Introduction To Management Accounting

Introduction to Management Accounting
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 1
Introduction to Management Accounting
Chapter 8
Flexible Budgets and

Variance Analysis
Favorable and Unfavorable Variances
Favorable variances arise when

actual results exceed budgeted.
Unfavorable variances arise when

actual results fall below budgeted.
Favorable (F) versus Unfavorable (U) Variances
Profit Revenue Costs
Actual > Expected F F U
Actual < Expected U U F
Learning
Objective 1
Static and Flexible Budgets
A static budget is prepared for only one level

of a given type of activity. Differences between
actual results and the static budget for level
of output achieved are static-budget variances.
A flexible budget (variable budget) adjusts

for different levels of activities. Differences
between actual results and the flexible
budget are flexible-budget variances.
Learning
Objective 2 Flexible Budget Formulas
To develop a flexible budget, managers

determine revenue and cost behavior
(within the relevant range) with
respect to cost drivers.
Note that the static budget is just

the flexible budget for a single
assumed level of activity.
Learning
Objective 3
Activity-Based Flexible Budget
An activity-based flexible budget

is based on budgeted costs for
each activity and related cost driver.
For each activity, costs

depend on an different cost driver.
Learning
Objective 4
Evaluation of Financial Performance
Actual results may differ from

the master budget because...
1) sales and other cost-driver activities were

not the same as originally forecasted, or
2) revenue or variable costs per unit of activity and

fixed costs per period were not as expected.
Evaluation of Financial Performance
Actual Flexible
results budget
for actual Sales-
at actual Flexible-
activity budget sales Activity Static
level variances activity Variance Budget
(1) (2) = (1)-(3) (3) (4) = (3)–(5) (5)
Units 7,000 – 7,000 2,000U 9,000

Sales $217,000 – $217,000 $62,000 U $279,000
Variable costs 158,200 5,670 U 152,600 43,600 F 196,200
Contribution margin $ 58,730 $ 5,670 U $ 64,400 $18,400 U $ 82,800
Fixed costs 70,300 300 U 70,000 – 70,000
Operating income $ (11,570) $5,970 U $(5,600) $18,400 U $ 12,800
Isolating the Causes of Variances
Managers use comparisons among

actual results, master budgets,
and flexible budgets to evaluate
organizational performance.
Isolating the Causes of Variances
Effectiveness is the degree to which

a goal, objective, or target is met.
Efficiency is the degree to which inputs are

used in relation to a given level of outputs.
Performance may be effective,

efficient, both, or neither.
Learning
Objective 5
Flexible-Budget Variances
Total flexible-budget variance

= Total actual results
– Total flexible-budget planned results
Actual Flexible
results budget
$(11,570) $(5,600)
$5,970 Unfavorable
Flexible-budget variances
Sales-Activity Variances
Total sales - activity variance = Actual sales unit – Master budgeted sales units
× Budgeted contribution margin per unit
Flexible
budget (7,000 – 9,000) × $9.20 Master
budget
= $18,400 Unfavorable
Activity-level variances
Setting Standards
A standard cost is a carefully

An expected cost is the cost that
developed cost per unit
is most likely to be attained.
that should be attained.
Perfection (ideal) standards are expressions of the most

efficient performance possible under the best conceivable
conditions, using existing specifications and equipment.
No provision is made for waste, spoilage,

machine breakdowns, and the like.
Currently Attainable Standards...
are levels of performance that

managers can achieve by
realistic levels of effort.
They make allowances for normal

defects, spoilage, waste,
and nonproductive time.
Trade-Offs Among Variances
Improvements in one area could lead to

improvements in others and vice versa.
Likewise, substandard performance

in one area may be balanced by
superior performance in others.
When to Investigate Variances
When should management

investigate a variance?
Many organizations have developed

such rules of thumb as “investigate
all variances exceeding $5,000 or 25%
of expected cost, whichever is lower.”
Comparison with Prior Periods
Some organizations compare the most

recent budget period’s actual results with
last year’s results for the same period.
These comparisons are not as useful as comparisons

of actual outcomes with planned results.
Flexible-Budget Variance in Detail
Standard per unit of output:

Std. inputs Std. price Flexible
expected expected Budget Amount
Direct Material 5 pounds $ 2 /pound $10

Direct Labor ½ hour $16/hour $ 8
Variances from Material and Labor Standards
Actual results for 7,000 units produced:
Direct material
Direct labor
Pounds purchased
Hours used: 3,750
and used: 36,800
Actual price (rate): $16.40
Price/pound: $1.90
Total actual cost:
Total actual cost:
$61,500
$69,920
Flexible Budget or Total Standard Cost Allowed

=
Units of good output achieved
×
Input allowed per unit of output
×
Standard unit price of input
Standard Direct-Materials Cost Allowed:

7,000 units X 5 pounds X $2.00 per pound = $70,000*
Standard Direct-Labor Cost Allowed:

7,000 units X 1/2 hour X $16 per hour = $56,000**
(1) (2) (3)

Flexible
Actual Flexible Budget
Costs Budget Variance
Direct Materials $69,920 *$70,000 $ 80 F
Direct Labor 61,500 **$56,000 $5,500 U
Learning
Objective 6 Price and Quantity Variances
(Actual price – Standard Price) × Actual quantity used
(Actual quantity used – standard quantity allowed

for actual output) × Standard price
Price Variance Computations
($1.90 – $2.00) per pound

× 36,800 pounds = $3,680 F
($16.40 – $16.00) per hour

× 3,750 hours = $1,500 U
Quantity (Usage) Variance Computations
[36,800 – (7,000 × 5)] pounds

× $2 per pound = $3,600 U
[3,750 – (7,000 × ½)] hours

× $16 per hour = $4,000 U
Favorable or Unfavorable Variance?
To determine whether a variance is Favorable or

unfavorable, use logic rather than memorizing a formula.
A price variance is A quantity variance is

favorable is the favorable if the actual
actual price is less quantity used is less
than the standard. than the standard
quantity allowed.
Direct Materials Flexible Budget Variance
Direct-Materials Flexible-budget variance:

$3,680 favorable
+ $3,600 unfavorable
= $80 favorable
Direct-Labor Flexible-budget variance:

$1,500 unfavorable
+ $4,000 unfavorable
= $5,500 unfavorable
Interpretation of Price and Usage Variances
Price and usage variances are helpful

because they provide feedback to
those responsible for managing inputs.
Managers should not use these

variances alone for decision
making, control, or evaluation.
Learning Variable-Overhead Spending
Objective 7 and Efficiency Variances
A variable-overhead efficiency variance occurs when

actual cost-driver activity differs from the standard
amount allowed for the actual output achieved.
A variable-overhead spending variance occurs when

the difference between the actual variable overhead
and the amount of variable overhead budgeted
for the actual level of cost-driver activity.
Variable-Overhead Variances
variable- actual standard standard

overhead
efficiency
variance
= cost-driver
activity - cost-driver
activity
allowed
X variable-overhead
rate per
cost-driver unit
variable- actual standard actual

overhead
spending
variance
= variable
overhead - variable-overhead
rate per unit
of cost-driver
X cost-driver
activity
used
Learning
Objective 8 Fixed Overhead Spending Variance
The difference between actual fixed

overhead and budgeted fixed overhead
Is the fixed overhead spending variance.
The End
End of Chapter 8

Introduction To Management Accounting

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Introduction To Management Accounting

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Introduction to Management Accounting

Flexible Budgets and

Favorable variances arise when

Unfavorable variances arise when

A static budget is prepared for only one level

A flexible budget (variable budget) adjusts

To develop a flexible budget, managers

Note that the static budget is just

An activity-based flexible budget

For each activity, costs

Actual results may differ from

1) sales and other cost-driver activities were

2) revenue or variable costs per unit of activity and

Units 7,000 – 7,000 2,000U 9,000

Managers use comparisons among

Effectiveness is the degree to which

Efficiency is the degree to which inputs are

Performance may be effective,

Total flexible-budget variance

× Budgeted contribution margin per unit

A standard cost is a carefully

Perfection (ideal) standards are expressions of the most

No provision is made for waste, spoilage,

are levels of performance that

They make allowances for normal

Improvements in one area could lead to

Likewise, substandard performance

When should management

Many organizations have developed

Some organizations compare the most

These comparisons are not as useful as comparisons

Standard per unit of output:

Direct Material 5 pounds $ 2 /pound $10

Actual results for 7,000 units produced:

Flexible Budget or Total Standard Cost Allowed

Standard Direct-Materials Cost Allowed:

Standard Direct-Labor Cost Allowed:

(1) (2) (3)

(Actual price – Standard Price) × Actual quantity used

(Actual quantity used – standard quantity allowed

($1.90 – $2.00) per pound

($16.40 – $16.00) per hour

[36,800 – (7,000 × 5)] pounds

[3,750 – (7,000 × ½)] hours

To determine whether a variance is Favorable or

A price variance is A quantity variance is

Direct-Materials Flexible-budget variance:

Direct-Labor Flexible-budget variance:

Price and usage variances are helpful

Managers should not use these

A variable-overhead efficiency variance occurs when

A variable-overhead spending variance occurs when

variable- actual standard standard

variable- actual standard actual

The difference between actual fixed

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