Chapter 7 Flexible Budgets, Variances and Management Control: I

1. Chapter 7Flexible Budgets, Variances and Management Control: I

2. Static and Flexible Budgets Static budget • a budget based on a single level of output Flexible budget • a budget which is adjusted for the actual level of output, revenue, or cost driver Standard cost • a carefully predetermined amount representing what management thinks a cost should be Examples Standard quantity of materials = 2 kg. per unit Standard cost of materials = $8 per kg. Standard cost of materials = $16 per unit Page 236

3. Static Actual Variance Budget Volume 10,000 2,000 U 12,000 Revenue $1,850,000 $310,000 U $2,160,000 Variable Costs 1,120,000 68,000 F 1,188,000 Contribution Margin 730,000 242,000 U 972,000 Fixed costs 705,000 5,000 F 710,000 Operating income $25,000 $237,000 U $262,000 Variances • Variances represent the difference between the cost that was incurred and the budgeted cost • Actual cost > Budgeted cost = Unfavourable variance • Budgeted cost > Actual cost = Favourable variance Static budget variance • difference between actual results achieved and the original static budget Pages 236 - 238

4. Sales Volume Variance 2,000 U $360,000 U 198,000 F 162,000 U $162,000 U Static Actual Budget Volume 10,000 12,000 Revenue $1,850,000 $2,160,000 Variable Costs 1,120,000 1,188,000 Contribution Margin 730,000 972,000 Fixed costs 705,000 710,000 Operating income $25,000 $262,000 Flexible Budget Variances 0 $50,000 F 130,000 U 80,000 U 5,000 F $75,000 U Flexible Budget 10,000 $1,800,000 900,000 810,000 710,000 $100,000 $75,000 U Flexible budget variance $162,000 U Sales volume variance $237,000 U Total static budget variance Using A Flexible Budget Pages 238 - 240

5. Selling Price Variance Variance analysis • used to evaluate performance • separate measures of effectiveness and efficiency Selling price variance = = ($185 - $180) x 10,000 units = $50,000 F Budgeted selling price Actual units sold Actual selling price x - Pages 240 - 241

6. Sales Volume Variance Effectiveness • degree to which the organization’s goals were met • measured by the Sales volume variance Sales volume variance = = (10,000 - 12,000) x $81 = $162,000 U Budgeted contribution margin per unit Budgeted units sold Actual units sold x - Note: This variance can be read as the difference between the contribution margin in the flexible and static budgets Pages 240 - 241

7. Price and Efficiency Variances • Price variance is the difference between the actual price and the budgeted price multiplied by the actual quantity of inputs used • Efficiency variance is the difference between the actual quantity of inputs used and the budgeted quantity of inputs that should have been used, multiplied by the budgeted price Static Budget Variance Flexible Budget Variance Sales Volume Variance Price Variance Efficiency Variance Pages 241 - 242

8. Price and Efficiency Variance - Materials Actual Budget Direct 22,200 sq metres 20,000 sq metres materials $31 per metre $30 per metre Price variance = (Actual price - Budgeted price) x Actual quantity used = ($31 - $30) x 22,200 = $22,200 U Efficiency variance = (Actual quantity used - Budgeted quantity used) x Budgeted price = (22,200 - 20,000) x $30 = $66,000 U Pages 243 - 247

9. Price and Efficiency Variance – Labour I Actual Budget Manufacturing 9,000 hours 8,000 hours labour $22 per hour $20 per hour Price (or rate) variance = (Actual price - Budgeted price) x Actual quantity used = ($22 - $20) x 9,000 = $18,000 U Efficiency variance = (Actual quantity used - Budgeted quantity used) x Budgeted price = (9,000 - 8,000) x $20 = $20,000 U Pages 243 - 247

10. Price and Efficiency Variance – Labour II Actual Budget Marketing 2,304 hours 2,500 hours labour $25 per hour $24 per hour Price (or rate) variance = (Actual price - Budgeted price) x Actual quantity used = ($25 - $24) x 2,304 = $2,304 U Efficiency variance = (Actual quantity used - Budgeted quantity used) x Budgeted price = (2,304 - 2,500) x $25 = $4,704 F Pages 243 - 247

11. Price and Efficiency Variances Material Price Variance $22,200 U Efficiency Variance $60,000 U Flexible Budget Variance $88,200 U Price Variance $18,000 U Efficiency Variance $20,000 U Manufacturing Labour Flexible Budget Variance $38,000 U Pages 243 - 247

12. Price and Efficiency Variances (Continued) Marketing Labour Price Variance $2,304 U Efficiency Variance $4,704 F Flexible Budget Variance $2,400 F Pages 243 - 247

13. Evaluating Performance • Variances are used to evaluate performance • Effectiveness – the degree to which organization’s predetermined goals were met • Efficiency - how well inputs were used in relation to a given level of output • Variances indicate that something was difference than expected • What is critical is to understand why variances arise and use this knowledge to promote learning and continuous improvement • Most companies investigate only significant variances Pages 248 - 250

14. Continuous Improvement and Variances • Using continuous improvement budgeted costs is another way to control variances • Budgeted cost is successively reduced over succeeding time periods • Signals importance of reducing costs Prior Month’s Reduction in Revised Month Budgeted Amount Budgeted Amount Budgeted Amount April - - $60.00 May $60.00 $0.600 (1% x $60.00) 59.40 June 59.40 $0.594 (1% x $59.40) 58.81 July 58.81 $0.588 (1% x $58.81) 58.22 Pages 250 - 251

15. Benchmarking and Variance Analysis • Can think of budgeted amounts as benchmarks (points of reference from which comparisons may be made) • Benchmarking refers to the continual process of measuring products, services and activities against the best levels of performance • May use internal or external benchmarks\ Key Questions to Ask • Why are the cost levels different between units? • How can best practices be transferred from more efficient to less efficient units? Pages 256 - 258