Flexible Budgets and Standard
Costs
Chapter 21
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Fixed and Flexible Budgets
Managers use budgets to control operations and see that
planned objectives are met.
• A master budget based on a predicted level of activity for the
budget period.
• Two alternative approaches: fixed or flexible budgeting.
• A fixed budget, or static budget, based on a single predicted
amount of sales or other activity measure.
• A flexible budget, or variable budget, based on several
different amounts of sales.
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a. Fixed Budget Performance Report
A fixed budget is based on a single predicted amount of sales.
Exhibit
21.2
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b. Purpose of Flexible Budgets
Show revenues and expenses that should
have occurred at the actual level of activity.
May be prepared for several activity levels
in the relevant range to provide a “what-if”
look at operations.
Provides an “apples to apples” comparison.
Improve performance evaluation and helps
managers focus on problem areas.
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Preparation of Flexible Budgets 1
To flex a budget for different activity levels, we
must know how costs behave with changes in
activity levels.
• Total variable costs change in direct proportion to
changes in activity.
• Total fixed costs remain unchanged within the
relevant range.
Learning Objective P1: Prepare a flexible budget and interpret a flexible budget performance report. 5
Preparation of Flexible Budgets 2
Variable costs are a constant amount per unit.
Exhibit
21.3
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Learning Objective P1: Prepare a flexible budget and interpret a flexible budget performance report.
Flexible Budget Performance Report
A flexible budget performance report compares actual performance and budgeted performance
based on actual sales. In SolCel’s case, January’s sales are 12,000 units.
Favorable sales variance because average selling price was greater than $10.00 per unit.
Unfavorable total variable cost and total fixed cost variances because actual costs are greater
than expected.
Favorable income from operations variance because sales variance is greater than unfavorable
variable cost variance.
Exhibit
21.4
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Learning Objective P1: Prepare a flexible budget and interpret a flexible budget performance report.
Analyzing variances
• The report shows a $5000
favorable variance in total
dollar sales. Because actual
and budgeted volumes are
both 12,000 units, the
variance must have
resulted from a higher
than expected selling price.
• What about the other
variances?
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Standard Costing
Standard costs can be used in a flexible budgeting system to enable
management to better understand the reasons for variances.
Preset costs for delivering a
product or service under normal
conditions.
Established by personnel,
engineering, and accounting
studies using past experiences.
The expected level of performance.
Manufacturers use standard
costing for direct materials, direct
labor and overhead costs.
Learning Objective C1: Define standard costs and explain how standard cost information is useful for 9
management by exception.
Setting Standard Costs
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Learning Objective C1: Define standard costs and explain how standard cost information is useful for 10
management by exception.
Standard Costs Example
The standard costs of direct materials, direct labor, and
overhead for one bat, manufactured by ProBat, are shown
below. This is called a standard cost card.
Exhibit 21.5
These standard cost amounts are then used to prepare
manufacturing budgets for a budgeted level of production.
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Learning Objective C1: Define standard costs and explain how standard cost information is useful for 11
management by exception.
Cost Variances
Cost variance is the difference between actual and standard
cost.
If actual cost > standard cost variance is unfavorable (U).
If actual cost < standard cost variance is favorable (F).
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Learning Objective P2: Compute the total cost variance.
Cost Variance Analysis
Exhibit
21.6
• Variance analysis involves preparing a standard cost performance
report.
• Computing and analyzing variances.
• Identifying questions and their answers.
• Taking corrective and strategic actions (if needed).
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Learning Objective P2: Compute the total cost variance.
Cost Variance Computation 1
Management needs information about the factors causing a cost variance,
but first it must properly compute the variance. In its most simple form, a
cost variance (CV) is computed as:
Exhibit
21.7
• Actual quantity (AQ) is the • Actual price (AP) is the actual
actual amount of material or amount paid to acquire the
labor used to manufacture the actual direct material or
actual quantity of output. direct labor used during the
• Standard quantity (SQ) is the period.
standard amount of input for • Standard price (SP) is the
the actual quantity of output. standard price.
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Learning Objective P2: Compute the total cost variance.
1. Materials and Labor Variances
Two main factors cause materials and labor variances:
Exhibit
21.8
Isolating these price and quantity factors in a cost variance
lead to these formulas.
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Learning Objective P2: Compute the total cost variance.
Cost Variance Computation 2
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Learning Objective P2: Compute the total cost variance.
Cost Variance Computation 3
( AP − SP ) × AQ ( AQ − SQ ) × SP
AQ = Actual Quantity SP = Standard Price
AP = Actual Price SQ = Standard Quantity
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Learning Objective P2: Compute the total cost variance.
1a. Materials Standard Cost
G-Max Company makes golf club heads with the
following standard cost information:
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Learning Objective P3: Compute materials and labor variances.
Material Variances 1
During May, G-Max produced 3,500 club heads using 1,800
pounds of material. G-Max paid $21.00 per pound for the
material.
Compute the material price and quantity variances.
Use this information to compute the material price and quantity variances
before you go to the next slide.
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Learning Objective P3: Compute materials and labor variances.
Material Variances 2
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Learning Objective P3: Compute materials and labor variances.
Evaluating Materials Variances
Who is responsible for material cost variances?
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Learning Objective P3: Compute materials and labor variances.
1b. Labor Variances 1
Instead of price and quantity, for direct labor we use the terms
rate and hours.
AH ( AR – SR ) SR ( AH – SH )
AH = Actual Hours SR = Standard Rate
AR = Actual Rate SH = Standard Hours
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Learning Objective P3: Compute materials and labor variances.
Labor Variances 2
During May, G-Max produced 3,500 club heads working 3,400
hours. G-Max paid an average of $16.50 per hour for the hours
worked.
Compute the labor rate and efficiency variances.
Use this information to compute the labor rate and efficiency variances
before you go to the next slide.
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Learning Objective P3: Compute materials and labor variances.
Labor Cost Variances 1
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Learning Objective P3: Compute materials and labor variances.
Evaluating Labor Variances
One possible explanation of G-Max’s labor rate and efficiency variances is
the use of workers with different skill levels.
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Learning Objective P3: Compute materials and labor variances.
Labor Cost Variances 2
Who is responsible for material cost variances?
Production managers who make work assignments are generally
responsible for labor cost variances.
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Learning Objective P3: Compute materials and labor variances.
2. Overhead Standards and Variances
Recall that overhead costs are assigned to
products and services using a predetermined
overhead rate (POHR):
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Learning Objective P4: Compute overhead controllable and volume variances.
Standard Overhead Rate
Standard overhead costs are the overhead amounts expected to occur at a
certain activity level.
To allocate overhead costs to products or services, management needs to establish the
standard overhead cost rate. Uses a three-step process:
Flexible budgets, showing budgeted amount of overhead for
various levels of activity, are used to analyze overhead costs.
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Learning Objective P4: Compute overhead controllable and volume variances.
Flexible Overhead Budgets
(Flexible budgets for overhead prepared at several levels of activity.)
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Learning Objective P4: Compute overhead controllable and volume variances.
Computing Overhead Cost
Variances
The difference between the total overhead cost applied to products
and the total overhead cost actually incurred is called an overhead
cost variance. It’s defined as:
Overhead cost Actual overhead Standard overhead
= −
variance (OCV) incurred (AOI) applied (SOA)
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Learning Objective P4: Compute overhead controllable and volume variances.
Total Overhead Cost Variance
Ex: During May, G-Max produced 3,500 club heads working 3,400
hours. G-Max budgeted for 4,000 units (80%). Actual variable overhead
was $3,650 and actual fixed overhead was $4,000.
Overhead cost variance = Actual overhead incurred − Standard overhead applied
= ($3,650 + $4,000) − (3,500 DLH × $2.00 per DLH)
= $7,650 − $7,000
= ( unfavorable ) $650
To help identify factors causing the overhead cost variance, let’s
analyze this variance separately for controllable and volume
variances.
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Learning Objective P4: Compute overhead controllable and volume variances.
Controllable and Volume Variances
Exhibit 21.15
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Learning Objective P4: Compute overhead controllable and volume variances.
Controllable and Volume
Variances for G-Max
Overhead Controllable Variance
Overhead Volume Variance
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Learning Objective P4: Compute overhead controllable and volume variances.
Sales Variances
A similar analysis can be applied to sales variances. We will use
two additional G-Max products, Excel golf balls and Big Bert
drivers, to illustrate.
Consider the following sales data from G-Max:
Budgeted Actual
Sales of Excel golf balls (units) 1,000 units 1,100 units
Sales price per Excel golf ball $10 $10.50
Sales of Big Bert drivers (units) 150 units 140 units
Sales price per Big Bert driver $200 $190
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Learning Objective A1: Analyze changes in sales from expected amounts.
Summary of COST variances
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Expanded Overhead Variances and
Standard Cost Accounting System
Exhibit
21A.1
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Learning Objective P5: Compute overhead spending and efficiency variances.
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Computing Sales Variances
for G-Max
Exhibit
21.18
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Learning Objective A1: Analyze changes in sales from expected amounts.
