Chapter 8. Flexible Budgets, Standard Costs, and Variance Analysis

The standard quantity allowed for actual output (also called the standard hours allowed for actual output when dealing with direct labor and variable overhead)

means the amount of an input that should have been used to produce the actual output of the period. This could be more or less than the actual amount of the input, depending on the efficiency or inefficiency of operations. The standard quantity allowed is computed by multiplying the actual output in units by the standard input allowed per unit of output

The labor rate variance

measures the difference between the actual hourly rate and the standard rate, multiplied by the actual number of hours worked during the period

The labor efficiency variance

measures the difference between the actual hours taken to complete a task and the standard hours allowed for the actual output, multiplied by the standard hourly rate

The variable overhead efficiency variance

measures the difference between the actual level of activity and the standard activity allowed, multiplied by the variable part of the predetermined overhead rate

Standard cost variance analysis decomposes spending variances from the flexible budget into two elements—

one due to the amount of the input that is used and the other due to the price paid for the input

The production manager is ordinarily responsible for

quantity variance. If the actual price were used in the calculation of the quantity variance, the production manager's performance would be unfairly influenced by the efficiency or inefficiency of the purchasing manager

Types of planning budgets

A planning budget is prepared before the period begins and is valid for only the planned level of activity. A static planning budget is suitable for planning but is inappropriate for evaluating how well costs are controlled.

As with direct labor, the price and quantity standards for variable manufacturing overhead are usually expressed in terms of rate and hours. What are the rates and hours?

• The rate represents the variable portion of the predetermined overhead rate discussed in the job-order costing chapter; the hours relate to the activity base that is used to apply overhead to units of product (usually machine-hours or direct labor-hours)

Three qualities of price and quantity variances -

1. can be computed for each of the three variable cost elements—direct materials, direct labor, and variable manufacturing overhead 2. are computed in exactly the same way regardless of whether one is dealing with direct materials, direct labor, or variable manufacturing overhead 3. the input is the actual quantity of direct materials or direct labor purchased; the output is the amount of finished goods produced during the period

Why would a cost have a favorable or unfavorable variance?

There are many possible explanations including paying a higher price for inputs than should have been paid, using too many inputs for the actual level of activity, a change in technology, and so on

Most companies use the quantity of materials purchased to compute the materials price variance and the quantity of materials used in production to compute the materials quantity variance. Why?

There are two reasons for this practice. First, delaying the computation of the price variance until the materials are used in production would result in less timely variance reports. Second, computing the price variance when materials are purchased allows materials to be carried in the inventory accounts at their standard costs

How does a company improve its budgeting and performance analysis process beyond using one cost driver?

a company can also decompose its spending variances into two parts—a part that measures how well resources were used and a part that measures how well the acquisition prices of those resources were controlled

Flexible budgets take into account how changes in activity affect costs. A flexible budget is

an estimate of what revenues and costs should have been, given the actual level of activity for the period. When a flexible budget is used in performance evaluation, actual costs are compared to what the costs should have been for the actual level of activity during the period rather than to the static planning budget

Management by exception

is a management system that compares actual results to a budget so that significant deviations can be flagged as exceptions and investigated further. This approach enables managers to focus on the most important variances while bypassing trivial discrepancies between the budget and actual results

A price variance

is the difference between the actual price of an input and its standard price, multiplied by the actual amount of the input purchased

A revenue variance

is the difference between what the total revenue should have been, given the actual level of activity for the period, and the actual total revenue. If actual revenue exceeds what the revenue should have been, the variance is labeled favorable. If actual revenue is less than what the revenue should have been, the variance is labeled unfavorable. Basically, the revenue variance is favorable if the average selling price is greater than expected; it is unfavorable if the average selling price is less than expected

The standard rate per hour for direct labor

should include hourly wages, employment taxes, and fringe benefits

The standard quantity per unit for direct materials

should reflect the amount of material required for each unit of finished product as well as an allowance for waste

The standard price per unit for direct materials

should reflect the final, delivered cost of the materials

A spending variance is

the difference between how much a cost should have been, given the actual level of activity, and the actual amount of the cost. If the actual cost is greater than what the cost should have been, the variance is labeled as unfavorable. If the actual cost is less than what the cost should have been, the variance is labeled as favorable

A quantity variance

the difference between how much of an input was actually used and how much should have been used and is stated in dollar terms using the standard price of the input

A materials price variance measures

the difference between the actual price per unit of an input and its standard price, multiplied by the actual quantity purchased

It is very common for a company's quantity of materials purchased to differ from its quantity used in production. When this happens ->

the materials quantity variance is computed using the quantity of materials used in production, whereas the materials price variance is computed using the quantity of materials purchased

The materials quantity variance

measures the difference between the actual quantity of materials used in production and the standard quantity allowed for the actual output, multiplied by the standard price per unit of materials. It is labeled as unfavorable (favorable) when the quantity of materials used in production is greater than (less than) the quantity that should have been used according to the standard

The variable overhead rate variance

measures the difference between the actual variable overhead cost incurred during a period and the standard cost that should have been incurred based on the actual activity of the period

A standard cost card

shows the standard quantities and costs of the inputs required to produce a unit of a specific product. Observe that the standard cost per unit for variable manufacturing overhead is computed the same way as for direct materials or direct labor—the standard quantity allowed per unit of the output is multiplied by the standard price