Flexible Budgets and Standard Costs

Flexible Budgets and Standard Costs

• Managers use budgets to control operations and meet planned objectives.
• Budget reports compare actual results to budgeted results.
• A master budget is based on a predicted level of activity for the budget period.
• A fixed budget (or static budget) is based on one predicted amount of sales or other activity measure.
• A flexible budget (or variable budget) is based on more than one amount of sales or other activity measure.

Fixed Budget Performance Report

• Fixed budget performance reports compare actual results with expected results under a fixed budget.
• An example fixed budget uses 100 units in the budget, however 140 actual units were sold, resulting in variances.

Flexible Budget Usage

• Prepared before the period begins, incorporating several levels of activity.
• It provides a “what-if" analysis that includes best-case and worst-case activity levels.
• It provides an "apples to apples" comparison.
• Prepared after the period ends to help evaluate performance, allowing management to focus on problems.

Flexible Budget Preparation

• Total Budgeted Costs = Total Fixed Costs + (Total Variable Cost Per Unit x Units of Activity)

Standard Costs

• Standard costs can be used in a flexible budgeting system, enabling management to understand the reasons for variances better.
• Standard costs are preset costs for delivering a product or service under normal conditions.
• Standard costs are the expected level of performance.
• Manufacturers use standard costing for direct materials, direct labor and overhead costs.

Setting Standard Costs

• Direct materials involve consideration of costs, quantity, and grade.
• Direct labor involves motion and time studies.
• Variable overhead involves available resources.

Cost Variance

• The difference between actual and standard cost.
• If actual cost is less than the standard cost. the variance is favorable (F).
• If actual cost is more than the standard cost, the variance is unfavorable (U).

Cost Variance Analysis Process

• Preparation of a standard cost performance report.
• Computation and analysis of variances.
• Identification of questions and answers related to variances.
• Implementation of corrective and strategic actions.

Cost Variance Computation

• Cost Variance (CV) is computed as Actual Cost (AC) less Standard Cost (SC)
• Actual Quantity (AQ) is the actual amount of direct material or direct labor used.
• Standard Quantity (SQ)is the standard amount of input for the actual quantity of output.
• Actual Price (AP) is the actual amount paid to acquire the actual direct material or direct labor used during the period.
• Standard Price (SP) is the standard price.

Direct Materials and Direct Labor Variances

• Two main factors cause materials and labor variances
• Price Variance (PV) is computed as [Actual Price (AP) - Standard Price (SP)] × Actual Quantity (AQ)
• Quantity Variance (QV) is computed as [Actual Quantity (AQ) - Standard Quantity (SQ)] × Standard Price (SP)

Direct Materials Variance Example

• G-Max produced and sold 3,500 units, using 1,800 pounds of DM at $21.00 per lb, whereas a standard is 1,750 lbs. at $20 per lb per unit.

Direct Labor Variance Example

• G-Max produced and sold 3,500 units, using 1,700 hours of direct labor at $33.00 per hr, whereas a standard is 1,750 lbs. at $32 per hr per unit

Flexible Overhead Budgets

• Budgets for factory overhead at different production levels are prepared in flexible overhead budgets

Standard Overhead Rate

• First, determine an allocation base.
• Then, predict an activity level.
• Then, compute the standard overhead rate.
• Use the formula: Standard overhead rate = Budgeted overhead at predicted activity level / Standard allocation base at predicted activity level.

Analyzing Changes In Sales

• A similar analysis can be applied to sales variances.

Sales Variance Example

• Data provided for sales of Excel golf balls (units) and sales prices per ball, in addition to sales of Big Bert drivers (units) and sale price per driver unit.

Computing Sales Variance

• Sales price variance is the actual sales price minus the budgeted sales price.
• Sales volume variance is the actual sales volume minus the budgeted sales volume.

Expanded Overhead Variance Framework

• Total overhead variances can be divided between variable and fixed overhead variances.
• Spending and efficiency variances are used to further analyze variable overhead, while spending and volume variances are used to analyze fixed overhead.

Computing Variable and Fixed Overhead Variances

• These are computed as the difference between actual, standard, and applied overhead amounts.

Recording Direct Material Costs

• Debit Work in Process Inventory (standard cost)
• Credit Direct Materials Price Variance
• Credit Direct Materials Quantity Variance
• Debit Raw Materials Inventory (actual cost)

Recording Direct Labor Costs

• Debit Work in Process Inventory (standard cost)
• Credit Direct Labor Rate Variance
• Credit Direct Labor Efficiency Variance
• Debit Factory Wages Payable (actual cost)

Recording Overhead Costs

• Credit Work in Process Inventory (standard cost)
• Debit Volume Variance
• Debit Controllable Variance
• Credit Factory Overhead at standard rate