Cost Chapter 10

what is a budget based on

the corporate strategy and expresses the organizations operating and financial plans

budgets help to

promote coordination and communication among subunits

provide a framework for judging performance

motivate managers and other employees

the budgeting process includes

all levels of the organization

what asepcts of operations are generally of interest to management when they are assessing operations

effectiveness in attaining goals ad efficient in carrying out operations

what is an important short term goal for the company

to earn the operating income projected for the period

what do variances do

help in assessing operations

static budget variances and flexible budget variances

what is a budget

proposed plan of action by management for a specified period and an aid to coordinating what needs to be done to execute that plan

what is variance analysis

identifies and calculates the difference between the actual and budgeted outcomes so that corrective action can be taken

variances are

differences between actual results and budgeted performance

differences are described as favorable or unfavorable

revenues/sales variance analysis

F = A>B

U = A<B

expenses variances

F = A<B

U = A>B

what does variances enable management to do

utilize management by excption as they highlight areas that are not operating as expected

management by exception

focused on things that do not go accoridng to plan

usual criteria are matriality and controllability

materiality

usually expressed as a percentage difference from budget. those differences falling outside particular parameters will be investigated

controllability

whetehr the manager can control the occurance of the variance

budgets and variance analysis help an organization to

motivate and benchmark

plan and control

evaluate performance and troubleshoot

motivate and benchmark

sets the standards for performance - high and achieveable

budgeted numbers are benchmarks to which actual performance is compared to

plan and control

allow for detailed operational planning

control activities are put in place to prevent deviations from budgeted numbers and detect when deviations occur

evaluate performance and troubleshoot

variance analysis looks at how actual performance compares to budget

logical, systematic identification of the source problems in order to fix them and avoid their recurrence

master static budget

comprehensive, organization-wide plan used to coordinate a company’s goals and objectives, and to allocate resources for the upcoming year (or operating period)

prepared at the beginning of the year based on planned output

assists with planning and coordination

prepared for only one level of sales volume and production

includes sales, expenses (MFG. costs: DM, DL, VMOH, FMOH), and oeprating income

budgeted outputs: income statement, balance sheet, statement of cash flows

what is the shortfall of the master static budget

does not show causes for deviation or help identify courses of corrective action to reduce or eliminate similar deviations in the future

master budget variance

difference between actual results and master budget

(AV x AP) - (BV x BP)

felxible budget

adjusts the master budget: uses actual volume (output) to recalculate revenue and variable costs for the budgeted period

• actual sales volume (when different from budget)

• budgeted price

prepares at or near the end of the period when actual output is known

assists with evaluating efficiency of operations

separates costs into variable and fixed

steps in developing a flexible budget

identify actual output quantity

calculate flexible budget revenues (SP x AQ)

calculate flexible budget costs (SP per VC x AQ) +FC

what question does the flexible budget answer

“since actual sales volume differes from master budget sales volume, what will the updated variable costs and revised budgeted operating income look like”

what does a favorable variance mean

favorable impact on operating income

either less costs or higher sales

increase in income compared to budgeted

what does unfavorable variance mean

unfavorable imppact on operating income

more costs less sales

decrease in income compared to budget

sales activity variance

isolates for the difference between actual and master budget sales volume, holding selling price and input costs constant

impacts both product and period costs

(AQ xBP) - (BQ x BP)

flexible budget variance

isolates for the difference between actual and budgeted selling prices for input costs

volume quantity is held constant

difference between actual operating results and flexible budget at the actual operating level for the period

(AQ x AP) - (AQ x BP)

can be calculated on more lines thna just sales

calculate variances in price/cost and quantity/usage/efficiency

variances include

sales volume variance: measures the effect of change in unit sales

flexible budget variance - isolates changes in costs

purpose of standard costing

costing method that uses budgets set at the unit level as product costs in the general ledger

provides information for financial reporting

• cost products (WIP) at standard

• journal entries are made using standard costs

simplifies product costing: can cost a product immediately upon its completion

standard costs

expected costs to manufacture one unit of product

• ideal predetermined cost a firm ought to incur for an operation

• used to determine budgeted amounts

• each unit has standards for quantity and price

• compute for every aspect of production costs: DM, DL, VMOH, FMOH

standard cost card

summarizes the standard price and input quantities for each cost element to produce one unit

standard costing system

traces direct costs to ouput produced by multiplying standard prices or rates times standard input quantities allowed for actual outputs produced

allocates overhead costs to outputs produced using standard overhead rates times standard quantities of allocation bases allowed for actual outputs produced

standard help managers

in budget prep, calculation of variances, target levels of performance, identify performance standards, set sales prices and product mixes, decrease costs, improve efficiency, production decisions

performance evaluation, monitoring, controlling

levels of standards

ideal standard

practical standards

ideal standards

for each unit have no tolerance for machine breakdowns or employee breaks

optimum levels of performance under perfect operating conditions

practical standards

involve firm, yet attainable, unit benchmarks that allow for the realities of lide: machine breakdowns, worker mistakes, and downtime

more reasonable levels of performance

what happens to standards once variances are found at the end of each period

they will be reviewed and updated if needed

set standards that are currently attainable

• this is motivating and helpful for planning and accounting

standards are determined by detailed breakdown of steps to make a product

production variance

costs incurred in production - DM, DL, VMOH, FMOH

the master budget is not considered at this point

for DM, DL, and VMOH, we calculate a price variance and an efficiency variance

• these variances help explain the two reasons that actual costs differ form the budgeted numbers

DM price variance

compares actual cost incurred for DM to the standard cost allowed for the actual quantity purchased

what should we have paid for DM inputs according to standard prices

U = paid more than the standard

F = paid less than the standard

DM efficiency variance

comapres the actual quantity used of DM to the standard quantity allowed, at its standard cost

what quantity of DM inputs should we have used in making out actual volume of units

U = used more than standard

F = used less than standard

direct labor price variance

difference between the actual DL rate and the standard labor rate for all DL hours used

what should we have paid for DL to make this actual volume of units

U = paying mroe for workers time

F = paying less for workers time

Direct labor efficiency variance

difference in standard DL costs for the actual DL hours used and the DL hours we expected to use for actual production

How much DL time should we have used in making this actual volume of units

what costs are used to record journal entries during the period

standard costs

WIP = (SP x SQ per unit) x AQ

wages payable = AP x AQ

what is recorded with each transaction where standard costs do not equal actual costs

variances

U are debited (decrease income)

F are credited

DL journal entries

use the price and efficiency variances to balance the JE because any differences are due to these variances

DM journal entries

remeber buying DM at a different time than using

1. DM purchased: recognize price variance

2. DM used: recognize efficiency variance

overhead costs are divided into

variable and fixed overhead

variable overhead

focus on activities that create and provide a sueprior product

eliminate activities that do not add value

plan only essential activities and be efficient

timing: day to day operating decisions affect the level of variable costs incurred during the period

fixed overhead

effective planning for FOH is simmilar in planning for VOH

focus on eliminating nonvalue-added activities

additional issue: choosing appropriate level of capacity

• benefit company in the long run

fixed costs provide capacity

timing: most decisions regarding fixed costs will have been made by beginning of the budget period

the decision making process can have a long-term effect on the firms profitability

standard costing for MOH

traces direct costs to output by multiplying standard prices of inputs allowed for actual outputs produced

allocates overhead costs based on standard OH cost rates times the standard quantities of allocation bases allowed for the actual outputs produced

developing standards for VOH and FOH

based on standard quantities of inputs for actual outputs provided

• company will choose the budgeted period - usually 12 months but a shorter time frame may be appropriate

variable OH cost rate = budgeted varian=ble costs/quantity of cost allocation base

• fixed OH cost rate = budgeted fixed costs/quantity of cost allocation base

setting standard for variable overhead

1. choose the allocation base that is most strongly related to VOH or FOH costs:cost driver: machine hours, DL hours, # DM, #of production runs, etc

• variable costs: seek a cause and effect relationship between costs and cost driver, SP and SQ relate to allocation base

• fixed costs: not always feasible or possible to find a cause and effect relationship between the level of activity and the costs incurred. typical to use a generic allocation base such as machine hours or direct labor hours

2. identify and estimate VOH or FOH costs

• VOH: power, indirect materials, some indirect labor, repairs, etc

• FOH: insurance, rent, depreciation

3. set standrd input quantity (SQ) for the base

• amount of base for 1 unit of product

4. estimate amount of base for year (SQ x TO)

5. set standard price = estimated OH /estimated base

variable MOH price variance

compares the real cost incurred for variable MOH resources to the planned variable MOH cost for the actual quantity of cost ddriver used

standard price - is predetermined MOH rates

F = less was paid than expected

U = more was paid than expected

MOH variable efficiency variance

compares the standard variable cost for the actual quantity of the cost driver used with the cost driver quantity expected for actual units produced

• efficency of cost driver

F. using less of the cost driver than expected

U = using more of the cost driver than expected

fixed MOH price variance

compares the real cost incurred for FMOH resources and budgeted FMOH costs for those same resources

= actual MOH incurred - master budget

F = actual costs is less

U = actual cost is more

fixed MOH volume variance

compares a company’s budgeted and applied fixed moh costs

= master budget - FMOH applied (SQ x SP)

F = actual production exceeds planned volume (FC spread over more units)

U = actual production is less than planned volume

different from VOH due to nature of fixed costs

fixed accross relevant range for a given period

do not automatically change based on level of activity

unaffected by how efficiently the base is used

use unit cost used to assign cost to product/service

fixed OH spending variance and flexible budget variance is the same. why?

flex budget = static budget

FMOH does not chaange based on output

stays the same across the relevant range

journal entries to close variances

Variance accounts are closed at year-end. Treatment is similar to over/under

allocated costs

Variance accounts with

• overall favorable effects - credit balances (which increase income)

• overall unfavorable effects - debit balances (which decrease income.)

• Temporary accounts and must be closed at year-end.
  Close to:

• Cost of Goods Sold - immaterial.

• Prorate to Inventory Accounts - Direct material, WIP, Finished Goods