Introduction to Management Accounting

1. Introduction to Management Accounting Chapter 8 Introduction to Budgets & Variance Analysis

2. Goals and objectives Budgets and the Organization Budgets A budget provides a comprehensive financial overview of planned company operations.

3. Compel managers to think ahead Provide an opportunity to reevaluate existing activities and evaluate new ones. Aid managers in communicating objectives and coordinating actions across the organization. Benefits of Budgets

4. Types of Budgets Strategic plan Long-range planning Master budget Capital budget Continuous budget

5. Strategic Plan The most forward-looking budget is the strategic plan, which sets the overall goals and objectives of the organization. The strategic plan leads to long-range planning, which produces forecasted financial statements for five- to ten-year periods.

6. Sales Production Distribution Finance Master Budget The master budget is a detailed and comprehensive analysis of the first year of the long-range plan. It summarizes the planned activities of all subunits of an organization.

7. are a common form of master budgets that add a month in the future as the month just ended is dropped. Continuous Budget Rolling budgets...

8. Master Budget Financial budget. . . Operating budget (Profit plan). . . Focuses on the Income Statement and supporting schedules or budgeted expenses. Focuses on the effects that the operating budget and other plans will have on cash balances.

9. 2. Operating budget 3. Financial budget Steps in Preparing the Master Budget 1. Basic data

10. Steps in Preparing the Master Budget The principal steps in preparing the master budget: 1. Basic data a. Sales budget b. Cash collections from customers c. Purchases and cost-of-goods sold budget d. Cash disbursements for purchases e. Operating expense budget f. Cash disbursements for operating expenses

11. Steps in Preparing the Master Budget Operating Budget 2. Prepare budgeted income statement using basic data in step 1. • Financial Budget • Prepare forecasted financial statements: • b. Capital budget • c. Cash budget • d. Budgeted Balance sheet

12. Human Relations Problems 1. Low levels of participation in the budget process and Lack of acceptance of responsibility for the final budget. 2. Incentives to lie and cheat in the budget process. 3. Difficulties in obtaining accurate sales forecasts.

13. Factors to Consider When Forecasting Sales General economic conditions Estimates made By sales force Past patterns of sales Competitors’ actions Market research studies Changes in the firm’s prices Advertising and sales promotion plans Changes in product mix

14. Favorable and Unfavorable Variances Favorable (F) versus Unfavorable (U) Variances Profit Revenue Costs Actual > Expected F F U Actual < Expected U U F

15. Case 1

16. Static and Flexible Budgets A static budget is prepared for only one level of a given type of activity. Differences between actual results and the static budget for level of output achieved are static-budget variances. A flexible budget (variable budget) adjusts for different levels of activities. Differences between actual results and the flexible budget are flexible-budget variances.

17. Evaluation of Financial Performance Actual results may differ from the master budget because... 1) sales and other cost-driver activities were not the same as originally forecasted, or 2) revenue or variable costs per unit of activity and fixed costs per period were not as expected.

18. Units 7,000 – 7,000 2,000U 9,000 Sales $217,000 – $217,000 $62,000 U $279,000 Variable costs 158,200 5,670 U 152,600 43,600 F 196,200 Contribution margin $ 58,730 $ 5,670 U $ 64,400 $18,400 U $ 82,800 Fixed costs 70,300 300 U 70,000 – 70,000 Operating income $ (11,570) $5,970 U $(5,600) $18,400 U $ 12,800 Evaluation of Financial Performance Flexible budget for actual sales activity (3) Actual results at actual activity level (1) Sales-Activity Variance (4) = (3)–(5) Flexible-budget variances (2) = (1)-(3) Static Budget (5)

19. Isolating the Causes of Variances Managers use comparisons among actual results, master budgets, and flexible budgets to evaluate organizational performance.

20. Isolating the Causes of Variances Effectiveness is the degree to which a goal, objective, or target is met. Efficiency is the degree to which inputs are used in relation to a given level of outputs. Performance may be effective, efficient, both, or neither.

21. Actual results $(11,570) Flexible budget $(5,600) Flexible-budget variances Flexible-Budget Variances Total flexible-budget variance = Total actual results – Total flexible-budget planned results $5,970 Unfavorable

22. Activity-level variances Sales-Activity Variances Total sales - activity variance Actual sales unit – Master budgeted sales units = Budgeted contribution margin per unit × Flexible budget (7,000 – 9,000) × $9.20 Master budget = $18,400 Unfavorable

23. Trade-Offs Among Variances Improvements in one area could lead to improvements in others and vice versa. Likewise, substandard performance in one area may be balanced by superior performance in others.

24. When to Investigate Variances When should management investigate a variance? Many organizations have developed such rules of thumb as “investigate all variances exceeding $5,000 or 25% of expected cost, whichever is lower.”

25. Flexible-Budget Variance in Detail Standard per unit of output: Std. inputs Flexible expected Budget Amount Direct Material 5 pounds $ 2 /pound $10 Direct Labor ½ hour $16/hour $ 8 Std. price expected Actual results for 7,000 units produced: Direct material Pounds purchased and used: 36,800 Price/pound: $1.90 Total actual cost: $69,920 Direct labor Hours used: 3,750 Actual price (rate): $16.40 Total actual cost: $61,500

26. Variances from Material and Labor Standards Flexible Budget or Total Standard Cost Allowed = Units of good output achieved × Input allowed per unit of output × Standard unit price of input

27. Variances from Material and Labor Standards Standard Direct-Materials Cost Allowed: 7,000 units X 5 pounds X $2.00 per pound = $70,000* Standard Direct-Labor Cost Allowed: 7,000 units X 1/2 hour X $16 per hour = $56,000** (1) (2) (3) Flexible Actual Flexible Budget Costs Budget Variance Direct Materials $69,920 *$70,000 $ 80 F Direct Labor 61,500 **$56,000 $5,500 U

28. Price and Quantity Variances Price variance: (Applied to labor is called a rate variance) (Actual price – Standard Price) × Actual quantity used Quantity variance: (Often called usage or efficiency variance) (Actual quantity used – standard quantity allowed for actual output) × Standard price

29. Price Variance Computations Direct materials price variance: ($1.90 – $2.00) per pound × 36,800 pounds = $3,680 F Direct labor price (rate) variance: ($16.40 – $16.00) per hour × 3,750 hours = $1,500 U

30. Quantity (Usage) Variance Computations Direct-materials quantity variance: [36,800 – (7,000 × 5)] pounds × $2 per pound = $3,600 U Direct-labor quantity variance: [3,750 – (7,000 × ½)] hours × $16 per hour = $4,000 U

31. Direct Materials Flexible Budget Variance Direct-Materials Flexible-budget variance: $3,680 favorable + $3,600 unfavorable = $80 favorable Direct-Labor Flexible-budget variance: $1,500 unfavorable + $4,000 unfavorable = $5,500 unfavorable

32. Interpretation of Price and Usage Variances Price and usage variances are helpful because they provide feedback to those responsible for managing inputs. Managers should not use these variances alone for decision making, control, or evaluation.

33. Setting Standards A standard cost is a carefully developed cost per unit that should be attained. An expected cost is the cost that is most likely to be attained. Perfection (ideal) standards are expressions of the most efficient performance possible under the best conceivable conditions, using existing specifications and equipment. No provision is made for waste, spoilage, machine breakdowns, and the like.

34. Currently Attainable Standards... are levels of performance that managers can achieve by realistic levels of effort. They make allowances for normal defects, spoilage, waste, and nonproductive time.

35. Variable-Overhead Spending and Efficiency Variances A variable-overhead efficiency variance occurs when actual cost-driver activity differs from the standard amount allowed for the actual output achieved. A variable-overhead spending variance occurs when the difference between the actual variable overhead and the amount of variable overhead budgeted for the actual level of cost-driver activity.

36. Variable-Overhead Variances variable- actual standard standard overhead cost-driver cost-driver variable-overhead efficiency activity activity rate per variance allowed cost-driver unit - = X variable- actual standard actual overhead variable variable-overhead cost-driver spending overhead rate per unit activity variance of cost-driver used - = X

37. Fixed Overhead Spending Variance The difference between actual fixed overhead and budgeted fixed overhead Is the fixed overhead spending variance.