3.1 Flexible budgets and direct cost variances

What is the key difference between flexible budget and static budget?

- A key difference between a flexible budget and a static budget is the use of the actual output level in the flexible budget.

What are the steps in developing flexible budgets?

Step 1: Determine budgeted selling price, budgeted variable cost per unit and budgeted fixed cost Step 2: Determine the actual quantity of output Step 3: Determine the flexible budget for revenues based on budgeted selling price and actual quantity of output Step 4: Determine the flexible budget for costs based on budgeted variable costs per output unit, actual quantity of output and the budgeted fixed costs.

Performance measurement using variances

- A key use of variance analysis is in performance evaluation. - Two attributes of performance are commonly measured: 1. Effectiveness is the degree to which a predetermined objective or target is met 2. Efficiency is the relative amount used to achieve a given level of output - Variances should not solely be used to evaluate performance - If any single performance measure, such as a labour efficiency variance, receives excessive emphasis, managers tend to make decisions that maximize their own reported performance in terms of that single performance measure.

What are the purpose of flexible budgets and variances?

- Flexible budgets and variances help managers gain insights into why the actual results differ from the planned performance

When to investigate variances

- Frequently managers base their answer on subjective judgements - For critical items, a small variable may prompt follow up - For other items a minimum monetary variance or a certain percentage of variance from budget may prompt an investigation.

What may be some causes for a favourable price variance?

- LSY's purchasing manager negotiated more skillfully than was planned - Labour prices were set without careful analysis of the market

What may some causes for an unfavourable efficiency variance?

- LSY's purchasing manager received lower quality of materials - The personnel manager hired under skilled workers - The maintenance department did not properly maintain machines

What could be the multiple causes of variances?

- Often the causes of variances are interrelated - A favourable price variance might be due to lower quality materials - It is best to always consider possible interdependencies among variances and do not interpret variances in isolation of each other.

What do the different Level analysis mean?

Level 0 = Compares actual operating profit with budgeted operating profit Level 1= provides more detailed information on the operating profit, static budget variance Level 2 = provides information on the two components of the static budget variance 1. Flexible budget variance 2. Sales volume variance Level 3 = Separate the flexible budget variance into price and efficiency variances

What is the efficiency variance and how is it calculated?

The difference between the actual and budgeted quantity of inputs used multiplied by the budgeted price of input Efficiency variance = (actual quantity of inputs used - budgeted quantity of inputs allowed for actual output) x budgeted price of inputs

What is the price variance? And how is calculated?

The difference between the actual price and the budgeted price of inputs multiplied by the actual quantity of inputs o Input - prince variance o Rate variance Price variance = (actual price of inputs - budgeted price of inputs) x actual quantity of inputs.

Why does the flexible budget variance arises?

The flexible budget variance arises because the actual selling price, variable costs per unit, quantities and fixed costs differ from the budgeted amount o The flexible budget variance pertaining to revenues is often called a selling price variance because it arises solely from differences between the actual selling price and the budgeted selling price.

What is ABC?

- Activity based costing (ABC) systems focus on individual activities as the fundamental cost object. - ABC systems classify the cost of various activites into a cost hierarchy - output unit level, batch level, product sustaining and facility sustaining. - Material costs and direct manufacturing labour costs are examples of output - unit level costs. - Batch level costs are resources sacrificed on activities that are related to a group of units of product(s) or service(s) rather than to each individual unit of product or service

Financial and non financial measures

- Almost all organisations use a combination of financial and non financial performance measures rather than relying exclusively on either type - Control may be excercised by observation of workers - LSY may compare the percentage of suits started and completed at one period without requiring rework with those of another period.

Describe benchmarking and how it can be used by managers in variance analysis

- Benchmarking refers to the continuous process of measuring products, services and activities against the best levels of performance - The best levels of performance are often found in competing organisations or in other organisations having similar processes - Companies should ensure that the benchmark numbers are comparable - Benchmarking facilitates companies using the best levels of performance within their organization, in competitor organisations to gauge the performance of their own managers.

What is a favourable variance and what is an unfavourable variance?

o A favourable variance is a variance that increases operating profit relative to the budgeted amount, it also means for revenue items that actual revenues exceeded budgeted revenues. o An unfavourable variance is a variance that decreases operating profit relative to the budgeted amount, it also means for cost items that actual costs were less than budgeted costs.

What is a flexible budget?

o A flexible budget is developed using budgeted revenues or cost amounts based on the level of output actually achieved in the budget period.

What is a static budget?

o A static budget is a budget prepared for only one level of activity o It is based on the level of output planned at the start of the budget period. o The master budget is an example of a static budget.

What is static budget variance?

o A static budget variance is the difference between an actual result and a budgeted amount on the static budget.

What is the sales volume variance?

o The sales-volume variance is the difference between the static budget for the number of units expected to be sold and the flexible budget for the number of units that were actually sold.