Flexible Budgets and Standard Costs

Fixed and Flexible Budgets

• Purpose of Budgets: Used by managers to control operations and meet planned objectives.
  • Master Budget: Based on a predicted level of activity during the budget period.
  • Budget Reports: Compare actual results to budgeted results.

Types of Budgets

• Fixed Budget (Static Budget):
  • Based on one predicted sales amount or activity measure.
  • Example: Performance reports compare actual results to those expected under a fixed budget.
• Flexible Budget:
  • Based on multiple levels of sales or other activity measures.
  • Prepared before the period starts and allows for different activity levels.
  • Example: Provides an “apples to apples” comparison for performance analysis.

Preparing Flexible Budgets

• Formula: Total Budgeted Costs = Total Fixed Costs + (Total Variable Cost Per Unit x Units of Activity).
• Purpose of Flexible Budgets:
  • Evaluate performance post-period.
  • Focus on problems and provide a “what-if” analysis of best/worst cases.

Flexible Budget Performance Report

• Comparison: Compares actual performance to budgeted performance based on actual activity levels.
• Varieties of Variance:
  • Favorable Sales Variance: Occurs when the average selling price exceeds expected value (e.g., > $10.00 per unit).
  • Unfavorable Direct Materials & Labor Variances: Actual costs > expected costs.
  • Favorable Sales Commissions Variance: Actual commissions < expected.

Standard Costing

• Definition: Used by manufacturers for direct materials, direct labor, and overhead.
  • Represents the expected performance level under normal conditions.
  • Involves preset costs for delivering a product or service.
• Standard Costs in Budgets: Can aid in understanding variances in a flexible budget.

Setting Standard Costs

• Components:
  • Quantity & Grade Costs (Direct Materials).
  • Time studies, Motion studies (Direct Labor).
  • Resources for Variable Overhead.

Cost Variances

• Criteria for Variance:
  • If actual cost < standard cost: Variance is favorable (F).
  • If actual cost > standard cost: Variance is unfavorable (U).
• Cost Variance Computation:
  • CV Formula: Actual Quantity (AQ), Standard Quantity (SQ), Actual Price (AP), Standard Price (SP).

Analyzing Cost Variances

1. Prepare a Standard Cost Performance Report.
2. Compute and Analyze Variances.
3. Identify Questions and Answers.
4. Take Corrective Actions.

Direct Materials and Labor Variances

• Factors Causing Variances:

  • Variance calculations:
  • Price Variance (PV): (PV = (AP - SP) imes AQ).
  • Quantity Variance (QV): (QV = (AQ - SQ) imes SP).

• Example of Variance:

  • G-Max produced/sold 3,500 units with 1,800 pounds of direct materials at $21 per lb. while the budgeted standard was 1,750 lbs. at $20 per lb.

Evaluation of Variances**

• Understanding responsibility for variances:
  • Example: Poor material choice leads to excess material usage by untrained workers.

Variance Summary (Final Overview)

• Key variances as follows:
  • Direct Materials Variance:
  • Price Variance = $(AQ imes AP) - (AQ imes SP)$
  • Quantity Variance = $(AQ imes SP) - (SQ imes SP)$
  • Direct Labor Variance:
  • Rate Variance = $(AH imes AR) - (AH imes SR)$
  • Efficiency Variance = $(AH imes SR) - (SH imes SR)$
  • Controllable Variance: Actual overhead - Budgeted (flexible) overhead.
  • Volume Variance: Budgeted (flexible) overhead - Applied overhead.