Flexible budgets and budget variances First, let us consider the following example: Standard Cost Sheet Product: Widget Direct materials 2 lbs. @ $4.00 $ 8.00 Direct labor 0.5 hrs. @ $20.00 10.00 Variable overhead 0.5 hrs. @ $ 3.00 1.50 Fixed overhead 0.5 hrs. @ $25.00 12.50 Standard cost per unit $ 32.00 Additional data: Variable selling, general, and administration $3.00 Fixed selling, general, and administration $2.00 Operating Data Budgeted units of production and sales 10,000 Actual units manufactured and sold 8,000 Selling price per unit (budgeted and actual) $60 per unit Direct materials purchased and used 18,000 lbs. @$4.50 $81,000 Direct labor 3,800 hrs. @22.00 83,600 Variable overhead 11,800 Fixed overhead 128,000 Total manufacturing cost $304,400 Variable SG&A $ 24,000 Fixed SG&A 16,000 Total SG&A $ 40,000 On the next page is the static budget. 1
Budgeted units 10,000 Sales $600,000 Variable Costs Direct Materials $80,000 Direct Labor 100,000 Variable OH 15,000 Fixed OH 125,000 320,000 Selling and Admin Variable 30,000 Fixed 20,000 50,000 Operating Income $230,000 The flexible budget is Actual units 8,000 Sales $480,000 Variable Costs Direct Materials $64,000 Direct Labor 80,000 Variable OH 12,000 Fixed OH 125,000 281,000 Selling and Admin Variable 24,000 Fixed 20,000 44,000 Operating Income $155,000 On the next page, we compare the actual results, the flexible budget, and the static budget. 2
Actual Results Variance Flexible Budget Variance Master (static) Budget Units 8,000 - F 8,000 2,000 U 10,000 Sales $480,000 $- F $480,000 $120,000 U $600,000 Variable Costs Direct Materials $81,000 $17,000 U $64,000 $16,000 F $80,000 Direct Labor 83,600 3,600 U 80,000 20,000 F 100,000 Variable OH 11,800 200 F 12,000 3,000 F 15,000 Fixed OH 128,000 3,000 U 125,000 - F 125,000 304,400 23,400 U 281,000 39,000 F 320,000 Selling and Admin Variable 24,000 - F 24,000 6,000 F 30,000 Fixed 16,000 4,000 F 20,000 - F 20,000 40,000 4,000 F 44,000 6,000 F 50,000 Operating Income $135,600 $19,400 U $155,000 $75,000 U $230,000 We will now proceed to variance analysis. As I mentioned in class, this analysis above is called a level 0 analysis. I don t care if you know that term. It relates to the overall variances between flexible budget and actual results and between the static budget and flexible budget. We will be primarily concerned with the flexible budget variances here (the differences between the flexible budget and actual results). We will break each of these (actually, only materials, labor, variable overhead) into a price/rate/spending variance and an efficiency/usage variance. Which it is depends to which variance we are referring. Materials have price and usage variances, Labor has rate and efficiency (sometimes called usage) variances, and Variable overhead has spending (since there is not a real rate out there) and efficiency variances. In addition, we will have two variances for fixed overhead. A spending variance and a production volume variance. Let s begin with direct materials and direct labor. Recall that SOMETIMES direct materials has a different amount used than purchased. If that is the 3
case, then you must compute the price variance based upon the actual amount of materials purchased and the usage variance based upon the actual amount USED. The general model for breaking down materials, labor, and variable overhead variances was shown in class. Actual Quantity X Actual Price AQ X AP Actual Quantity X Standard Price AQ X SP Standard Quantity X Standard Price SQ X SP Rate, price, spending variance Usage or efficiency variance Let us begin by breaking down the direct materials flexible budget variance of $17,000 U between the actual results and the flexible budget into a price variance and a usage variance. The actual price spent for materials was $4.50 per pound (sometimes you are not given this breakdown) and the quantity used was 18,000 pounds (again, for this case amount purchased and used are the same). The Standard price per pound is $4.00 and the quantity that we would have expected to use under the flexible budget (our standard) would have been 2 pounds per unit X 8,000 units actually produced or 16,000 pounds. This yields the following price and usage variances: AQ X AP 18,000 X 4.50 $81,000 AQ X SP 18,000 X $4.00 $72,000 SQ X SP 2 X 8,000 X $4.00 $64,000 $9,000 U $8,000 U Price variance 4 Usage variance
Notice that the flexible budget variance of $17,000 U is the SUM of the price and the usage variances ($9,000 U and $8,000 U respectively). Now let s explain the $3,600 U direct labor variance. The standard labor rate is $20 per labor hour and the flexible budget (standard) usage for the 8,000 units produced would be.5 X 8,000 = 4,000 hours. We actually incurred labor costs of $83,600 which relate 3,800 labor hours used at a labor rate of $22.00 per hour. AQ X AR 3,800 X 22.00 $83,600 AQ X SR 3,800 X $20.00 $76,000 SQ X SR.5 X 8,000 X $20.00 $80,000 $7,600 U $4,000 F Rate variance Efficiency variance Adding these two variances together we get $3,600 U for the flexible budget variance. The variable overhead variance is similar to the labor variance and if variable overhead is based upon labor hours, as in this case, the efficiency variance will be proportionate (and the same sign) as the direct labor efficiency variance. Actual variable overhead costs were $11,800. Note that there is not ACTUAL RATE. The actual driver (as with direct labor) was 3,800 labor hours and the standard hours allowed for producing 8,000 units was.5 X 8,000 = 4,000 hours. The standard rate per hour is $3.00. Actual variable OH $11,800 AQ X SR 3,800 X $3.00 $11,400 SQ X SR.5 X 8,000 X $3.00 $12,000 $400 U $600 F Spending variance Efficiency variance 5
The flexible budget variance for variable overhead was $200 F which equals $400 U plus $600 F. Finally, we consider the fixed overhead variances. These are a bit different. First, let us define a couple of things. The flexible budget overhead for variable overhead is the number to the far right in the figure above ($12,000). That is because it is based upon the ACTUAL quantity produced. For fixed overhead, though, the ACTUAL quantity and the BUDGETED quantity (10,000 units) should yield the SAME fixed overhead since the cost is fixed. That is why fixed overhead ALWAYS has a zero sales volume variance The number of units produced or sold is, theoretically, irrelevant. So the flexible budget will be the same as the static budget amount and will be based upon the number of units budgeted. We call that the denominator level of activity. Budgeted fixed overhead is $25.00 X.5 hours per unit X 10,000 units or $125,000. Note, as a sideline, that the fixed overhead rate (FOHR) plus the variable overhead rate (VOHR) is equal to the predetermined overhead rate from chapter 4 (POHR). That is total estimated overhead divided by total activity (in this case, total estimated direct labor hours). The first variance (and the only one relevant to the budget analysis) for fixed overhead is the fixed overhead spending variance. That is just the difference between the actual fixed overhead costs and the flexible budget (and, therefore, the static budget). That is $128,000 - $125,000 = $3,000 U. It is unfavorable since the actual cost is $3,000 more than the budgeted cost. Finally, we compute the fixed overhead production volume variance. For this, we PRETEND that the fixed overhead rate works like the variable overhead rate. The fixed overhead rate is given here as $25.00. Fixed overhead is applied based upon this number and the number of labor hours. In other words, applied fixed overhead was $25 X.5 X 8,000 since we only manufactured 8,000 units. So applied fixed overhead would, in a standard costing system, be $100,000. Since the flexible budget fixed overhead was $125,000, we have an unfavorable variance (underproduction) of $25,000 U for our production volume variance. The two fixed overhead variances are shown below: 6
Actual fixed OH $128,000 Flexible budget Denominator Q X FOHR.5 X 10,000 X $25.00 $125,000 SQ X FOHR.5 X 8,000 X $25.00 $100,000 $3,000 U $25,000 U Spending variance Production volume variance Notice that the $25,000 unfavorable variance DOES NOT SHOW UP anywhere on the level 0 variance analysis. The $3,000 unfavorable variance is the TOTAL variance (difference) between our actual results for fixed overhead and our flexible budget. There is no difference between our flexible budget and our static budget. 7