Flexible Budgets,

Variances,
and Management Control

Manaswee
 Static and Flexible Budgets

Planned level of
Static Budget Based on output at start of
the budget period

Budgeted revenues
Based on
Flexible Budget and cost based on
actual level of output
Manaswee
 Static Budget Example

Assume that Pasadena Co. manufactures

and sells dress suits.
Budgeted variable costs per suit are as follows:
Direct materials cost $ 65
Direct manufacturing labor 26
Variable manufacturing overhead 24
Total variable costs $115
Manaswee
 Static Budget Example

Budgeted selling price is $155 per suit.

Fixed manufacturing costs are expected
to be $286,000 within a relevant range
between 9,000 and 13,500 suits.
Variable and fixed period costs are ignored.
The static budget for year 2004 is based
on selling 13,000 suits.
What is the static-budget operating income?
Manaswee
 Static Budget Example

Revenues (13,000 $155) $2,015,000

Less Expenses:
Variable (13,000 $115) 1,495,000
Fixed 286,000
Budgeted operating income $ 234,000
Assume that Pasadena Co. produced and sold
10,000 suits at $160 each with actual variable
costs of $120 per suit and fixed manufacturing
costs of $300,000.
Manaswee
 Static Budget Example

What was the actual operating income?

Revenues (10,000 $160) $1,600,000
Less Expenses:
Variable (10,000 $120) 1,200,000
Fixed 300,000
Actual operating income $ 100,000

Manaswee
Static-Budget Variance Example

What is the static-budget variance of

operating income?
Actual operating income $100,000
Budgeted operating income 234,000
Static-budget variance of
operating income $134,000 U
This is a Level 0 variance analysis.
Manaswee
 Static-Budget Variance Example

Static-Budget Based Variance Analysis

(Level 1) in (000)
Static Budget Actual Variance
Suits 13 10 3U
Revenue $2,015 $1,600 $415 U
Variable costs 1,495 1,200 296 F
Contribution margin $ 520 $ 400 $120 U
Fixed costs 286 300 14 U
Operating income $ 234 $ 100 $134 U
Manaswee
 Steps in Developing
Flexible Budgets

Step 2:
Determine the actual quantity of output.
In the year 2004, 10,000 suits were
produced and sold.
Step 3:
Determine the flexible budget for revenues.
$155 10,000 = $1,550,000
Manaswee
 Steps in Developing
Flexible Budgets

Step 4:
Determine the flexible budget for costs.
Variable costs: 10,000 $115 = $1,150,000
Fixed costs 286,000
Total costs $1,436,000

Manaswee
 Variances

Level 2 analysis provides information

on the two components of the
static-budget variance.
1. Flexible-budget variance
2. Sales-volume variance

Manaswee
 Flexible-Budget Variance

Flexible-Budget Variance
(Level 2) in (000)
Flexible
Budget Actual Variance
Suits 10 10 0
Revenue $1,550 $1,600 $ 50 F
Variable costs 1,150 1,200 50 U
Contribution margin $ 400 $ 400 $ 0
Fixed costs 286 300 14 U
Operating income $ 114 $ 100 $ 14 U
Manaswee
 Flexible-Budget Variance

Actual quantity sold: 10,000 suits

Actual results
operating income
Flexible-budget $100,000
variance
$14,000 U Flexible-budget
operating income
$114,000
Manaswee
 Flexible-Budget Variance

Actual Budgeted
Amount Amount
Selling price $160 $155
Variable cost 120 115
Contribution margin $ 40 $ 40

Manaswee
 Flexible-Budget Variance

Why is the flexible-budget variance $14,000 U?

Selling-price variance $50,000 F
Actual variable costs exceeded
flexible budget variable costs 50,000 U
Actual fixed costs exceeded
flexible budget fixed costs 14,000 U
Total flexible-budget variance $14,000 U
Manaswee
 Sales-Volume Variance

Sales-Volume Variance
(Level 2) in (000)
Flexible Static Sales-Volume
Budget Budget Variance
Suits 10 13 3U
Revenue $1,550 $2,015 $465 U
Variable costs 1,150 1,495 295 F
Contr. margin $ 400 $ 520 $120 U
Fixed costs 286 286 0
Operating income $ 114 $ 234 $120 U
Manaswee
 Sales-Volume Variance

Actual quantity sold: 10,000 suits

Flexible-budget
operating income
Sales-volume $114,000
variance
$120,000 U Static-budget
operating income
$234,000
Manaswee
 Sales-Volume Variance

Actual sales unit Master budgeted sales units

13,000 10,000 = 3,000

Budgeted contribution margin per unit $40

=
Total sales-volume variance $120,000 U
Manaswee
 Budget Variances

Static-budget
Level 1 variance
$134,000 U

Flexible-budget Sales-volume
Level 2 variance variance
$14,000 U $120,000 U
Manaswee
 Obtaining budgeted price and
quantity
Past data: for continuous improvement,
may include past inefficiency, may not
reflect expected changes in the budgeted
period
Data from other companies using similar
process provides a benchmark, right
benchmark!
Standard cost
Manaswee
 Budget & standard
Budgeted price, quantity, cost may not be
based on standard
If standards are used, both are
interchangeable

Manaswee
 Standards

Pasadenas budgeted cost for each variable

direct cost item is computed as follows:

Standard input Standard cost

allowed for
per input unit
one output unit

Manaswee
 Standards

4.00 square yards allowed per output unit

at $16.25 standard cost per square yard.
Standard cost per output unit
4.00 $16.25 = $65.00

Manaswee
 Standards

2.00 manufacturing labor-hours of input

allowed per output unit at $13.00 standard
cost per hour.
Standard cost per output unit
2.00 $13.00 = $26.00

Manaswee
 Learning Objective

Compute price variances

and efficiency variances
for direct-cost categories.

Manaswee
 Actual Data

Direct materials purchased and used:

42,500 square yards at $15.95
Cost of direct materials = $677,875
Labor hours: 21,500 at $12.90
Cost of direct manufacturing labor = $277,350

Manaswee
 Material Price Variance

Direct-material price variance

Actual price Actual

= Budgeted price quantity

= ($15.95 $16.25) 42,500 = $12,750 F

Manaswee
 Labour Rate Variance

Direct-labor rate variance

Actual rate Actual

= Budgeted rate quantity

= ($12.90 $13.00) 21,500 = $2,150 F

Manaswee
 Material Efficiency Variance

Direct-material efficiency variance

Actual quantity
Standard
= Standard price
quantity

= (42,500 40,000) $16.25 = $40,625 U

Manaswee
 Labour Efficiency Variance

Direct-labor efficiency variance

Actual quantity
Standard
= Standard price
quantity

= (21,500 20,000) $13.00 = $19,500 U

Manaswee
 Flexible Budget Material Variance

AQ x AP AQ BP BQ BP
42,500 $16.25 40,000 $16.25
$677,875 $690,625 $650,000
$12,750 F $40,625 U

$27,875 U
Manaswee
 Flexible Budget Labor Variance

AQ x AP AQ BP BQ BP
21,500 $13.00 20,000 $13.00
$277,350 $279,500 $260,000
$2,150 F $ 19,500 U

$17,350 U
Manaswee
 Variance Analysis

Level 1
Static-budget variance
Materials $167,125 F
Labor 60,650 F
Total $227,775 F
Level 2 Level 2
Flexible-budget variance Sales-volume variance
Materials $27,875 U Materials $195,000 F
Labor 17,350 U Labor 78,000 F
Total $45,225 U Total $273,000 F
Manaswee
 Variance Analysis

Level 2
Flexible-budget variance
Materials $27,875 U
Labor 17,350 U
Total $45,225 U
Level 3 Level 3
Price variance Efficiency variance
Materials $12,750 F Materials $40,625 U
Labor 2,150 F Labor 19,500 U
Total $14,900 F Total $60,125 U
Manaswee
 Learning Objective

Explain why purchasing

performance measures should
focus on more factors than
just price variances.

Manaswee
Performance Measurement
Using Variances

Effectiveness is the degree to which a

predetermined objective or target is met.
Efficiency is the relative amount of inputs
used to achieve a given level of output.
Variances should not solely be used to
evaluate performance.

Manaswee
When to Investigate Variances

When should variances be investigated?

Subjective judgments
Rules of thumb as investigate all variances
exceeding $10,000 or 5% of expected cost,
whichever is lower.

Manaswee
 Learning Objective

Perform variance analysis in

activity-based costing systems.

Manaswee
 Flexible Budgeting and
Activity-Based Costing

Materials costs and direct manufacturing labor

costs are examples of output-unit level costs.
Batch-level costs are resources sacrificed
on activities that are related to a group of
units of product(s) or service(s) rather than
to each individual unit of product or service.

Manaswee
 Flexible Budgeting and
Activity-Based Costing

Denver Co. produces metal planters (MP).

Assume that material-handling labor costs vary
with the number of batches produced rather
than the number of units in a batch.
Material-handling labor costs are direct batch
level costs that vary with the number of batches.

Manaswee
 Flexible Budgeting and
Activity-Based Costing

Static Actual
Budget Amounts
Units produced and sold 18,000 15,660
Batch size 180 174
Number of batches 100 90
Material-handling
labor-hours per batch 5.00 5.20

Manaswee
 Flexible Budgeting and
Activity-Based Costing

Static Actual
Budget Amounts
Total labor-hours 500 468
Cost per material-handling
labor-hour $14.00 $14.50
Total material-handling
labor cost $7,000 $6,786

Manaswee
 Flexible Budgeting and
Activity-Based Costing

How many batches should have been employed

to produce the actual output units?
15,660 units 180 units per batch = 87 batches
How many material-handling hours
should have been used?
87 batches 5 hours/batch = 435 hours
Manaswee
 Flexible Budgeting and
Activity-Based Costing

What is the flexible budget for

material-handling labor-hours?
435 hours $14.00/labor-hour = $6,090
Flexible-budget costs $6,090
Actual costs 6,786
Flexible-budget variance $ 696 U

Manaswee
 Price and Efficiency Variances

Price variance = ($14.50 $14.00) 468 = $234 U

Efficiency variance = (468 435) $14.00 = $462 U
Total variance $696 U

Manaswee
 Breaking Sales Volume
Variance
1. Market size variance =[(Actual Industry Sales in
Units Budgeted Industry Sales in Units) x
Budgeted Market Share Percentage] x
Budgeted Average Unit Contribution Margin
2. Market share variance=[(Actual Market Share
Percentage Budgeted Market Share
Percentage) x Actual Industry Sales in Units] x
Budgeted Average Unit Contribution Margin
[Size variance is uncontrollable, share variance
is controllable]