Horngren’s Financial & Managerial

Accounting: The Managerial Chapters

Seventh Edition

Flexible Budgets

Ir.drs.
Copyright © 2018, 2016, 2014 Houke
Pearson Holswilder
Education, Inc. All Rights Reserved
 Controlling Costs
• Companies use budgets to specify how much they expect different
parts of the firm’s operations to cost
• Budget performance reports can then be constructed afterwards
by comparing the budget with the actual outcome
• In this chapter we learn (1) how a budget can be created using a
standard cost system, and (2) how we can analyze the budget
performance report

• This is Chapter 8, of which we cover today: p431-443

• And the remainder next week

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 Overview
1. How are budgets constructed?
– Standards and how to use them
– Fixed vs. flexible budgets

2. How do we analyze the difference between the budget

and the actual results?
– Budget variances
– Budget performance reports

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 Static vs. Flexible Budgets
• A static budget is a master budget, which is prepared for one level
of sales volume
– If a firm expects sales of e.g. 10,000 units, the budget is prepared
based on 10,000 units

• A flexible budget is a series of budgets, prepared for different levels

of sales
– If a firm expects sales of e.g. 10,000 units, flexible budgets might be
prepared for 8,000; 9,000; 10,000; 11,000; 12,000 units

• When we talk about the flexible budget, we generally mean the

budget constructed at the actual level of sales

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 Standards
• Setting standards means defining what the norm is
• In terms of costs ($ P)
– E.g. how much does the firm normally pay for its materials?
• And efficiency (Q)
– E.g. how many labor hours normally going into making one unit of final
product?
• We do this for direct material, direct labor, and manufacturing
overhead costs

• Standards are used for budgeting purposes, as well as analyzing

performance
– If we produce 10,000 units, how much would that normally cost?

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 Standard Setting Issues
Exhibit 23-6 Standard Setting Issues

Cost Standards
$P Efficiency Standards
Q
Direct Responsibility: Responsibility: Production
Materials Purchasing manager manager
(DM) and engineers
Factors: Purchase cost, Factors: Product specifications,
discounts, delivery requirements, spoilage, production
credit policies scheduling
Direct Responsibility: Human Responsibility: Production
Labor resources manager
(DL) manager and engineers
Factors: Wage rate based on Factors: Time requirements for
experience the production level
requirements, and employee
payroll taxes, fringe experience needed
benefits

Manufacturing Responsibility: Production manager

Overhead
Factors: Nature and amount of resources needed to support activities, such as
moving materials, maintaining equipment, and product inspection
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 Example

Exercise:
Construct the static budget
for September 2014

Expected sales revenue was ©$106,700

Copyright ; actual
2014 Pearson sales
Education, Inc.revenue
Publishing $112,350
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Example
• Static budget is prepared on the basis of standard costs
(i.e. how much you expect something to cost) and
expected sales
• The actual costs and actual sales are therefore not
relevant for constructing the budget

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Example answer
Units 97,000
Sales revenue $106,700
Variable costs:
Direct materials
Direct labor
Variable overhead
Total variable costs $64,020
Contribution margin $42,680
Fixed costs $32,980
Operating income $9,700

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 Budget Variances
• The difference between a budget and the actual outcome
is called a budget variance
• It can be either:
– Favorable, if the difference leads to a higher operating income
(compared to what was budgeted)
– Unfavorable, if the difference leads to a lower operating income
(compared to what was budgeted)

• Budget variances can be analyzed on different levels

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 Budget Variances
A=Actual
Exhibit 23-4 Budget Variances B=Budget

PA * Q A PB * Q A PB * Q B
Actual Results Flexible Budget Static Budget
Based on actual Based on expected
number of units sold number of units sold

Static Budget Variance Level 1 variance

Flexible Budget Variance Sales Volume Variance

Level 2 variance

Change in P Change in Q

Level 3 follows next week!

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 Budget Variances
Static budget variance can thus be divided into two components:

• Flexible budget variance

– Difference between actual results and flexible budget
– Shows a price effect
– For example: product sold for a higher price, lower per unit material cost, higher
fixed costs

• Sales volume variance

– Difference between static and flexible budget
– Shows a quantity effect
– If you sell more units than expected, you also have to produce more units 
make more costs than expected

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 Static Budget (Level1) Performance Report
Compare the static Budget and actual results: Favorable or Unfavorable?
Exhibit 23-2 Static Budget Performance Report Impact on OI?
CHEERFUL COLORS
Static Budget Performance Report
For the Year Ended December 31, 2015

PA* QA Actual PB* QB Static

Results Budget Variance

Units (Batches of 100) 52,000 50,000 2,000 F

$ $ $
Sales Revenue 384,800 375,000 9,800 F
Variable Costs:
Manufacturing:

Direct Materials 104,000 87,500 16,500 U

Direct Labor Performance

145,600 report150,000
: 4,400 F
Where did we go “off” compared to the budget?
Variable Overhead 30,160 37,500 7,340 F
Selling and Administrative:

Supplies 19,200 18,750 450 U

Total Variable Costs 298,960 293,750 5,210 U

Contribution Margin 85,840 81,250 4,590 F

Fixed Costs: Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall 23-13
 Flexible Budget (Level 2)Performance Report
To improve yourBudget
Exhibit 23-5 Flexible company’s result, which item will you address first?
Performance Report

CHEERFUL COLORS
Flexible Budget Performance Report
For the Year Ended December 31, 2015
1 2 3 4 5
(1) – (3) (3) – (5)
Budget
Amounts Actual PFlexible
B* Q A Static
Per Unit Results Budget Budget

Units (Batches of 100) 52,000 52,000 50,000

$ $ $ $ $ $

Sales Revenue 7.50 384,800 5,200 U 390,000 15,000 F 375,000

Variable Costs:
Manufacturing:

Direct Materials 1.75 104,000 13,000 U 91,000 3,500 U 87,500

Direct Labor 3.00 145,600 10,400 F 156,000 6,000 U 150,000

Variable Overhead 0.75 30,160 8,840 F 39,000 1,500 U 37,500

Selling and Administrative:

Supplies 5% of sales 19,200 300 F 19,500 750 U 18,750

Total Variable Costs 298,960 6,540 F 305,500 11,750 U 293,750

Contribution Margin 85,840 1,340 F 84,500 3,250 F 81,250

Fixed Costs: Flexible Budget Variance Sales Volume Variance
internal $ 680 U $ 3,250 F
Manufacturing processes ( P) 23,920 1,080 F 25,000
Static 0
Budget Variance 25,000
$ 2,570 F
Selling and Administrative 25,600 3,100 U 22,500 0 additional
22,500
Copyright © 2014 Pearson sales 23-14
( Q)
Total Fixed Costs 49,520 Education,
2,020Inc. Publishing
U as Prentice Hall
47,500 0 47,500
$ $ $ $ $
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E8-16
MURPHY COMPANY
Flexible Budget Performance Report
For the Year Ended July 31, 2018

Flexible Sales
Actual Budget Flexible Volume Static
Results Variance Budget Variance Budget
Units 35,000 35,000 5,000 F
Sales Revenue $ 219,000 $ 219,000 $ 27,000 F
Variable Expenses
85,000 84,000 13,000 U
Contribution
Margin 134,000 135,000 14,000 F
Fixed Expenses 105,000 100,000 0F
Operating Income $ 29,000 $ 35,000 $ 14,000 F

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E8-16
MURPHY COMPANY
Flexible Budget Performance Report
For the Year Ended July 31, 2018

Flexible Sales
Actual Budget Flexible Volume Static
Results Variance Budget Variance Budget
Units 35,000 35,000 5,000 F 30,000
Sales Revenue $ 219,000 $ 219,000 $ 27,000 F $ 192,000
Variable Expenses
85,000 84,000 13,000 U 71,000
Contribution
Margin 134,000 135,000 14,000 F 121,000
Fixed Expenses 105,000 100,000 0F 100,000
Operating Income $ 29,000 $ 35,000 $ 14,000 F $ 21,000

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E8-16
MURPHY COMPANY
Flexible Budget Performance Report
For the Year Ended July 31, 2018

Flexible Sales
Actual Budget Flexible Volume Static
Results Variance Budget Variance Budget
Units 35,000 0 35,000 5,000 F 30,000
Sales Revenue $ 219,000 $ 0 $ 219,000 $ 27,000 F $ 192,000
Variable Expenses
85,000 1,000 U 84,000 13,000 U 71,000
Contribution
Margin 134,000 1,000 U 135,000 14,000 F 121,000
Fixed Expenses 105,000 5,000 U 100,000 0F 100,000
Operating Income $ 29,000 $ 6,000 U $ 35,000 $ 14,000 F $ 21,000

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 MURPHY COMPANY
Flexible Budget Performance Report
For the Year Ended July 31, 2018

Flexible Sales
Actual Budget Flexible Volume Static
Results Variance Budget Variance Budget
Units 35,000 0 35,000 5,000 F 30,000
Sales Revenue $ 219,000 $ 0 $ 219,000 $ 27,000 F $ 192,000
Variable Expenses
85,000 1,000 U 84,000 13,000 U 71,000
Contribution
Margin 134,000 1,000 U 135,000 14,000 F 121,000
Fixed Expenses 105,000 5,000 U 100,000 0F 100,000
Operating Income $ 29,000 $ 6,000 U $ 35,000 $ 14,000 F $ 21,000

Analysis:
• First fire the person who submitted the incomplete performance report
• Favorable variance is entirely due to higher sales
– Did the sales department simply do a great job, or is there something going on?
• All costs show unfavorable flexible budget variance
– Check in with responsible cost managers to find out the cause

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E23-17
8 Preparing a flexible budget performance report

Top managers of Marshall Industries predicted 2018 sales of 14,800 units of its product at a unit price of
$9.50. Actual sales for the year were 14,600 units at $12.00 each. Variable costs were budgeted at $2.00
per unit, and actual variable costs were $2.10 per unit. Actual fixed costs of $48,000 exceeded budgeted
fixed costs by $4,000.
Prepare a. Static budget, Actual results, Static budget variance
b. Flexible budget, Flexible budget variance, Sales Volume variance

MARSHALL INDUSTRIES
Flexible Budget Performance Report
For the Year Ended December 31, 2018
1 2 3 4 5
(1) – (3) (3) – (5)
Budget
Amounts
per Unit Flexible
Actual Budget Flexible Sales Static
Results Variance Budget Volume Variance Budget
Units 14,600 0 14,600 200 U 14,800
Sales Revenue $ 9.50 $ 175,200 $ 36,500 F $ 138,700 $ 1,900 U $ 140,600

Variable Costs 2.00 30,660 1,460 U 29,200 400 F 29,600

Contribution Margin 144,540 35,040 F 109,500 1,500 U 111,000

Fixed Costs 48,000 4,000 U 44,000 0 44,000

Operating Income $ 96,540 $ 31,040 F $ 65,500 $ 1,500 U $ 67,000

Flexible budget variance Sales Volume variance

Static budget variance $29,540 F

 Static budget
Units
Sales revenue
Variable costs
Contribution margin
Fixed costs
Operating income

• Budgeted costs () and budgeted quantities ()

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 Flexible budget
Units
Sales revenue
Variable costs
Contribution margin
Fixed costs
Operating income

• Budgeted costs () and actual quantities ()

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 Actual results
Units
Sales revenue
Variable costs
Contribution margin
Fixed costs
Operating income

• Actual costs () and actual quantities ()

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 MARSHALL INDUSTRIES
Flexible Budget Performance Report
For the Year Ended December 31, 2018
1 2 3 4 5
(1) – (3) (3) – (5)
Budget
Amounts
per Unit Flexible
Actual Budget Flexible Sales Static
Results Variance Budget Volume Variance Budget
Units 14,600 0 14,600 200 U 14,800
Sales Revenue $ 9.50 $ 175,200 $ 36,500 F $ 138,700 $ 1,900 U $ 140,600

Variable Costs 2.00 30,660 1,460 U 29,200 400 F 29,600

Contribution Margin 144,540 35,040 F 109,500 1,500 U 111,000

Fixed Costs 48,000 4,000 U 44,000 0 44,000

Operating Income $ 96,540 $ 31,040 F $ 65,500 $ 1,500 U $ 67,000

Flexible budget variance Sales Volume variance

Static budget variance $29,540 F

Follow-up exercise:
Analyze the performance report and summarize your
conclusions.
• The company managed to sell their product for a significantly higher
price than expected ($12 vs. $9.50)
– Company should analyze how this happened, particularly if it is likely to
happen again in the future
• There is a significant unfavorable flexible budget variance for the
fixed costs in particular ($48,000 vs. $44,000)
– Company should investigate and take steps to ensure that fixed costs are
controled
• The sales volume fell slightly by 200 units, leading to some
unfavorable sales volume variance, but these amounts are all
quite small
– No action needed

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 Questions?
• If not, see you next week!

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