The Flexible Budget and Standard Costing: Direct Materials and Direct Labor

1. The Flexible Budget and Standard Costing:Direct Materials and Direct Labor

2. Evaluating Operating Results Performance is evaluated by comparing actual results with the budget. Actual Budget

3. Effectiveness and Efficiency Anoperation is effective ifit has attainedor exceededits goals. Anoperation is efficient if ithas not wastedresources. An operation may be effective but inefficient,and it may be efficient but ineffective.

4. Hmm! Comparing actual results withthe master budget will helpme determine myeffectiveness. Consider the following examplefrom the Cheese Company . . . Assessing Effectiveness Master budgets are prepared for a single activity level. Comparing actual results with the master budget reveals operating income variances.

5. Assessing Effectiveness

6. Assessing Effectiveness U = Unfavorable variances – Cheese Company was ineffective in achieving its budgeted level of sales.

7. Assessing Effectiveness

8. Assessing Effectiveness U = Unfavorable operating income variance – Cheese Company was ineffective in achieving its budgeted operating income.

9. Assessing Effectiveness F = Favorable variance – actual costs are less than budgeted costs.

10. Assessing Effectiveness Since cost variances are favorable, has Cheese Company done a good job of controlling costs at the lower level of sales?

11. I do know that actualsales are below budgetedsales, which is unfavorable. But shouldn’t variable costsbe lower if actual salesare below budgeted sales? Assessing Effectiveness I don’t think I cananswer the questioncomparing actual resultswith the master budget.

12. The Flexible Budget • The relevant question is . . . “How much of the favorable cost variance isdue to lower activity, and how much is due to good cost control?” • To answer the question, we must the budget to theactual activity. • A willhelp me evaluate efficiency. flexible budget

13. The Flexible Budget Show revenues and expensesthat should have occurred at theactual activity. May be prepared for any activity level in the relevant range. Reveal variances due to good cost control or lack of cost control. Improve performance evaluation.

14. The Flexible Budget Central Concept If you can tell me what your activity wasfor the period, I will tell you what your costs and revenue should have been.

15. The Flexible Budget To a budget for different activitylevels, we must know how costs behave with changes in activity levels. • Total variable costs changein direct proportion to changes in activity. • Total fixed costsremain unchangedwithin the relevantrange. Variable Fixed

16. The Flexible Budget Let’s prepare a budget for the Cheese Company at 8,000 units.

17. A flexible budgetis prepared for thesame activity level (8,000 units) as actually achieved. The Flexible Budget

18. The Flexible Budget Variable costs are expressed as a constant amount per unit. In the original static budget, variable manufacturing costs were $30,000 for 10,000 units resulting in $3.00 per unit. Fixed costs are expressed as a total amounts thatdo not changewithin the relevant range of activity.

19. 8,000 units × $3.00 per unit = $24,000 The Flexible Budget

20. The Flexible Budget Note: There is no flexin the fixed costs.

21. The Flexible Budget

22. The Flexible Budget Original actual results for Cheese Company that we saw earlier.

23. The Flexible Budget Variable costs have unfavorable variances because actual costs are more than the flexible budget costs.

24. Assessing Efficiency Now we can answer our original question: “What part of the variances is due to activity and what part is due to cost control?”

25. Assessing Efficiency Recall the original variances resulting from the comparison of actual results with the master budget.

26. Assessing Efficiency Now let’s insert our new tool, the budget for 8,000 units, into the analysis.

27. Assessing Efficiency

28. Assessing Efficiency Variances due toactivity change

29. Assessing Efficiency Variances dueto cost control

30. Selling Price Variance A selling price variance is the difference betweenthe total sales revenue received and thetotal sales revenue of the flexible budget. In the Cheese Company example, the budgetedand actual selling price was $10 per unit. Now assume that the selling price changes to $11 per unit, with all other information unchanged. Continue

31. Selling Price Variance 8,000 units × $11 per unit 8,000 units × $10 per unit

32. Selling Price Variance 8,000 units × ($11 per unit – $10 per unit)

33. Selling Price Variance Flexible budget variances are variances are unchanged.

34. Standard Costs are Standard Costs Based on carefullypredetermined amounts. Used for planning labor, materialand overhead requirements. Cost The expected levelof performance. Benchmarks formeasuring performance.

35. Standard Costs Standard A standard cost varianceis the amount by whichan actual cost differs fromthe standard cost. Product Cost

36. Standard Cost Variances This variance is unfavorable because the actual cost exceeds the standard cost. Standard A standard cost varianceis the amount by whichan actual cost differs fromthe standard cost. Product Cost

37. Standard Cost Variances Managers focus on quantities and coststhat exceed standards, a practice known asmanagement by exception. Standard Amount DirectMaterial DirectLabor Type of Product Cost

38. Variance Analysis Cycle Takecorrective actions Identifyquestions Receive explanations Conduct next period’s operations Analyze variances Prepare standard cost performance report Begin

39. Types of Standards Accountants, engineers, personnel administrators, and production managers combine efforts to set standards based on experience and expectations.

40. Standards should be setat levels that are currently attainablewith reasonable and efficient effort. Types of Standards Should we havestandards that aredifficult to achieveor standards that canbe achieved withminimal effort?

41. I agree. Unattainable standards are discouraging while standards that are too easy to achieve provide little motivation. Types of Standards

42. Selection of a Standard • Activity analysis • Historical data • Benchmarking • Market expectation • Strategic decisions

43. Nonfinancial Measures • Friendly service • On-time delivery • Quality • Cleanliness • Value

44. Direct Materials Standards PriceStandards UsageStandards Use competitivebids for the qualityand quantity desired. Use product design specifications.

45. Direct Materials Standards The standard material cost for one unit of product is: standard quantity standard price for of material one unit of material required for one unit of product ×

46. Direct Labor Standards RateStandards EfficiencyStandards Use wage surveys andlabor contracts. Use time and motion studies foreach labor operation.

47. Direct Labor Standards The standard labor cost for one unit of product is: standard number standard wage rate of labor hours for one hour for one unit of product ×

48. A General Model forVariance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price or RateVariance Usage or Efficiency Variance The total variance is the flexible budget variance.

49. A General Model forVariance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price or RateVariance Usage or Efficiency Variance Standard price is the amount that should have been paid for the resources acquired.

50. A General Model forVariance Analysis Actual Quantity Actual QuantityStandard Quantity × × × Actual Price Standard Price Standard Price Price or RateVariance Usage or Efficiency Variance Standard quantity is the quantityallowed for the actual good output.