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
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 2
With over 28,000 locations, how does McDonald’s maintain cost and
quality control?
It uses standards, budgets and variance analysis
The material standard for a hamburger is the same in every location
Material variances are computed for every ingredient by comparing
what was actually used with what should have been used for the
number of hamburgers sold each day
What are these standards?
It also has nonfinancial standards such as average drive-through
time
Knowing what went wrong and what went right helps managers
plan
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 3
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
Actual > Expected
Actual < Expected
Profit Revenue Costs
F
F
U
U
U
F
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 4
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.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 5
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.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 6
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.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 7
Evaluation of Financial Performance
Units
Sales
Variable costs
Contribution margin
Fixed costs
Operating income
Actual
results
at actual
activity
level
(1)
Flexiblebudget
variances
Flexible
budget
for actual
sales
activity
SalesActivity
Variance
Static
Budget
(2) = (1)-(3)
(3)
(4) = (3)–(5)
(5)
2,000U
$62,000 U
43,600 F
$18,400 U
–
$18,400 U
9,000
$279,000
196,200
$ 82,800
70,000
$ 12,800
7,000
–
7,000
$217,000
–
$217,000
158,200
5,670 U
152,600
$ 58,730 $ 5,670 U $ 64,400
70,300
300 U
70,000
$ (11,570) $5,970 U
$(5,600)
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 8
Isolating the Causes of Variances
Managers use comparisons among
actual results, master budgets,
and flexible budgets to evaluate
organizational performance.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 9
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.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 10
Learning
Objective 5
Flexible-Budget Variances
Total flexible-budget variance
= Total actual results
– Total flexible-budget planned results
Actual
results
$(11,570)
$5,970 Unfavorable
Flexible
budget
$(5,600)
Flexible-budget variances
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 11
Sales-Activity Variances
Total sales - activity variance
=
Actual sales unit – Master budgeted sales units
×
Flexible
budget
Budgeted contribution margin per unit
(7,000 – 9,000) × $9.20
=
Master
budget
$18,400 Unfavorable
Activity-level variances
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 12
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.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 13
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.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 14
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.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 15
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.”
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 16
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.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 17
Flexible-Budget Variance in Detail
Standard per unit of output:
Std. inputs
expected
Direct Material
Direct Labor
5 pounds
½ hour
Std. price
expected
Flexible
Budget Amount
$ 2 /pound
$16/hour
$10
$ 8
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 18
Variances from Material and Labor Standards
Actual results for 7,000 units produced:
Direct material
Pounds purchased
and used: 36,800
Price/pound: $1.90
Total actual cost:
$69,920
Direct labor
Hours used: 3,750
Actual price (rate): $16.40
Total actual cost:
$61,500
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 19
Variances from 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
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 20
Variances from Material and Labor Standards
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)
Actual
Costs
Direct Materials $69,920
Direct Labor
61,500
(2)
Flexible
Budget
*$70,000
**$56,000
(3)
Flexible
Budget
Variance
$ 80 F
$5,500 U
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 21
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
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 22
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
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 23
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
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 24
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 is 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.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 25
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
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 26
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.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 27
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.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 28
Variable-Overhead Variances
variableoverhead
efficiency
variance
variableoverhead
spending
variance
=
=
actual
cost-driver
activity
actual
variable
overhead
-
-
standard
cost-driver
activity
allowed
X
standard
variable-overhead
rate per unit
of cost-driver
standard
variable-overhead
rate per
cost-driver unit
X
actual
cost-driver
activity
used
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 29
Learning
Objective 8
Fixed Overhead Spending Variance
The difference between actual fixed
overhead and budgeted fixed overhead
Is the fixed overhead spending variance.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 30
The End
End of Chapter 8
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 8 - 31