Flexible Budgets and Standard Costs

1
Flexible Budgets and Standard Costs
Chapter
24
2
Budgetary Control and Reporting

• Develop the budgetfrom planned objectives.

• Compareactual with budget andanalyze
  anydifferences.

• Reviseobjectivesand preparea newbudget.

Management usesbudgets to monitorand
controloperations.

• Take corrective andstrategic actions.

3
Fixed Budget Performance Report

• Fixed budgets are prepared for a single,
  predicted level of activity.
• Performance evaluation is difficult when
  actual activity differs from the predicted level
  of activity.

4
Fixed Budget Performance Report

• Considerthe following condensed example from
  the Optel Company . . .

5
Fixed Budget Performance Report
Exh. 24-2
6
Fixed Budget Performance Report
Exh. 24-2
U Unfavorable varianceActual cost is
greaterthan budgeted cost.
7
Fixed Budget Performance Report
Exh. 24-2
F Favorable varianceActual revenue and income
are greater than budgeted revenue and income.
8
Fixed Budget Performance Report
Exh. 24-2
If unit sales are higher, should we expect costs
to be higher? How much of the higher costs are
because of higher unit sales?
9
Fixed Budget Performance Report
10
Fixed Budget Performance Report
11
Flexible Budgets

• Central Concept
• If you can tell me what your activity wasfor
  the period, I will tell you what your costs and
  revenue should have been.

12
Purpose of Flexible Budgets
Show revenues and expensesthat should have
occurred at theactual 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.
13
Preparing Flexible Budgets

• To a budget for different activity
  levels, we must know how costs behave with
  changes in activity levels.
• Total variable costs changein direct proportion
  to changes in activity.
• Total fixed costs remainunchanged within
  therelevant range.

14
Preparing Flexible Budgets
15
Preparing Flexible Budgets
Exh. 24-3
Variable costs are expressed as a constant amount
per unit.
16
Preparing Flexible Budgets
Exh. 24-3
Total variable cost 4.80 per unit budget
level in units
17
Preparing Flexible Budgets
Exh. 24-3
Fixed costs are expressed as a total amount that
does not change within the relevant range of
activity.
18
Flexible Budget Performance Report
19
Flexible Budget Performance Report
Exh. 24-4
Favorable sales variance indicates that the
average selling price was greater than 10.00.
20
Flexible Budget Performance Report
Exh. 24-4
Unfavorable cost variances indicatecosts that
are greater than expected.
21
Flexible Budget Performance Report
Exh. 24-4
Favorable variances because favorable sales
variance overcomes unfavorable cost variances.
22
Standard Costs

• Lets change topics.

23
Standard Costs
Based on carefullypredetermined amounts.
Used for planning labor, materialand overhead
requirements.
The expected levelof performance.
Benchmarks formeasuring performance.
24
Setting Standard Costs
ProductionManager
ManagerialAccountant
Engineer
25
Setting Standard Costs
HumanResourcesManager
26
Setting Direct Material Standards
27
Setting Direct Material Standards
The standard material cost for one unit of
product is standard quantity
standard price for of material
one unit of material
required for one unit of product

28
Setting Direct Labor Standards
29
Setting Direct Labor Standards
The standard labor cost for one unit of product
is standard number standard wage
rate of labor hours
for one hour for one
unit
of product

30
Setting Variable Overhead Standards
31
Setting Variable Overhead Standards
The standard variable overhead cost for one unit
of product is standard variable
standard number overhead rate for
of activity units one unit
of for one unit
of activity product


32
Standard Cost Card
Exh. 24-5
A standard cost card might look like this
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Variances
A standard cost varianceis the amount by
whichan actual cost differs fromthe standard
cost.
34
Variances
This variance isfavorable becausethe actual
costis less than thestandard cost.
This variance is unfavorable because the actual
cost exceeds the standard cost.
35
Variance Analysis


Takecorrective actions
Identifyquestions
Receive explanations
Conduct next periods operations

Analyze variances
Prepare standard cost performance report
Begin
36
Computing Variances
37
Computing Variances
38
Computing Variances
Standard quantity is the quantity that should
have been used for the actual good output.
39
Computing Variances
AQ(AP - SP)
SP(AQ - SQ) AQ Actual Quantity
SP Standard Price AP Actual Price
SQ Standard Quantity
40
Computing Materialand Labor Variances
G-Max Company makes golf clubheads withthe
following standard cost information
41
Material Variances
During May, G-Max produced 3,500 clubheads
using3,600 pounds of material. G-Max paid 1.05
perpound for the material.Compute the material
price and quantity variances.
42
Material Variances
Exh. 24-10
SQ 3,500 units 1 lb. per unit 3,500 lbs.
Actual Quantity Actual Quantity
Standard Quantity

Actual Price Standard Price
Standard Price
3,600 lb. 3,600 lbs.
3,500 lbs.

1.05 per lb.
1.00 per lb. 1.00 per lb.
3,780 3,600
3,500
Price variance180 unfavorable
Quantity variance100 unfavorable
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Responsibility for Material Variances
I am not responsible for this unfavorable
materialquantity variance. You purchased
cheapmaterial, so my peoplehad to use more of
it.
44
Labor Variances

• Lets turn our attention to labor variances.

45
Labor Variances
Actual Hours Actual Hours
Standard Hours

Actual Rate Standard Rate
Standard Rate
Rate Variance
Efficiency Variance
Materials price variance Materials
quantity variance Labor rate variance
Labor efficiency variance
Variable overhead Variable
overhead spending variance
efficiency variance
AH(AR - SR)
SR(AH - SH) AH Actual Hours SR Standard
Rate AR Actual Rate SH Standard Hours
46
Labor Variances
During May, G-Max produced 3,500 clubheads
working3,400 hours. G-Max paid an average of
8.30 perhour for the hours worked.Compute the
labor rate and efficiency variances.
47
Labor Variances
Exh. 24-11
SH 3,500 units 1 hour per unit 3,500 hours
Actual Hours Actual Hours
Standard Hours

Actual Rate Standard Rate
Standard Rate
3,400 hours 3,400 hours
3,500 hours

8.30 per hour 8.00 per
hour 8.00 per hour 28,220
27,200
28,000
Rate variance1,020 unfavorable
Efficiency variance800 favorable
48
Labor Variances
Using highly paid skilled workers toperform
unskilled tasks results in anunfavorable rate
variance.
High skill,high rate
Low skill,low rate
Production managers who make work assignmentsare
generally responsible for rate variances.
49
Labor Variances
UnfavorableEfficiencyVariance
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Responsibility for Labor Variances
I am not responsible for the unfavorable
laborefficiency variance! You purchased
cheapmaterial, so it took moretime to process
it.
51
Responsibility for Labor Variances
Maybe I can attribute the laborand material
variances to personnel for hiring the wrong
peopleand training them poorly.
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Overhead Standards and Variances

• Lets change topics again.

53
Overhead Standards and Variances

• Recall that overhead costs are assigned to
  products and services using a predetermined
  overhead rate (POHR)

Assigned Overhead POHR Standard Activity
Estimated total overhead costsEstimated activity
POHR
54
Setting Overhead Standards
Contains a variableunit rate which
staysconstant at all levelsof activity.
Contains a fixedoverhead rate whichdeclines as
activitylevel increases.
Overhead Rate
Function of activity levelchosen to determine
rate.
55
Setting Overhead Standards

• Flexible budgets, showing budgeted amount of
  overhead for various levels of activity, are used
  to analyze overhead costs.

G-Maxs flexiblebudget for overhead
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Flexible Overhead Budget
Exh. 24-12
7,500 3,500 hours 2.14 per hour
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Flexible Overhead Budget
Exh. 24-12
G-Max predicted an 80 percent activity level
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Computing Overhead Variances
59
Computing Overhead Variances
Exh. 24-14
Actual Flexible Budget
Applied Variable
for Variable Variable
Overhead Overhead at
Overhead at Incurred
Actual Hours Standard
Hours
AH SVR
AH AVR
SH SVR
Spending Variance
EfficiencyVariance
AH Actual Hours of ActivityAVR Actual
Variable Overhead RateSVR Standard Variable
Overhead RateSH Standard Hours Allowed
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Computing Overhead Variances
Exh. 24-14
Actual
Fixed Fixed
Fixed Overhead
Overhead Overhead
Incurred
Budget Applied
SH SFR
Spending Variance
VolumeVariance
SFR Standard Fixed Overhead RateSH
Standard Hours Allowed
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Overhead Variance Analysis
Exh. 24-15
TotalOverheadVariance
VariableOverhead
FixedOverhead
EfficiencyVariance
SpendingVariance
VolumeVariance
SpendingVariance
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Computing Overhead Variances
During May, G-Max produced 3,500 clubheads
working3,400 hours. G-Max budgeted for 4,000
units (80).Actual variable overhead was 3,650
andactual fixed overhead was 4,000.Compute the
variable overhead spending andefficiency
variances and the fixed overheadspending and
volume variances.
63
Computing Variable Overhead Variances
Exh. 24-16
Actual Flexible Budget
Applied Variable
for Variable Variable
Overhead Overhead at
Overhead at Incurred
Actual Hours
Standard Hours
3,400 hours
3,500 hours
1.00 per hour
1.00 per hour
3,650
3,400
3,500
Spending variance250 unfavorable
Efficiency variance100 favorable
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Variable Overhead Variances

• Spending Variance

• Efficiency Variance

Results from paying moreor less than expected
foroverhead items and from excessive usage
ofoverhead items.
A function of the selected cost driver. It does
not reflect overhead control.
65
Computing Fixed OverheadVariances
Exh. 24-17
Actual
Fixed Fixed
Fixed Overhead
Overhead Overhead
Incurred
Budget Applied

3,500 hours

1.00 per hour
4,000
4,000
3,500
Spending variance0
Volume variance500 unfavorable
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Fixed Overhead Variances

• Spending Variance

• Volume Variance

Results from paying moreor less than expected
forfixed overhead items.
Results from the inabilityto operate at the
activityplanned for the period. Has no
significance for cost control.
67
Volume Variance
Exh. 24-18
Cost
Fixed overhead applied to products
Volume
4,000 ExpectedUnits
3,500ActualUnits
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Standard Costs for Control
Managers focus on quantities and coststhat
differ from standards, a practice known as
management by exception.
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Sales Variances
A similar analysis can be applied to
salesvariances. We will use two additional
G-Maxproducts, golf balls and drivers, to
illustrate.
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Exh. 25-20
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End of Chapter 24