The Use of Budgets for Cost Control and Performance Evaluation

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Chapter 10

• The Use of Budgets for Cost Control and
  Performance Evaluation

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Topics to be Discussed
Introduction Standard Costing Ideal Versus
Practical Standards Use of Standards by
Nonmanufacturing Organizations Application in
Business
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Introduction
Key Concept The purpose of the control function
in management is to make sure that the goals of
the organization are being attained.
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Introduction
Variance Analysis At the end of the an accounting
period, managers use the budget as a control tool
by comparing budgeted sales, budgeted production
and budgeted manufacturing costs with actual
sales, production and manufacturing
costs. Variance analysis allows managers to see
whether sales, production and manufacturing costs
are higher or lower than planned, and WHY actual
sales, production and costs differ from those
budgeted.
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Introduction
Management by Exception Managers choose
deviations to investigate by focusing on material
or significant differences.
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Standard Costing
Standard Price the Budgeted Price of the
material, labor or overhead for each
unit. Standard Quantity the Budgeted Quantity of
the material, labor or overhead for each unit.
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Standard Costing
Task Analysis examines the production process in
detail with an emphasis on determining what it
should cost to produce a product, not what it
cost last year.
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Ideal vs Practical Standards
Ideal Standards One that is attained only when
near perfect conditions are present. Assumes that
every aspect of the production process, from
purchasing through shipment, is at peak
efficiency.
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Ideal vs Practical Standards
Practical Standards Should be attained under
normal, efficient operating conditions. Take into
consideration that machines break down
occasionally, that employees are not always
perfect, that waste in materials does occur.
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Ideal vs Practical Standards
Pause and Reflect How do you think you would
react to being evaluated using ideal standards?
Only As or Fs for a grade? What about practical
standards?
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Use of Standards by Nonmanufacturing Organizations
Auto dealership How much should it cost to sell
a car? City How much should it cost to provide
garbage pickup? State University How much should
it cost to provide an education per student? CPA
firm How much time is needed to prepare certain
types of tax forms or returns?
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Use of Standards by Nonmanufacturing Organizations
Pause and Reflect The estimated cost of providing
an education to a student at a typical state
university has been estimated to exceed 30,000
per year. However, in-state tuition at most
public universities rarely exceeds 3,000 to
5,000 per year. Who is paying the rest of the
cost?
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Application in Business
Some managed health care companies have a
standard amount of time for doctors seeing
patients for particular ailments. Initial visit
20 minutes Full physical 45 minutes
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Standard Costing Topics
Flexible Budgeting with Standard Costs Sales
Volume Variance Variable Manufacturing Cost
Variances A Model Variance Analysis Direct
Material Variances Direct Labor
Variances Variable Overhead Variances Fixed
Overhead Variances
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Flexible Budgeting with Standard Costs
Standard Costs for Corinnes Country Rocker
Standard Quantity 20 linear ft of oak 5 labor
hours 5 labor hours
Standard Price 2 per foot 12 per hour 3 per
hour
Standard Cost 40 60 15 115
Direct Material Direct Labor Variable OH
Total Variable Production Costs
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Flexible Budgeting with Standard Costs
Comparison of Budget to Actual
Static Budget 1,500 1,500 375,000 172,500 37,500
165,000
Flexible Budget 1,600 1,600 400,000 184,000 40,00
0 176,000
Actual Budget 1,600 1,600 396,800 189,200 40,800
168,800
Units sold Units produced Sales revenue Variable
manuf. Costs Variable S A Contribution margin
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Flexible Budgeting with Standard Costs
Comparison of Budget to Actual, cont.
Static Budget 165,000 15,000 18,000 132,000
Flexible Budget 176,000 15,000 18,000 143,000
Actual Budget 168,800 15,000 16,000 136,800
Contribution margin Fixed manuf. Costs Fixed S
A Operating Income
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Flexible Budgeting with Standard Costs
Why is the difference between the static budget
and flexible budget contribution margin the same
as the difference between the static budget and
flexible budget operating income?
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Sales Volume Variance
Sales Volume Variance (Actual Budgeted Sales
Volume) X (Budgeted Contribution Margin Per
Unit) For Corrines 11,000 (1,600 1,500) x
110
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Sales Volume Variance
Sales Vol Var 25,000 11,500 2,500 11,000 11,00
0
Flexible Budget 1,600 1,600 400,000 184,000 40,000
176,000 15,000 18,000 143,000
Static Budget 1,500 1,500 375,000 172,000 37,500 1
65,000 15,000 18,000 132,000
Units sold Units produced Sales revenue Variable
manuf. Costs (-) Variable S A (-) Contribution
margin Fixed manuf. Costs (-) Fixed S A
(-) Operating Income
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Flexible Budget Variance
The difference between the flexible budget
operating income and actual operating income is
called the flexible budget variance. The flexible
budget removes any differences due to volume.
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Flexible Budget Variance
Flexible Budget 1,600 250 400,000 184,000 40,000
176,000 15,000 18,000 143,000
Flexible Budget Variance (3,200) 5,200 800 (9.20
0) 1,000 (2,000) (8,200)
Actual Results 1,600 248 398,800 189,200 40,800 1
66,800 16,000 16,000 134,800
Units sold Avg. sales price per unit Sales
revenue Variable manuf. Costs (-) Variable S A
(-) Contribution Margin Fixed manuf. Costs
(-) Fixed S A (-) Operating Income
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Flexible Budget Variance
Key Concept The flexible budgeting process
removes any differences or variances due only to
variations in volume.
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Sales Price Variance
Sales Price Variance (Actual - Expected Sales
Price) x Actual volume -3,200 (248-250) x
1,600 Why?
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Variance Analysis
Basic Variance Analysis Model
SQ x SP Flexible Budget Amount
AQ x AP Actual Cost
AQ x SP
AQ (AP-SP) Price Variance
SP (AQ - SQ) Usage Variance
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Variance Analysis
SQ Actual number of units produced X
Standard (budgeted) quantity of material or
number of hours budgeted per unit
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Direct Material Variances
AQ x AP 33,600 x 1.90 63,840
AQ x SP 33,600 x 2.00 67,200
SQ x SP 32,000 x 2.00 64,000
33,600 (1.90 - 2.00) 3,360 F Price Var.
2.00 (33,600 - 32,000) 3,200 U Usage Var
Total Variance 3,360 F 3,200 U 160 F
SQ 20 ft./unit x 1,600 chairs
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Direct Material Variances
What are some possible reasons for an unfavorable
direct material price variance and a favorable
material usage variance?
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Direct Material Variances

• AQ X AP AQ X SP
  AQ X SP SQ X SP
• 35,000 X 1.90 35,000 X 2.00 33,600
  X 2.00 32,000 X 2.00
• 66,500 70,000
  67,200 64,000
• 3,500 F
  3,200
• Price Var
  Usage Var
• The model above is when quantities purchased are
  not the same as quantities used.

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Direct Material Variances

• AH X AR AH X SR
  SH X SR
• 8,400 X 12.10 8,400 X
  12.00 8,000 X 12.00
• 101,640
  100,800 96,000
• 840 U
  4,800 U
• Rate Var
  Efficiency Var
• Total Direct Labor Variance 840 U 4,800 U
  5,640 U
• SH 1,600 chairs X 5 hrs/chair

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Direct Labor Variances
What are some possible reasons for favorable
direct labor rate and efficiency variances?
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Variable Overhead Variances

• Actual Variable AH X SVR
  SH X SVR
• Overhead Expense 8,400 X 3.00
  8,000 X 3.00
• 23,720
  25,200 24,000
• 1,480 F
  1,200 U
• Spending Variance
  Efficiency Variance
• Total Variable Overhead Variance 1,480 F
  1,200 U 280 F

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Variable Overhead Variances
Key Concept The variable overhead efficiency
variance does not measure the efficient use of
overhead but rather the efficient use of the cost
driver or overhead allocation base used in the
flexible budget.
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Fixed Overhead Variances
Budget Variance the difference between the
amount of fixed overhead actually incurred and
the flexible budget amount. Volume Variance the
difference between the flexible budget amount and
the amount of fixed overhead applied to products.
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Fixed Overhead Variances

• Actual Fixed Budgeted
  Applied
• Overhead Expense Fixed Overhead
  Fixed Overhead
• 16,000 15,000
  16,000
• 1,000 U
  1,000 F
• Spending Variance
  Volume Variance

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Overhead Variances
Key Concept Total over- or underapplied overhead
is the sum of the four overhead variances (two
variable overhead variances and the two fixed
overhead variances).
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Overhead Variances
Key Concept The fixed overhead volume variance
should not be interpreted as favorable or
unfavorable, or as a measure of the efficient
utilization of facilities.
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More Topics
ABC and Variance Analysis Selling and
Administrative Expense Variance Interpreting and
Using Variance Analysis Behavioral Considerations
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Selling and Administrative Expense Variance
A price standard can be developed for the time
spent to process each mail-order sales by
telephone, which includes the salary costs
incurred by the sales representatives handling
the call and the direct costs of the toll-free
line. Then the actual costs incurred can be
compared to the the flexible budget and the price
and usage variances can be calculated.
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Selling and Administrative Expense Variance
Drawbacks on Variances The information from VA is
likely to be too aggregated for operating
managers to use. The information from VA is not
timely enough to be useful to managers.
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Selling and Administrative Expense Variance
Drawbacks on Variances Traditional VA of variable
and fixed overhead provides little useful
information for managers. Traditional VA focuses
on cost control instead of product quality,
customer service, delivery time, and other
nonfinancial measures of performance.
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Interpreting and Using Variance Analysis
Use the decision model Define the
problem Identify objectives Identify and analyze
available options Select the best option
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Interpreting and Using Variance Analysis
An unfavorable direct material usage variance
generally points to a problem in
production. However, further analysis might
reveal that usage was high because of an unusual
number of defective parts and the large number of
defective parts was a result of the purchasing
manager buying materials of inferior quality.
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Interpreting and Using Variance Analysis
Pause and Reflect Even though the purchasing
manager caused the problem, the material price
variance would be favorable. As discussed
earlier, favorable variances are not necessarily
good.
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Behavioral Considerations
Standards Costs and Variance Analysis can provide
very useful control and performance evaluations,
or they can cause dysfunctional behavior among
employees and management.
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End of Chapter 10
What variances do you need for your business?