AF5231 Managerial Accounting & Information Systems

Budgeting & Standard Costing

AGENDA
Nature & Purpose of Standard Costs The Master Budget Characteristics of a good budgetary system Budget application of decision control Static and Flexible Budgets Variance Analysis

NOT Required: PP. 567 - 569, Supplementary Note, Appendices 12A, B

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Standard Costs
Predetermined.

Purpose of Standards
To Facilitate product costing Planning future operations Monitoring current operations Motivating manager and employee behavior Evaluating Performance

Standard Costs are

Used for planning labor, material and overhead requirements. Benchmarks for measuring performance.

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Sources for Setting Standards

Historical data

Establishing Standards
Ideal standards demand
maximum efficiency and can be achieved only if everything operates perfectly. Currently attainable/Practical standards can be achieved under efficient operating conditions. Kaizen standards reflect a planned improvement and are a type of currently attainable standard.
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Usethecostpredictedbythe costfunctionasstandard cost.

Task analysis /

Engineering estimate
Analyzetheproduction processtodeterminehow muchaproductshouldcost.

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Standards vs. Budgets

Functions of budgets

The Master Budget

Are standards the same as budgets? A budget is set for total costs.

A standard is a per unit cost. Standards are often used when preparing budgets.
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Translateanorganizationsstrategiesintoaformalized financialplan Assembleknowledge&communicateamongmanagers (decisionmanagement) Defineareasofresponsibilityandmeasureperformance (decisioncontrol) Acomprehensiveplanfortheupcomingaccountingperiod. Usuallypreparedforaoneyearperiod. Comprisedofacollectionofbudgets,startingfromsalesto balancesheet.
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A master budget is

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Master Budget Components

Characteristics of a Good Budgetary System

Frequent feedback on performance Monetary and non-monetary incentives Participative Budgeting Realistic Standards Controllability of Costs Multiple Measures of Performance

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Frequent Feedback on Performance

Enable managers to take corrective actions and change plans promptly. Management by exception is often adopted.

Monetary & Non-monetary Incentives

Incentive are the means that are used to encourage goal congruent behavior. Incentive can be both positive and negative

Managerswillonlyinvestigatesignificant variancesonareaswhichrequirestheirattention.

Positive:Bonus,stockoptions Negative:Dismissal

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Participative Budgeting
Facilitate managers to get involved into the budgetary process. Advantages:

Participative Budgeting
Problems:
Settingstandardsthatareeithertoohighortoo low. Intentionallyunderestimaterevenueand overestimatecost (paddingthebudget) Buildingslack(budgetaryslack)intothebudget Pseudoparticipation

Managerscanobtainasenseofresponsibility Enhancesgoalcongruence Managerswillworkhardertoachievethese objectivesasitsbeingsetbythem

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Realistic Standards
Budgets should be developed based on realistic conditions and expectations. It should reflect operating realities:

Cost Controllability
Managers should be accountable for costs in which they can control in order to maintain fairness in performance evaluation.

Actualactivitylevels Seasonalvariations,efficienciesandgeneral economictrends

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Applications to Decision Control

Line Item Budget

Applications to Decision Control

Budget Lapsing

Authorizemanagerstospendonlyuptothespecified amountoneachlineitem. Advantages:

Tight control reduces opportunities for managers to

Arequirementthatfundsallocatedforaparticular yearcannotbecarriedovertothefollowingyear. Advantages:

Tighter control than budgets that do not lapse Prevents risk-averse managers from accumulating

take actions inconsistent with firm goals

Disadvantages:
Inflexible in responding to unanticipated needs Little incentive for cost savings

funds

Disadvantages:
Encourages wasteful spending near end of fiscal year

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Static vs. Flexible Budget

Static Budget

Static vs. Flexible Budget

Flexible Budget

Abudgetpreparedforasinglelevelofsalesvolume. Preparedatthebeginningoftheyear. Example:Masterbudget

Abudgetpreparedforamultiplelevelsofsalesvolume. Preparedatthebeg.oftheyearforplanningpurposes andattheendoftheyearforperformanceevaluation.

Static budgets are good planning devices, but using static budgets for control (performance evaluation) purposes can be problematic. Static Budget Variances

Flexible budgets are usually used for control purposes by expressing the static budget under the actual output level.

Managersperformanceisinsulatedfromoutputvolume changes. Differencesbetweenactualresults&theflexiblebudget

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Differencebetweenactualresults&thestaticbudget.
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Flexible budget Variances

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Flexible Budget - Example

CheeseCo

Flexible Budget - Example

CheeseCo

Variable costs are expressed as a constant amount per hour. $40,000 10,000 hours is $4.00 per hour.

Fixed costs are expressed as a total amount.

$4.00 per hour 8,000 hours = $32,000

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Flexible Budget - Example

CheeseCo

Flexible Budget - Example

CheeseCo

Total fixed costs do not change in the relevant range.

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Variance Analysis Cycle

Identify questions Receive explanations Take corrective actions

Management by Exception
Managers focus on quantities and costs that exceed standards, a practice known as management by exception.

Analyze variances Prepare standard cost performance report

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Conduct next periods operations

Amount

Standard Direct Material

Direct Labor

Manufacturing Overhead

Begin

Type of Product Cost

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Standard Cost Variances

A standard cost variance is the amount by which an actual cost differs from the standard cost.

Standard Cost Variances

Standard Cost Variances

Standard Cost

Price Variance This variance is unfavorable because the actual cost exceeds the standard cost.

Quantity Variance

The difference between the actual price and the standard price
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The difference between the actual quantity and the standard quantity

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General Model for Variance Analysis

Actual Quantity Actual Price Actual Quantity Standard Price Standard Quantity Standard Price

General Model for Variance Analysis

Actual Quantity Actual Price Actual Quantity Standard Price Standard Quantity Standard Price

Price Variance

Quantity Variance

Standard price is the amount that should have been paid for the resources acquired.

Price Variance Quantity Variance Standard quantity is the quantity of input allowed for the actual good output. Standard input per unit of output times amount of good output.
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General Model for Variance Analysis

Actual Quantity Actual Price Actual Quantity Standard Price Standard Quantity Standard Price

DM Price and Usage Variances

AP x AQ (Actual Quantity at Actual Price) (1) SP x AQ (Actual Quantity at Standard Price) (2) SP x SQ (Standard Quantity at Standard Price) (3)

Price Variance
AQ(AP - SP) AQ = Actual Quantity AP = Actual Price
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Quantity Variance
SP(AQ - SQ) SP = Standard Price SQ = Standard Quantity
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Price Variance (1) (2)

Usage Variance (2) (3)

Total Variance (1) (3)

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Material Variances Example

Glacier Peak Outfitters has the following direct material standard for the fiberfill in its mountain parka.
0.1 kg. of fiberfill per parka at $5.00 per kg.

Material Variances Summary

Actual Quantity Actual Price Actual Quantity Standard Price Standard Quantity Standard Price

Last month 210 kgs of fiberfill were purchased and used to make 2,000 parkas. The material cost a total of $1,029.
Price variance
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Quantity variance

Concept Check
Suppose only 190 kgs of fiberfill were used to make 2,000 parkas. What is the materials quantity variance? Remember that the standards call for 0.1 kg of fiberfill per parka at a cost of $5 per kg of fiberfill. a.$50F b.$50U c.$100F d.$100U
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Zippy

DM Variances Continued
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.
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DM Variances Continued

DM Variances Continued
Actual Quantity Purchased Actual Price 2,800 lbs. $3.90 per lb. = $10,920 Actual Quantity Purchased Standard Price 2,800 lbs. $4.00 per lb. = $11,200

Zippy

Hanson purchased and used 1,700 pounds. How are the variances computed if the amount purchased differs from the amount used?
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The price variance is computed on the entire quantity purchased. The quantity variance is computed only on the quantity used.

Price variance $280 favorable

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Price variance increases because quantity purchased increases.

DM Variances Continued
Actual Quantity Used Standard Price 1,700 lbs. $4.00 per lb. = $6,800 Quantity variance is unchanged because actual and standard quantities are unchanged.
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Zippy

Interpretation of DM Variance
Price Variance
Paying higher or lower prices than planned Losing or gaining quantity discounts Buying higher/lower quality material

Standard Quantity Standard Price 1,500 lbs. $4.00 per lb. = $6,000

Usage Variance
Greater or lower yield from material The use of high/lower quality materials Greater/lower rate of scrap than anticipated.

Causes

Responsibility The Purchasing Manager Quantity variance $800 unfavorable

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The Production Manager

DL Rate and Efficiency Variance

AH x AR (Actual Hours at Actual Rate) (1) AH x SR (Actual Hours at Standard Rate) (2) SH x SR (Standard Hours at Standard Rate) (3)

Remarks on DL Variances
Rate Variance is conceptually similar to the Price Variance (General Model)

Salaryisnotmeasuredbypricebutbyrateinstead ($x/hour)

Rate Variance (1) (2)

Efficiency Variance (2) (3) Total Variance (1) (3)

Efficiency Variance is conceptually similar to Quantity Variance (General Model)

Themeasureofquantityoflaborusedrefersto efficiencyoflabor.

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Zippy

Zippy

Labor Variances Example

Hanson Inc. has the following direct labor standard to manufacture one Zippy:
1.5 standard hours per Zippy at $12.00 per direct labor hour

Labor Variances Summary

Actual Hours Actual Rate Actual Hours Standard Rate Standard Hours Standard Rate

Last week 1,550 direct labor hours were worked at a total labor cost of $18,910 to make 1,000 Zippies.
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Rate variance
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Efficiency variance

Interpretation of DL Variances
Rate Variance
1. Labor demand/supply 2. Higher wages due to
wage award 3. Use of higher/lower grade of worker 4. Payment of unplanned overtime or bonus

Significance of Cost Variances

Size of variance

Efficiency Variance
1. Use incorrect labor grade 2. Poor staff supervision 3. Incorrect
material/machine problems 4. Lack of staff training

Dollaramount Percentageofstandard

Causes

Responsibility

For (1) Uncontrollable The Production Manager The Production Manager The Human Resource Manager
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What clues help me to determine the variances that I should investigate?

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Recurring variances Trends Controllability Favorable variances Costs and benefits of investigation

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Statistical Control Charts

Warning signals for investigation Favorable Limit Desired Value

Advantages of Standard Costs

Possible reductions in production costs Management by exception

Unfavorable Limit

9 Improved cost control and performance evaluation

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Advantages
Better Information for planning and decision making
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Variance Measurements
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Disadvantages of Standard Costs

Emphasis on negative may impact morale.

The End

Potential Problems

Favorable variances may be misinterpreted. Continuous improvement may be more important than meeting standards. Emphasizing standards may exclude other important objectives.

Standard cost reports may not be timely.

Incentives to build inventories.

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