ACCT 2302

Fundamentals of Accounting II

Spring 2011

Lecture 13

Professor Jeff Yu

Cash Budget: (1) determine the amount of cash excess or deficiency; (2) determine required borrowing if cash deficiency; (3) calculate interest expense.

Budgeted Balance Sheet

Budgeted Income Statement

Review:

Chapter 10: Flexible Budget

The master budgets discussed in Chapter 9 could also be called STATIC budgets because they are prepared based on a fixed level of future activity.

A static budget (also called “planning budget”) is suitable for planning, but is inadequate for evaluating cost control.

Static Budget and Performance Analysis

Static budgets are prepared for

a single, planned level of activity.

Performance evaluation is difficult when actual activity

level differs from the planned activity level.

Hmm! Comparingstatic budgets withactual costs is likecomparing apples

and oranges.

Static Actual DifferenceBudget Results (Act. - Bud.)

Machine hours 10,000 8,000 -2,000

Variable costs Indirect labor 40,000$ 34,000$ ($6,000) Indirect materials 30,000 25,500 ($4,500) Power 5,000 3,800 ($1,200)

Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,000 0

Total overhead costs 89,000$ 77,300$ ($11,700)

Example: Inference using Static Budget

I don’t think I can answer this question

using a static budget.

I do know thatactual activity is belowbudgeted activity which

is unfavorable.

But shouldn’t variable costsbe lower if actual activity

is below budgeted activity?

Did the firm do a good job in cost control?

Example: Inference using Static Budget

How much of the favorable cost variance in the example is due to lower activity level and how much is due to good cost control?

To answer the question, we must the

budget to the actual level of activity.

The relevant question?

Flexible Budgets

Improve performance evaluation.

May be prepared for any activity level in the relevant range.

Show costs that should have beenincurred at the actual activity level, enabling “apples to apples”cost comparisons.Help managers control costs.

Variable Total Flexible BudgetsCost Fixed 8,000 10,000 12,000

Per Hour Cost Hours Hours Hours

Machine hours 8,000 10,000 12,000

Variable costs Indirect labor 4.00 32,000$ 40,000$ 48,000$ Indirect material 3.00 24,000 30,000 36,000 Power 0.50 4,000 5,000 6,000 Total variable cost 7.50$ 60,000$ 75,000$ 90,000$

Fixed costs Depreciation 12,000$ 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ 104,000$

Example: Preparing a Flexible Budget

Variable TotalCost Fixed Flexible Actual

Per Hour Costs Budget Results Variances

Machine hours 8,000 8,000 0

Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 24,000 25,500 1,500 U Power 0.50 4,000 3,800 200 FTotal variable costs 7.50$ 60,000$ 63,300$ $ 3,300 UFixed Expenses Depreciation 12,000$ 12,000$ 12,000$ 0 Insurance 2,000 2,000 2,000 0Total fixed costs 14,000$ 14,000$ 0Total overhead costs 74,000$ 77,300$ $ 3,300 U

Flexible Budget Performance Report

Flexible budget is prepared for the same

activity level as actually achieved.

Variance Analysis

This $15,000F variance is due to

lower actual activity than budgeted.

(Activity Variance)

Activity

This $3,300Uvariance is due

to poor cost control. (Spending Variance)

Cost control

Static Flexible ActualOverhead Overhead OverheadBudget at Budget at at

10,000 Hours 8,000 Hours 8,000 Hours

89,000$ 74,000$ 77,300$

Flexible Budget Performance Report

Summary: Flexible Budget

Flexible budget is prepared based on the actual activity level and is used for performance evaluation (control) purpose.

Activity Variance = Flexible budget amount – planning (static) budget amount

Spending Variance = Actual cost – flexible budget cost Spending variance is unfavorable if positive, favorable if negative;

Spending variance captures the efficiency of cost control.

Revenue Variance = Actual revenue – flexible budget revenue

Revenue variance is favorable if positive, unfavorable if negative;

Harrald’s Fish House has following data for April, 2009 operations (Q refers to the number of meals served):

 

Q: (1) Prepare the planning budget for April assuming Q=1800. (2) prepare a flexible budget for the actual Q of 1700 meals served.(3) Calculate activity variances for revenue and all three expenses.(4) Compute revenue variance;(5) Compute spending variances for all three expenses.

Practice Problem: flexible budget

Formula used for budgeting

Actual data with Q=1700

Revenue $16.5Q $27,920

Cost of Ingredients $6.25Q $11,110

Wages $12,600 $12,330

Miscellaneous $1,400+$1Q $3,320

Aly Tours operates tours of glaciers on its tour boat with data below.

 

Aly’s planning budget for July is based on 24 cruises and 1,400 passengers using the historical cost formula as in columns 2-4. The actual activity levels are 20 cruises and 1,500 passengers.

Q: Compute activity variances and spending variances for all three expenses.

Practice Problem: multiple cost drivers

Expenses Fixed cost per month

Cost per Cruise

Cost per Passenger

Actual costs

Boat operating $5,200 $480 $2 $20,000

Advertising $4,600 $4,600

Administrative $4,300 $24 $1 $6,300

Chapter 11 Standard Costs

Standards are benchmarks or “norms” for measuring performance. Two types of standards are commonly used.

Quantity standardsspecify how much of aninput should be used to

make one unit of the product.

Price standards specify how much should

be paid for each unitof the input.

Standard Cost Standard vs. Budget:

• A budget is set for total costs;• A standard is set for per unit cost;• Standards are often used when preparing for budgets.

Quantity standards are set for each unit of production (How much units of input are needed for each unit of output?)

Price standards are set for each unit of input (How much should be paid for each unit of input?)

• Standard quantity per unit and Standard price (SP) for DM; • Standard hours per unit and Standard rate per hour (SR) for DL; • Standard activity level (allocation base for POHR) per unit and

Standard rate (variable portion of POHR) for MOH

Example: Standard Cost

A A x BStandard Standard StandardQuantity Price Cost

Inputs or Hours or Rate per Unit

Direct materials 3.0 lbs. 4.00$ per lb. 12.00$ Direct labor 2.5 hours 14.00 per hour 35.00 Variable mfg. overhead 2.5 hours 3.00 per hour 7.50 Standard cost per unit 54.50$

B

Management by Exception

Compare the actual quantities and costs of inputs to the quantity and cost standards we have set for performance evaluation purposes.

If the actual quantity or cost departs significantly from the standard, managers investigate the discrepancy.

Goal: Find the cause of the problem and eliminate it.

The act of computing and interpreting the deviation (variance) is called VARIANCE ANALYSIS.

Variance Analysis

Materials price varianceLabor rate varianceVOH rate variance

Materials quantity varianceLabor efficiency varianceVOH efficiency variance

A General Model for Variance Analysis

Price Variance Quantity Variance

A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price

Materials Price Variance

AQ(AP - SP)

Labor/VOH Rate Variance

AH(AR – SR)

Materials Quantity Variance

SP(AQ - SQ)

Labor/VOH Efficiency Variance

SR(AH – SH)

SQ (SH)= Standard quantity (hours) allowed for the actual output = actual production in units * standard quantity (hours) per unit

Glacier Peak Outfitters has the following direct material standard for the fiberfill in its mountain parka: 0.1 kg. of fiberfill per parka at $5.00 per kg.

Last month 210 kgs of fiberfill were purchased and used to make 2,000 parkas. The actual cost of fiberfill was $4.90 per kg.

Q: Compute Materials Variances for the company.

Example: Materials Variances

210 kgs. 210 kgs. 0.1kg. * 2000 × × × $4.90 per kg. $5.00 per kg. $5.00 per kg.

= $1,029 = $1,050 = $1,000

Materials Price variance$21 favorable

Materials Quantity variance

$50 unfavorable

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price

Materials Variances

Material Variances: Using the Factored Equations

Materials price varianceMPV = AQ (AP - SP)

= 210 kgs ($4.90/kg - $5.00/kg)

= 210 kgs (-$0.10/kg)

= $21 F

Materials quantity varianceMQV = SP (AQ - SQ)

= $5.00/kg (210 kgs-(0.1 kg/parka 2,000 parkas))

= $5.00/kg (210 kgs - 200 kgs)

= $5.00/kg (10 kgs)

= $50 U

Material Price and Quantity Variances

Price and quantity variances are determined separately for two reasons:

The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used.

The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used.

The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production.

The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production.

Isolation of Material Variances

I need the price variancesooner so that I can better

identify purchasing problems.

You accountants just don’tunderstand the problems thatpurchasing managers have.

I’ll start computingthe price variancewhen material is

purchased rather thanwhen it’s used.

Responsibility for Material Variances

Materials Price VarianceMaterials Quantity Variance

Production Manager Purchasing Manager

The standard price is used to compute the quantity varianceso that the production manager is not held responsible for

the purchasing manager’s performance.

The standard price is used to compute the quantity varianceso that the production manager is not held responsible for

the purchasing manager’s performance.

I am not responsible for this unfavorable material

quantity variance.

You purchased cheapmaterial, so my peoplehad to use more of it.

Your poor scheduling sometimes requires me to rush order material at a

higher price, causing unfavorable price

variances.

Responsibility for Material Variances

Bella Inc. has the following direct material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound.

Last week 1,700 pounds of material were purchased at a total cost of $6,630 and all 1,700 pounds are used to make 1,000 Zippies.

Question:

1.What is the actual price per pound paid for the material?

2.What is Bella’s materials price variance for the week?

3.What is Bella’s materials quantity variance for the week?

Practice Problem: Materials Variances

When material purchased ≠ material used

To compute the PRICE variance, use the total quantity of raw materials PURCHASED.

To compute the QUANTITY Variance, use only the quantity of raw materials USED.

Materials Variances: purchased ≠ used

Bella has the following material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound.

Last week 2,800 pounds of material were purchased at a total cost of $10,920, and 1,700 pounds were used to make 1,000 Zippies.

Question: 1) What is Bella’s materials price variance for the week?2) What is Bella’s materials quantity variance for the week?

Practice Problem: Materials Variances

Practice Problem: Materials Variances

During February, Pisces Co. produced 1000 fishing rods with the following information:

Materials quantity variance $6,000 U

Materials price variance $1,200 U

Standard cost information for materials:

5 ounces at $6 per ounce.

Q: If the quantity of materials purchased was equal to the quantity of materials used. What was the actual per ounce cost of materials purchased?

For Next Class

Finish Chapter 11 Start Chapter 12 Attempt the assigned HW problems

Harvey Co.’s variable MOH rate is $5 per direct labor hour and fixed MOH is $10,000 per month. Its planning budget for March is based on 6,000 direct labor hours. The actual total MOH cost is $38,000 and the actual activity level is 5,000 direct labor hours in March.

Q: (1) what is the amount of Activity Variance for total MOH cost in March?

(2) What is the amount of Spending Variance for total MOH cost in March?

Homework Problem 1

In May, Vail Co. produced 10,000 units of Zippies, purchased 20,000 pounds of material at a total cost of $30,000, and used 15,000 pounds of material. Materials quantity variance is $3,000 U. Material quantity standard indicates that 1.4 pounds of material are needed to produce each unit of Zippy.

Q: What is Vail’s materials price variance in May?

Homework Problem 2