Chapter 23 : Flexible Budgets and Standard Costs - Accounting 2

Favorable Variance

Actual revenue is greater than budgeted revenue, or actual cost is lower than budgeted cost.

Unfavorable Variance

Actual revenue is lower than budgeted revenue, or actual cost is greater than budgeted cost.

Two types of budgeting

1) Fixed Budgeting 2). Flexible Budgeting

Setting Standard Costs : 2 types

1) Ideal standard 2) Practical standard

Flexible Budget Performance Report

1) Lists differences between actual performance and budgeted performance based on actual sales volume ( or other level of activity) 2) Helps direct mangagement's attention to those costs or revenues that differ substantially from budgeted amounts; areas where corrective actions may help management control operations. 3) Used for variance analysis

Flexible budgets prepared after the period

Help managers evaluate past performance.

Fixed budget reports show variances

However, the manager doesn't know if a change in sales volume (or other activity level) is cause for variances, or if other factors have influenced the amounts.

Master budgets

Is based on a predicted level of activity, such as sales volume, for the budget period.

Flexible Budget (also called variable budget)

Is based on predicted amounts of revenue and expenses corresponding to actual level of output.

Major limitation of fixed budget performance report

Is inability of fixed budget reports to adjust for changes in activity levels.

Layout of flexible budget

Layout follows contribution margin a) Sales are followed by variable costs (per unit), and then by fixed costs — difference between sales and variable costs equals contribution margin. b) First column shows flexible budget amounts of variable costs per unit, and second column shows fixed costs for any volume of sales in relevant range. c) Third, fourth, and fifth columns show flexible budget amounts computed for specified sales volumes (three different sales volumes used in this example). d) Total Budgeted Costs = Total Fixed Cost + (Total Variable Cost Per Unit x Units of Activity).

Budgetary Control

Managers use budgets to control operations and see that planned objectives are met.

Standard Cost (SC)

Standard quantity (SQ) x Standard price (SP) = Standard Cost (SC)

To set direct material costs

Study quantity, grade, and cost of each material used

Flexible budget reports

Superior alternative to fixed budget reports

Identifying Standard Costs

1) Managerial accountants, engineers, personal administrators, and other managers work together to set standard costs. 2) Actual costs frequently differ from standard costs, differences often due to more than one factor.

Standard Costs

Actual costs are amounts paid in past transactions; a measure of comparison is usually needed to decide whether actual cost amounts are reasonable or excessive, and standard costs offer one basis for comparison.

Standard costs are preset costs for delivering a product or service expected under normal conditions:

1) Used by management to access the reasonableness of actual costs incurred for producing the product or service. 2) When actual costs vary from standard costs, management follows up to identify potential problems and take corrective action 3) Mangagement by exception: managers focus attention on most significant differences and give less attention where performance is reasonably close to standard. 4) Often used in preparing budgets because they are the anticipated costs incurred under normal conditions. 5) Can also help control nonmanufacturing costs.

Cost Variance Analysis

1) Variances are commonly identified in performance reports 2) Management examines circumstances to determine factors causing the variance; analysis , evaluation, and explanation involved. 3) Results of efforts should allow assignment of responsibility for the variance; actions can then be taken to correct problems.

Fixed Budgeting

A fixed budget (also called a static budget) is based on a single product amount of sales or other activity measure.

Flexible Budgeting

A flexible budget (also called a variable budget) is based on several different amounts of sales or activity levels.

Actual Cost (AC)

Actual quantity (AQ) x Actual Price (AP) = Actual Cost (AC)

Flexible budget prepare before the period

Are based on several levels of activities. Include both best case and worst case scenarios.

To set direct labor costs

Conduct time and motion studies for each labor operation in the process of providing product or service; set standard labor time required for each operation under normal conditions.

Cost Variance Computation

Cost variance (CV) equals difference between actual cost (AC) and standard cost (SC).

Standard cost card shows:

The standard cost of direct materials, direct labor, and overhead for one unit of product or service.

Fixed Budget Performance Report

a) A fixed budget performance report compare actual results with results expected under the fixed budget (that predicted a certain sales volume or other activity level) b) Difference between budgeted and actual results are designated as variances.

Flexible budget performance report : variance analysis

a) Actual and budgeted sales volumes are the same; as such, any variance in total dollar sales must have resulted from a selling price that was different than expected. b) Difference between actual price per unit of input and budgeted price per unit of input can be described as a price variance. c) Difference between actual quantity of input used and budgeted quantity can be described as a quantity variance.

Difference in actual costs versus standard costs

a) Actual quantity used ( of direct labor hours or direct materials) may differ from standard b) Actual price paid per unit ( of direct labor or direct materials) may differ from standard.

Flexible budgets are especially useful because it reflects the different levels of activities in different amounts of revenues and costs.

a) Comparisons of actual results with budgeted performance are more likely to reveal the causes of any differences. b) Helps managers to focus attention on problem areas and to implement corrective actions.

When numbers making.up a flexible budget are created:

a) Each variable cost is expressed as either a constant amount per unit of sales dollar. b) Budgeted amount of fixed cost is expressed as the total amount expected to occur at any sales volume within the relevant range.

To prepare a flexible budget steps

a) Identify the activity level, units produced or sold b) Identify costs and classify them as fixed or variable. c) Computed budgeted sales and then subtract the sum of budgeted variable costs.

Four Steps involved in proper management of variance analysis

a) Preparation of standard cost performance report b) Computation and analysis of variances c) Identification of questions and their explanations d) Corrective and strategic action

Two main factors cause a cost variance

a) Price variance caused by difference between actual price paid and standard price b) Quantity (or usage or efficiency) variance caused by difference between the actual quantities of materials or hours used and the standard quantity.

Prepare a flexible budget : Must classify costs as variable and fixed within a relevant range.

a) Variable cost per unit of activity remains constant; total amount of variable cost changes in direct proportion to a change in level of activity. b) Total amount of fixed cost remains unchanged regardless of changes in level of activity within relevant (normal) operating range.

Actual quantity

is actual amount of material or labor used in manufacturing the actual quantity of output during the period, and Standard Quantity is the input expected for the quantity of output.

Actual Price

is amount paid for acquiring the input (material or labor) and Standard Price is the expected price.

Cost Variances

is difference between actual and standard cost; can be favorable (if actual cost is less than standard cost) or unfavorable (if actual cost is more than standard cost) Note that short term favorable variances can lead to long term unfavorable variances.

Ideal Standard

is the quantity of material required if process was 100% efficient without any loss or waste.

Practical standard

is the quantity of material required under normal application of process. The standard direct labor rate should include allowances for employee breaks, cleanup, and machine downtime.

Primary use of budget reports

is to help management monitor and control operations.