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Chapter 8

Flexible Budgets and


Variance Analysis

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Chapter 8 Learning Objectives


When you have finished studying this chapter,
you should be able to:
1.Identify variances and label them as favorable
or unfavorable.
2.Distinguish between flexible budgets and static
budgets.
3. Use flexible-budget formulas to construct a
flexible budget.
4. Compute and interpret static-budget variances,
flexible-budget variances, and sales-activity
variances.
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5. Understand how the setting of standards


affects the computation and interpretation of
variances.
6. Compute and interpret price and quantity
variances for materials and labor.
7. Compute variable overhead spending and
efficiency variances.
8. Compute the fixed-overhead spending
variance.
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Learning
Objective 1

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
Profits Revenue
Actual > Expected
F
F
Actual < Expected
U
U
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Costs
U
F
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Types of Favorable and Unfavorable Variances

Favorable profit variances arise when


actual profits exceed budgeted profits.
Unfavorable profit variance occurs when
actual profit falls below budgeted profit.
Actual revenues that exceed budgeted
revenues result in favorable revenue
variances, and actual revenues that fall
short of budgeted revenues result in
unfavorable revenue variances.
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Types of Favorable and Unfavorable Variances

When actual costs exceed budgeted costs,


we have unfavorable cost variances; when
actual costs are less than budgeted costs,
we have favorable cost variances.
The favorable and unfavorable labels
indicate only the directional relationships
summarized in the chartsthey do not
indicate that the explanation for the
variance is necessarily good or bad.
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Favorable or Unfavorable
Variance?
To determine whether a variance is
favorable or unfavorable,
use logic rather than memorizing a formula.

A price
variance is
favorable if the
actual price is
less than the
standard.

A quantity variance is
favorable if the actual
quantity used is less
than the standard
quantity allowed.

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Learning
Objective 2

Static and Flexible Budgets

A static budget is prepared for


only one expected level of activity.

A budget that adjusts to different


levels of activity is a flexible budget
(sometimes called a variable budget).

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Learning
Objective 3

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.
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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 a different cost driver.

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Activity-Based Flexible Budget

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Learning
Objective 4

Static-Budget Variances and


Flexible-Budget Variances

Differences between actual results and the


static budget for the original planned level
of output are static-budget variances.
Differences between actual results and the
flexible budget for the actual level of output
achieved are flexible-budget variances.
Flexible budget variances reflect how actual
results deviate from what was expected, given
the achieved activity level.
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Static-Budget Variances and


Flexible-Budget Variances
Actual results may differ from
the master budget because...
sales and other cost-driver activities were
not the same as originally forecasted

revenue or variable costs per unit of activity


and fixed costs per period were not as expected.
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Evaluation of Financial Performance


Actual
results
at actual Flexibleactivity
budget
level*
variances
(1)

Flexible
budget for
actual
sales
activity

(2) = (1)-(3)

(3)

Sales Activity
Variance
(4) =
(3)(5)

Static
Budget
(5)

Units
7,000
7,000
2,0
Sales
$217,000
$217,000
$62,000 U $27
Variable costs
158,200
5,670 U
152,600
Contribution margin $ 58,730 $ 5,670 U
$ 64,400
$1
Fixed costs
70,300
300 U
70,000
Operating income
$ (11,570) $5,970 U
$(5,600) $1

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Flexible-Budget Variances
Flexible-budget variance
= Actual results Flexible-budget

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Sales-Activity Variances
Sales
activity
income
variance

Actual unit Static budget units

(9,000 7,000)

Contribution
margin per unit

$9.20

$18,400 Unfavorable
Falling short of the sales target by 2,000 units explains
$18,400 of the shortfall of income relative to the amount
initially budgeted.
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Learning
Objective 5

Role of Standards in
Determining Variances

Static-budget variances and flexiblebudget variances depend on the costs


used in the budget formulas.
Budget formula costs are standard costs
costs that should be achieved.
Standard costs are defined in different
ways by different companies.
The level at which standards are set will
affect the variances generated and the
incentives created.
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Setting Standards
A standard cost is a
carefully developed cost per
unit that should be attained.

An expected cost is the


cost that is most likely
to 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.

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Currently Attainable Standards


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.
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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.
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When to Investigate Variances

When should management


investigate a variance?
Many organizations have developed
such rules of thumb as investigate
all variances exceeding either
$5,000 or 15% of expected cost.

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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.
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Comparison with Prior Periods

Some organizations compare the most


recent budget periods actual results with
last years results for the same period.
Even comparisons with the prior
months actual results may not be
as useful as comparisons with an
up-to-date flexible budget.

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Flexible-Budget Variance in Detail


Flexible-budget amounts based on $10 per unit of output
for direct materials and $8 per unit for direct labor.

Standard per unit of output:

Std. inputsStd. price


Flexible
expected expected Budget Amou
Direct Material
Direct Labor

5 pounds
hour

$ 2 /pound
$
$16/hour
$

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Variances for Material and Labor


Standards
Standard Costs Allowed:

Direct material
Cost allowed
7,000 units X
5 pounds X $2.00 per
pound =
$70,000

Direct labor
Cost allowed
7,000 units X 1/2 hour
X $16.00 per hour =
$56,000

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Variances for Material and Labor


Standards
Actual results for 7,000 units produced:

Direct material
Pounds purchased
and used: 36,800
Price/pound X $1.90
= Total actual cost
$69,920

Direct labor
Hours used: 3,750 X
Actual price (rate)
X $16.40
= Total actual cost
$61,500

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Variances for Material and Labor


Standards
Flexible Budget or Total Standard Cost Allowed

=
Units of good output achieved

Input allowed per unit of output

Standard unit price of input


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Variances for Material and Labor


Standards
Flexible-budget cost is the standard quantity allowed for
the actual level of activity multiplied by the standard
price per unit.
Flexible-budget variances for direct material and direct
labor: $80 F and $5,500 U, respectively.

(1)

(2)

(3)
Flexible
Actual
Flexible
Budget
Costs
Budget
Variance
Direct Materials $69,920
*$70,000
$
Direct Labor
61,500
**$56,000
$5,500
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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
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Quantity (Usage) Variance


Computations

[36,800 (7,000 5)] pounds


$2 per pound = $3,600 U

[3,750 (7,000 )] hours


$16 per hour = $4,000 U
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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
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Direct Materials Flexible Budget


Variance
The sum of the direct-labor price and quantity variances
equals the direct-labor flexible-budget variance.
Similarly, the sum of the direct-materials price and
quantity variances equals the total direct-materials
flexible-budget variance.
Direct-Labor
Flexible-budget variance:
$1,500 unfavorable
+ $4,000
unfavorable
= $5,500
unfavorable

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

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Interpretation of Price and


Quantity Variances
By dividing flexible-budget variances into price
and quantity variances, managers can be better
evaluated on variances that they can control.
Price and quantity 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.
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Learning
Objective 7

Variable-Overhead Spending
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.

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Variable-Overhead Variances

variableoverhead
efficiency
variance

actual
cost-driver
activity

variableactual
overhead variable
spending
overhead
variance

standard
cost-driver
activity
allowed

standard
variable-overhead
rate per
cost-driver unit

standard
variable-overhead
rate per unit
of cost-driver

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actual
cost-driver
activity
used

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Learning
Objective 8

Fixed Overhead Spending Variance

The flexible budget based on actual use of the


cost driver and the flexible budget based on
standard use of the cost driver are always the
same because fixed overhead does not vary
with the level of use of the cost driver.

Therefore . . .
The difference between actual fixed
overhead and budgeted fixed overhead
is the fixed overhead spending variance.
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electronic, mechanical, photocopying, recording,
or otherwise, without the prior written permission
of the publisher. Printed in the United States of
America.

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