Flexible Budgets,Direct-Cost Variances,

andManagement Control

1. Understand static budgets and static-budget variances

2. Examine the concept of a flexible budget and learn how to develop it

3. Calculate flexible-budget variances and sales-volume variances

4. Explain why standard costs are often used in variance analysis

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5. Compute _________ variances and ________________ variances for direct-cost categories.

6. Understand how managers use variances

7. Describe benchmarking and explain its role in cost management

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Variance — difference between actual results and expected (budgeted) performance.

Static (master) budget is based on the output planned at the start of the budget period.

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Static-budget variance — the difference between the actual result and the corresponding static budget amount (slide 9)

_________________ 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

Generally speaking, variances are favorable when actual revenues exceed budgeted revenues; and when actual costs are less than budgeted costs

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Variances can be calculated at _____________ levels; and those levels are identified with level numbers.

The most broad variance is a level 0; and is a very _________ view showing the difference between actual and static-budget operating income.

Therefore, variances may start out “at the top” with a Level 0 analysis.

Therefore, this is the highest level of analysis, a super-macro view of operating results.

Therefore, the Level 0 analysis is nothing more than the difference between actual and static-budget operating income.

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Further analysis decomposes (breaks down) the Level 0 analysis into progressively smaller and smaller components.Answers: “How much were we off?”

Levels , , and examine the Level 0 variance into progressively _________________ levels of analysis.Answers: “Where and why were we off?”

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Level 0 tells the user very little other than how much operating income 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 _____________ led to the total Level 0 variance. Level 1 answers the question: “Where were

we off?”7-8

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Level 1 analysis takes the static-budget variance (level 0); and breaks it down by _______ item. As a result, in addition to knowing that we fell short in operating income, we now know how we got there.

Column 1 presents the actual results. Column 3 presents the static budget. Column 2 presents the level 1 variances: difference between the static budget and the actual results.

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Variance analysis levels 2 and 3 answer the question WHY were we off? With level 2 and 3 variances, we can get quite _____________ about what went wrong in our operations that ______________ the shortfall in operating income.

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

Will allow for preparation of Level 2 and 3 variances Answers the question: “Why were we off?”

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Here is an example of a Level 2 analysis. In the first column, the actual results are reported. The third column reports the FLEXIBLE BUDGET and the 5th column reports the STATIC BUDGET.

The second column provides the variances between our actual results and the flexible budget. These variances are the flexible-budget variances. They help us to understand what results we should have had for the level of volume compared to what was actually obtained.

The fourth column provides the difference between the static and the flexible budget. This is called the sales-volume variance because it tells us how much we gained or lost as a result of a volume difference between what was originally anticipated and what we actually achieved.

The flexible budget uses budgeted per unit data applied to ACTUAL units. It represents what our budget would have been had we budgeted correctly for volume.

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Some possible reasons we might incur an unfavorable Sales-Volume Variance include:

1.Failure to execute the sales plan2.Weaker than anticipated demand3.Aggressive competitors taking market share4.Unanticipated market preference away from the product5.Quality problems

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The level 2 variances (previous slide) are great – they certainly break down our successes and shortfalls in more detail than level 1. However, as you’ll see, level 3 variances are even better because they separate what we call Price and Efficiency 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 (Ch 8).

Direct materials and direct labor both have _____________ and ________ variances, and their formulae are the same. 7-15

Price variance formula:

Efficiency variance formula:

Price Actual Price Budgeted Price Actual QuantityVariance Of Input Of Input Of InputX= { - }

Efficiency Actual Quantity Budgeted Quantity of Input Budgeted PriceVariance Of Input Used Allowed for Actual Output Of InputX= { - }

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Price Variance = (Actual Price – Budgeted Price) x Actual Quantity

Efficiency Variance = (Actual Quantity – Budgeted Quantity) x Budgeted Price

The Actual Quantity of Input used can be yards or pounds of material or direct labor or machine hours.

The Budgeted Quantity of Input Allowed for Actual Output means that we’ll take the quantity expected to be used per output (4 lbs of steel per item) x the actual quantity.

As an example, if we made 10 units and each required 4.4 lbs of plastic, we would expect to have used 44 lbs of plastic. If we ACTUALLY used 48 lbs of plastic, that element of the formula would be (48 – 44).

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Level 3 analysis looks at the flexible budget variances (the variance between the flexible budget and the actual results) and explains it in more detail.

For example, on slide 12, we saw that direct materials was unfavorable by $21,600. That means that we spent $21,600 more for the materials than we should have.

This level 3 analysis tells us how much of that amount was based on price (we paid more or less for the material than we expected to) and how much of the amount was based on usage or efficiency. You can see that the situation is even worse than it appears. We spent $66,000 more than we expected to on usage which was offset quite a bit by the $44,400 favorable purchase price variance.

These variances provide infinitely important information to management to help them improve operations in the future.

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This is a summary of the variances we’ve just discussed. At the top is our level 1 variance (remember, level 0 is the static-budget variance for operating income and level 1 is that variance broken down by line item).

Level two identifies the variances between the flexible budget and actual operating income by line item and in total.

Level three variances target one of the level 2 line item variances and breaks it down into more detail.

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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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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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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.

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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.

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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 (see next slide).

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Terms to Learn Page Number Reference

Benchmarking Page 267

Budgeted performance Page 249

Direct materials mix variance Page 272

Direct materials yield variance

Page 272

Effectiveness Page 265

Efficiency Page 265

Efficiency variance Page 258

Favorable variance Page 251

Flexible budget Page 252

Flexible-budget variance Page 253

Management by exception Page 249

Price variance Page 258 7-28

Terms to Learn Page Number Reference

Rate variance Page 258

Sales-volume variance Page 253

Selling-price variance Page 255

Standard Page 257

Standard cost Page 257

Standard input Page 257

Standard price Page 257

Static budget Page 251

Static-budget variance Page 251

Unfavorable variance Page 251

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Terms to Learn Page Number Reference

Usage variance Page 258

Variance Page 249

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