10-02-2017

Budgets and variance

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ANA MARQUES

Main topics:
2

Profit planning and activity-based

budgeting

Standard costing and variance analysis

Flexible budgets
Exercise: Web company

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Purposes of Budgeting Systems

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Budget
1. Planning
2. Facilitating
a detailed plan, in
Communication and
quantitative terms, that
specifies how resources Coordination
will be acquired and used, 3. Allocating Resources
during a specified period 4. Controlling Profit and
of time. Operations
5. Evaluating Performance
and Providing Incentives

Sales of Services or Goods

Ending 4
Inventory Production
Budget Budget
Work in Process
and Finished
Goods

Ending Direct Direct Selling and

Overhead
Inventory Materials Labor Administrative
Budget Budget Budget Budget
Budget
Direct Materials

Cash Budget
Budgeted Income
Statement
Budgeted Balance
Sheet
Budgeted Statement of
Cash Flows

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Types of budgets
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Capital budgets, with acquisitions that normally

cover several years

Financial budgets, with financial resource

acquisitions

Continuous or Rolling budget -> thisbudget is

usually a twelve-month budget that rolls forward
one month, as the current month is completed.

Activity-Based Costing versus Activity-Based

Applying ABC to budgeting
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Resources Resources
Activity-Based
Costing (ABC)

Activities Activities

Activity-Based
Cost objects: Budgeting (ABB)
Forecast of products
products and services and services to be
produced, and produced and
customers served. customers served.

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Sales Budget
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April May June Quarter

Budgeted
sales (units) 20,000 50,000 30,000 100,000
Selling price
per unit $ 10 $ 10 $ 10 $ 10
Total
Revenue $ 200,000 $ 500,000 $ 300,000 $ 1,000,000

From
Production Budget
sales
budget May8 sales 50,000 units
Desired percent 20%
April May June Quarter
Desired inventory 10,000 units
Sales in units 20,000 50,000 30,000 100,000
Add: desired
Ending inventory becomes
end. inventory 10,000 6,000 5,000
beginning inventory the 5,000
next
Total needed 30,000 56,000 35,000
month 105,000
Less: beg.
inventory 4,000 10,000 6,000 4,000
Units to be
produced 26,000 46,000 29,000 101,000

March 31
ending inventory

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From our Direct-Material Budget

production 9
budget
April May June Quarter
Production in units 26,000 46,000 29,000 101,000
Materials per unit 5 5 5 5
Production needs 130,000 230,000 145,000 505,000
Add: desired
ending inventory 23,000 14,500 11,500 11,500
Total needed 153,000 244,500 156,500 516,500
Less: beginning
inventory 13,000 23,000 14,500 13,000
Materials to be
purchased 140,000 221,500 142,000 503,500

10% of the following March 31

months production inventory

Direct-Labor Budget
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April May June Quarter
Production in units 26,000 46,000 29,000 101,000
Direct labor hours 0.10 0.10 0.10 0.10
Labor hours required 2,600 4,600 2,900 10,100
Guaranteed labor
hours 3,000 3,000 3,000
Labor hours paid 3,000 4,600 3,000 10,600
Wage rate $ 8 $ 8 $ 8 $ 8
Total direct labot cost $ 24,000 $ 36,800 $ 24,000 $ 84,800

From our This is the greater of

production labor hours required or
budget labor hours guaranteed.

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Overhead Budget
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Here is Breakers Overhead Budget for the quarter.

April May June Quarter

Indirect labor $ 17,500 $ 26,500 $ 17,900 $ 61,900

Indirect material 7,000 12,600 8,600 28,200
Utilities 4,200 8,400 5,200 17,800
Rent 13,300 13,300 13,300 39,900
Insurance 5,800 5,800 5,800 17,400
Maintenance 8,200 9,400 8,200 25,800
$ 56,000 $ 76,000 $ 59,000 $ 191,000

Selling & Administrative Expense Budget

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April May June Quarter

Sales in units 20,000 50,000 30,000 100,000
Variable S&A rate $ 0.50 $ 0.50 $ 0.50 $ 0.50
Variable expense $ 10,000 $ 25,000 $ 15,000 $ 50,000
Fixed S&A
expense 70,000 70,000 70,000 210,000
Total expense 80,000 95,000 85,000 260,000
Less: noncash
expenses 10,000 10,000 10,000 30,000
Cash
disbursements $ 70,000 $ 85,000 $ 75,000 $ 230,000
From our
Sales budget

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Cash Receipts Budget

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April May June Quarter

Accounts rec. - 3/31 $ 30,000 $ 30,000
April sales
70% x $200,000 140,000 140,000
25% x $200,000 $ 50,000 50,000
May sales
70% x $500,000 350,000 350,000
25% x $500,000 $ 125,000 125,000
June sales
70% x $300,000 210,000 210,000
Total cash collections $ 170,000 $ 400,000 $ 335,000 $ 905,000

Cash Disbursement Budget

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April May June Qua rte r
Accounts pay. 3/31 $ 12,000 $ 12,000
April purcha se s
50% x $56,000 28,000 28,000
50% x $56,000 $ 28,000 28,000
Ma y purcha se s
50% x $88,600 44,300 44,300
50% x $88,600 $ 44,300 44,300
June purcha se s
50% x $56,800 28,400 28,400
Total cash payments
for materials $ 40,000 $ 72,300 $ 72,700 $ 185,000

140,000 lbs. $.40/lb. = $56,000

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From our Cash Cash Budget

Receipts Budget
(Collections and Disbursements)
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April May June Qua rte r

Beginning cash balance $ 40,000
Add: cash collections 170,000 From our Cash Disbursements
Total cash available 210,000 Budget
Le ss: disbursements
From our Direct Labor Budget
Materials 40,000
Direct labor 24,000 From our Overhead Budget
Mfg. overhead 56,000
Selling and admin. 70,000
From our Selling and
Equipment purchase -
Administrative Expense Budget
Dividends 25,000
Total disbursements 215,000 To maintain a cash
Excess (deficiency) of balance of $30,000,
Cash available over Breakers must borrow
disbursements $ (5,000) $35,000 on its line of credit.

Cash Budget
(Financing and Repayment)
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April May June Quarter

Excess (deficiency) of
Cash available over
disbursements $ (5,000) $ 16,200 $ 86,000 $ 37,200
Financing:
Borrowing 35,000 13,800 48,800
Repayments - - (48,800) (48,800)
Interest - - (838) (838)
Total financing 35,000 13,800 (49,638) (838)
Ending cash balance $ 30,000 $ 30,000 $ 36,362 $ 36,362

A nnual M o n th s In te re s t
B o rro w in g R a te In te re s t O uts ta nd in g Ex pense
$ 3 5 ,0 0 0 12% = $ 4 ,2 0 0 2 m th s = $ 700
1 3 ,8 0 0 12% = 1 ,6 5 6 1 m th . = 138
$ 838

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Next steps:
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The cost of goods manufactured schedule is

prepared from the direct materials budget, the
direct labor budget and the overhead budget.
o The ending work-in-process inventory amounts are
estimates provided by management.
o The amounts for direct materials are in dollars, not
units.
The cost of goods sold schedule starts by
calculating the cost per unit and then considers the
beginning inventory to calculate COGS

Finally:
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Budgeted income statement

Budgeted statement of cash flows

Budgeted balance sheet

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Budget Administration
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The Budget Committee is a standing committee

responsible for . . .
overall policy matters relating to the budget.
coordinating the preparation of the budget.

Firms with international operations face special

problems when preparing a budget.
1. Fluctuations in foreign currency exchange rates.
2. High inflation rates in some foreign countries.
3. Differences in local economic conditions.

Behavioral impact of budgets

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Budgetary Slack: Padding the Budget

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Exercise 9-22
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Main topics:
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Profit planning and activity-based

budgeting

Standard costing and variance analysis

Flexible budgets
Exercise: Web company

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Managing costs
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Standard Actual
cost cost

Comparison between
standard and actual
performance
level

Cost
variance

Perfection v.s practical standards

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Practical standards
Should we use should be set at levels
practical standards that are currently
or perfection attainable with
standards? reasonable and
efficient effort.

FedEx: a delay of 1 minute in unloading their boxes

from a Boeing must be explained at a daily meeting
(they are allowed 18 minutes).

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Cost variance analysis

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Standard Cost Variances

Price Variance Quantity Variance

The difference between The difference between

the actual price and the the actual quantity and
standard price the standard quantity

A general model for variance analysis

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Actual Qt. Actual Qt. Standard Qt.

Actual Price Standard Price Standard Price

Price Variance Quantity Variance

AQ(AP
Materials price- variance
SP) SP(AQ
Materials - SQ)
quantity variance
Labor rate variance Labor efficiency variance
AQ = Actual
Variable overheadQt. SP = Standard
Variable overhead Price
AP = Actual
spending Price
variance SQ = Standard
efficiency variance Qt.

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MCQ 1
27

Hanson 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

and used to make 1,000 Zippies. The material cost
a total of $6,630.

MCQ 1
28

Hansons direct-material price variance for the

week was:

a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.

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MCQ 2
29

Hansons direct-material quantity variance for the

week was:

a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.

Direct material variances

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How are the variances computed if the amount

purchased differs from the amount used?

The price variance is computed on the entire

quantity purchased
The quantity variance is computed only on the
quantity used.

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Direct material variances

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Hanson Inc. 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.

Direct labor variances

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Hanson Inc. has the following direct labor standard

to manufacture one Zippy:
1.5 standard hours per Zippy at $10.00 per direct
labor hour
Last week 1,550 direct labor hours were worked at
a total labor cost of $15,810 to make 1,000 Zippies.

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MCQ 3
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Hansons labor rate (price) variance

for the week was:

a. $310 unfavorable.
b. $310 favorable.
c. $300 unfavorable.
d. $300 favorable.

MCQ 4
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Hansons labor efficiency (quantity) variance

for the week was:

a. $510 unfavorable.
b. $510 favorable.
c. $500 unfavorable.
d. $500 favorable.

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Direct labor variances

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Actual Hours Actual Hours Standard Hours

Actual Rate Standard Rate Standard Rate
1,550 hours 1,550 hours 1,500 hours

$10.20 / hour $10.00 / hour $10.00 / hour
$15,810 $15,500 $15,000

Rate variance Efficiency variance

$310 unfavorable $500 unfavorable

Significance of Cost Variances

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1. Size of variance
1. Dollar amount What clues help me
2. Percentage of standard to determine the
2. Recurring variances variances that I
should investigate?
3. Trends
4. Controllability
5. Favorable variances
6. Costs and benefits of investigation

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Interaction among Variances

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I am not responsible for

the unfavorable labor You used too much
efficiency variance! time because of poorly
trained workers and
You purchased cheap poor supervision.
material, so it took more
time to process it.

Main topics:
38

Profit planning and activity-based

budgeting

Standard costing and variance analysis

Flexible budgets
Exercise: Web company

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Flexible Budgets
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Static budgets are prepared for a single, planned

level of activity
Performance evaluation for overhead is difficult
when actual activity differs from the planned level
of activity
The relevant question is:
How much of the favorable cost variance is due to lower
activity, and how much is due to good cost control?
To answer the question, we must flex the budget to
the actual level of activity -> analysis of overhead

Flexible Budgets
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Central Concept

If you can tell me what your activity was

for the period, I will tell you what your
costs and revenue should have been.

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Advantages of Flexible Budgets

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Show revenues and expenses that should have occurred at

the actual level of activity

May be prepared for any activity level in the relevant range

Reveal variances due to good cost control or lack of cost

control

Improve performance evaluation

Flexible budget for overhead

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Variable Total Flexible Budgets

Cost 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

11-42

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Flexible budget performance report

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Va ria ble Total

Cost Fix ed Fle x ible Actua l
Pe r Hour Costs Budge t Re sults Va riance s
Ma chine hours 8,000 8,000 0
Va ria ble costs
Indire ct la bor $ 4.00 $ 32,000 $ 34,000 $ 2,000 U
Indire ct m a te ria l 3.00 24,000 25,500 1,500 U
Pow e r 0.50 4,000 3,800 200 F
Tota l varia ble costs $ 7.50 $ 60,000 $ 63,300 $ 3,300 U
Fix e d Ex pe nse s
De pre cia tion $12,000 $ 12,000 $ 12,000 0
Insura nce 2,000 2,000 2,000 0
Tota l fixe d costs $ 14,000 $ 14,000 0
Tota l ove rhe a d costs $ 74,000 $ 77,300 $ 3,300 U

Variable overhead variances

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Actual Flexible Budget Flexible Budget
Variable for Variable for Variable
Overhead Overhead at Overhead at
Incurred Actual Hours Standard Hours
AH AR AH SVR SH SVR

Spending Efficiency
Variance Variance
AH(AR - SVR) SVR(AH - SH)
AH = Actual Hours of Activity
AR = Actual Variable Overhead Rate
SVR = Standard Variable Overhead Rate
SH = Standard Hours Allowed

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Variable overhead variances

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ColaCos actual production for the period required

3,200 standard machine hours (each with a standard
cost of $2). Actual variable overhead incurred for the
period was $6,740. Actual machine hours worked
were 3,300.

Compute the variable overhead spending and

efficiency variances.

Variable overhead variances

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Spending Variance Efficiency Variance

Results from paying more A function of the
or less than expected for selected cost driver.
overhead items and from
It does not reflect
excessive usage of
overhead control.
overhead items.

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Fixed Overhead Variances

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Actual Fixed Fixed Fixed

Overhead Overhead Overhead
Incurred Budget Applied
SH PFOHR

Budget Volume
Variance Variance

PFOHR = Predetermined Fixed Overhead Rate

SH = Standard Hours Allowed

Fixed overhead variances

48

ColaCos actual production required 3,200 standard

machine hours. Actual fixed overhead was $8,450.
Budgeted fixed overhead was $9,000, for a planned
activity level of 3,000 hours.

Compute the fixed overhead budget and volume

variances.

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Fixed overhead variances

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Budget Variance Volume Variance

Results from paying more Results from the inability
or less than expected for to operate at the activity
overhead items. level planned for the period.
Has no significance for
cost control.

11-49

Sales variance analysis

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Actual Sales Volume Actual Sales Volume Budgeted Sales Volume

Actual Sales Price Budgeted Sales Price Budgeted Sales Price

Sales Price Variance Sales Volume Variance

ASV(ASP - BSP) BSP(ASV - BSV)

ASV = Actual Sales Volume BSP = Budgeted Sales Price
ASP = Actual Sales Price BSV = Budgeted Sales Volume

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Main topics:
51

Profit planning and activity-based

budgeting

Standard costing and variance analysis

Flexible budgets
Exercise: Web company

Next:
52

Case: Danshui Plant 2

Case: Midwest ice cream

Read chapters 12 & 13 (focus is transfer pricing)

Questions/ Comments?

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