual Input Qty. Actual Price) Direct Materials $200,000 $14,000 F Price variance $25,000 F Flexible-budget variance $90,000 Direct Labor $4,000 U Price variance $10,000 U Flexible-budget variance $86,000 $6,000 U Efficiency variance $80,000 Actual Input Qty. Budgeted Price $214,000 $11,000 F Efficiency variance Flexible Budget (Budgeted Input Qty. Allowed for Actual Output Budgeted Price) $225,000

Levels 1, 2 and 3 Variance Analysis

Level 1

Static-budget variance Static-budget variance for operating income for operating income Flexible-budget variance Flexible-budget variance for operating income for operating income
Selling Selling price price variance variance Direct Direct material material variance variance Direct Direct labor labor variance variance

Level 2

Sale-volume variance Sale-volume variance for operating income for operating income
Variable Variable overhead overhead variance variance Fixed Fixed overhead overhead variance variance

Level 3

Direct materials Direct materials price price variance variance

Direct materials Direct materials efficiency efficiency variance variance

Direct labor Direct labor price price variance variance

Direct labor Direct labor efficiency efficiency variance variance

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. P.222

Problem for Self-Study

Actual Costs Incurred (Actual Input Qty. Actual Price) Actual Input Qty. Budgeted Price (5,000 kg $15/kg) $75,000 Flexible Budget (Budgeted Input Qty. Allowed for Actual Output Budgeted Price) (2,000 units 2 kg/unit $15/kg) $60,000

Direct Materials

(5,000 kg $16.5/kg) $82,500

(4,400 kg $15/kg) $66,000

$7,500 U Price variance $66,300/3,250

$6,000 U Efficiency variance (2,000 units 1.5 hrs./unit $20/hr.) $60,000 $5,000 U Efficiency variance

Direct Labor

(3,250 hrs. $20.4/hr.) $66,300 $1,300 U Price variance

(3,250 hrs. $20/hr.) $65,000

Variances and Journal Entries

Exercise 7-23 Price and efficiency variances, journal entries.
Actual Costs Incurred (Actual Input Qty. Actual Price) (100,000 $3.10a) $310,000 Direct Materials Actual Input Qty. Budgeted Price Flexible Budget (Budgeted Input Qty. Allowed for Actual Output Budgeted Price) (9,810 10 $3.00) $294,300

Purchases Usage (100,000 $3.00) (98,073 $3.00) $300,000 $294,219

$10,000 U Price variance

$81 F Efficiency variance

a. $310,000 100,000 = $3.10

Variances and Journal Entries

Exercise 7-23 Price and efficiency variances, journal entries.
Actual Costs Incurred (Actual Input Qty. Actual Price) (4,900 $21b) $102,900 Actual Input Qty. Budgeted Price Flexible Budget (Budgeted Input Qty. Allowed for Actual Output Budgeted Price) (9,810 0.5 $20) or (4,905 $20) $98,100 $100 F Efficiency variance

Direct Manufacturing Labor

(4,900 $20) $98,000

$4,900 U Price variance

b. $102,900 4,900 = $21

Variances and Journal Entries

Exercise 7-23 Price and efficiency variances, journal entries.

2.

Direct Materials Control Direct Materials Price Variance Accounts Payable or Cash Control Work-in-Process Control Direct Materials Control Direct Materials Efficiency Variance Work-in-Process Control Direct Manuf. Labor Price Variance Wages Payable Control Direct Manuf. Labor Efficiency Variance

300,000 10,000 310,000 294,300 294,219 81 98,100 4,900 102,900 100

Standard Costing
Budgeted amounts and rates are actually booked into the accounting system. These budgeted amounts contrast with actual activity and give rise to Variance accounts. Reasons for implementation: Improved software systems. Wide usefulness of variance information.

Management Uses of Variances

To understand underlying causes of variances. Recognition of inter-relatedness of variances. Performance Measurement: Managers ability to be Effective. Managers ability to be Efficient.

Activity-Based Costing and Variances

ABC easily lends itself to budgeting and variance analysis. Budgeting is not conducted on the departmental-wide basis (or other macro approaches). Instead, budgets are built from the bottom-up with activities serving as the building blocks of the process.

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.