Chapter 10 Flexible Budgets and Standard Costs 1 How do Managers Use Flexible Budgets a Static Budget A budget that is prepared for one expected level of sales volume i Usually a master budget that does not change once it is developed b Variance Difference between the actual results and the budgeted results i Variances are considered Favorable F when a higher actual amount increases operating ii Variances are considered Unfavorable U when a higher actual amount decreases income operating income c Flexible Budgets Summarized budgets prepared for different levels of volume i Can help managers prepare for future periods and to evaluate performance after the period has ended in order to control costs for the actual volume of output that occurred ii Use for planning revenues and expenses at different sales volumes iii Flexible Budget Total Cost of output units Variable Cost Unit Total Fixed Costs corrective action flexible budget variance 2 How do Managers Compute the Sales Volume Variance Flexible Budget Variance a Managers want to know why a variance occurred in order to pinpoint problems and to identify b Separate the static budget variance into two parts 1 the sales volume variance and 2 the i Sales Volume Variance The difference between the static master budget and the flexible for the actual number of outputs 1 This variance only arises because the number of units actually sold differs from the volume originally planned for its static master budget 2 MARKETING is responsible for sales volume variance ii Flexible Budget Variance Difference between the flexible budget and the actual results 1 Arises because the company actually earned more or less revenue or incurred more or less expenses than expected for the actual level of output a Due to factors other than volume 2 MARKETING is responsible for flexible budget variance for sales revenue 3 PURCHASING PRODUCTION HR are responsible for flexible budget variance for expenses c Favorable sales volume variance means that strong sales should increase company s operating income the sales staff was able to increase sales without decreasing prices d Favorable flexible budget variance for sales revenue shows that the sales price on average was higher than budgeted e Unfavorable flexible budget variance for expenses means that there could potentially be uncontrollable rising costs for materials or employees could be wasting materials f Favorable flexible budget variances could be the result of efficiency that can be used in other areas of the company as well 3 What are Standard Costs a Standard Cost A budget for a single unit that are used to develop a flex budget i Quantity Standards Engineers and production managers set direct material and direct labor quantity standards usually allowing for unavoidable waste and spoilage ii Price Standards iii Standard MOH Rates 1 Standard Variable Overhead Rate Estimated total variable overhead cost estimated total quality of allocation base 2 Standard Fixed Overhead Rate Estimated total fixed overhead cost estimated total quality of allocation base 3 Standard Total Overhead Rate Variable Overhead Rate Fixed Overhead Rate b Standard Costs of Inputs Once managers have developed quantity and price standards they calculate the standard cost of each input aka DM DL MOH i Quantity Standard x Price Standard c Benefits of Standard Costs i Standards help managers plan by providing unit amounts for budgeting ii Standards help managers control operations by setting target levels of performance iii Standards motivate employees by serving as performance benchmarks iv Standards provide unit costs managers can use to set sale prices of products or services v Standards simplify record keeping and reduce clerical costs 4 How do Managers Use Standard Costs to Analyze DM DL Variances a FLEXIBLE BUDGET AMOUNTS ARE COMPUTED USING STANDARD QUANTITIES b DM Variances Pay too much for materials causing the company to not meet price standards or the workers used more materials than should have causing them to not meet the quantity standards i Separate the flexible budget variance for DM into price efficiency components 1 Price Variance Efficiency Variance Flexible Budget Variance ii DM Price Variance Measures how well the business keeps unit prices of materials and labor inputs within standards 1 Actual price unit standard price unit Actual quantity of input 2 PURCHASING is responsible for this variance iii DM Efficiency Variance Measures whether the firm meets its quantity standards 1 Is the quantity of materials actually used to make the actual number of outputs within the standard allowed for that number of outputs 2 Actual quantity of input used standard quantity of input allowed for actual number of outputs Standard price per input unit 3 Production managers are typically most responsible c DL Variances DL price variance is computer the same way as the direct materials price variance so we use the same formula i DL Price Variance Actual Price Per Input Unit Standard Price Per Input Unit Actual Quantity of Input 1 HR is responsible for DL price variances ii Efficiency Variance Actual quantity of input standard quantity of input allowed for the actual number of outputs Standard price per input unit 1 Production is responsible for DL efficiency variances d Pitfalls to Price Efficiency Variances AVOID i Static budgets play no role in computing the flexible budget variance or in determining how it is split into the price and efficiency variances ii In the efficiency variance the standard quantity is the standard quantity of inputs allowed for the actual number of outputs which is the basis for the flex budget iii In the DM price variance the difference in prices is multiplied by the actual quantity of materials In DM efficiency variance the difference in quantities is multiplied by the standard price of the materials e Using Variances i Many firms monitor sales volume DM efficiency and DL efficiency variances day to day or even hour to hour ii Some variances are caused by factors that we cannot control iii Variances could be the result of inaccurate or outdated standards iv Managers often make tradeoffs among variances v Evaluations based primarily on one variance can encourage managers to take actions that make the variance look good but hurt the company in the long run 1 Ex purchase low quality materials or hire less experienced workers to get favorable price variances 5 How do Managers Use Standard Costs to Analyze
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