© 2012 Pearson Prentice Hall. All rights reserved. Using Budgets for Using Budgets for Planning and Planning and Coordination Coordination Chapter 10
© 2012 Pearson Prentice Hall. All rights reserved.
Using Budgets for Planning Using Budgets for Planning and Coordinationand Coordination
Chapter 10
© 2012 Pearson Prentice Hall. All rights reserved.
What-If AnalysisWhat-If Analysis Structure and information required to prepare the
master budget can be used to easily provide the basis for what-if analysis– Evaluating Decision-Making Alternatives– Sensitivity Analysis
The process of selectively varying a plan’s or budget’s key estimates for the purpose of identifying over what range a decision option is preferred
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Variance AnalysisVariance Analysis Variance analysis – comparison of planned (or
budgeted) results with actual results Variance—difference between planned and actual
results– Should be investigated to determine:
What caused the variance What should be done to correct that variance
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Variance AnalysisVariance Analysis Budgeted or planned costs can come from three
sources:
– Standards established by industrial engineers
– Previous period’s performance
– A benchmark—the best in class results achieved by a competitor
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Variance AnalysisVariance Analysis The financial numbers are the product of a price
and a quantity component: – Budgeted amount = standard price per unit *
budgeted quantity– Actual amount = actual price per unit * actual
quantity
Variance analysis explains the difference between planned and actual costs by evaluating:– Differences between planned and actual prices– Differences between planned and actual quantities
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Variance AnalysisVariance Analysis Managers focus separately on prices and quantities
because in most organizations:– One department or division is responsible for the
acquisition of a resource and determining the actual price
– A different department uses the resource and determines the quantity
A variance is a signal that is part of a control system for monitoring results
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Basic Variance Analysis Basic Variance Analysis If managers learn that specific actions they took
helped lower the actual costs, then they can obtain further cost savings by repeating those actions on similar jobs in the future
If the factors causing actual costs to be higher than expected can be identified, then actions may be taken to prevent those factors from recurring in the future
If cost changes are likely to be permanent, cost information can be updated for future jobs
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First-Level VariancesFirst-Level Variances The first-level variance for a cost item is the
difference between the actual costs and the master budget costs for that cost item
Variances are favorable (F) if the actual costs are less than estimated master budget costs
Unfavorable (U) variances arise when actual costs exceed estimated master budget costs
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Decomposing the VariancesDecomposing the Variances A flexible budget adjusts the forecast in the master
budget for the difference between planned volume and actual volume
Cost differences between the master and the flexible budget are called planning variances– Reflect the difference between planned output and
actual output– Arise entirely because the planned volume of
activity was not realized
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Planning and FlexiblePlanning and FlexibleBudget VariancesBudget Variances
Flexible budget variances are the differences between the flexible budget and the actual results
Flexible budget variances reflect:– Quantity variances—the difference between the
planned and the actual use rates per unit of output – Cost variances—the difference between the
planned and the actual price or cost per unit of the various cost items
Static and Flexible BudgetsStatic and Flexible BudgetsStatic Budget Master budget Carefully forecasted sales
and operating targets
Actual Budget VariancesUnits 7,000 9,000Sales $217,000$279,000 Variable costs:Manufacturing $151,270 $189,000Shipping . 5,000 5,400Administrative 2,000 1,800Total variable $158,270 $196,200
Contr’n margin $58,730 $82,800
Fixed costs:Manufacturing $37,300 $37,000Sell & Admin 33,000 33,000Total fixed costs $70,300 $70,000
Op income (loss) $(11,570) $12,800
2,000 U
62,000 U
37,730 F 400 F 200 U $37,930 F
$24,070 F
300 U UNCH 300 U
$24,370 U
Evaluation of Financial PerformanceEvaluation of Financial Performance Subdivision of total difference between master or static budget and
actual results to evaluate performance
Flexible SalesActual Budget Flexible Activity MasterResults Variances Budget Variances Budget
Units 7,000 7,000 2,000 U 9,000
Sales $217,000 $217,000 $62,000 U $279,000
Variable costs 158,270 5,670 U 152,600 43,600 F 196,200
ContributionMargin 58,730 5,670 U 64,400 18,400 U 82,800
Fixed costs 70,300 300 U70,000 70,000
Operating income$(11,570) $5,970 U $(5,600) $18,400 U $12,800
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Second and Third-Level Second and Third-Level VariancesVariances
The second-level variances are the planning variance and the flexible budget variance
The direct material flexible budget variances and direct labor flexible budget variances can be decomposed further into third-level variances:– Efficiency variances – Price variances
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Price and Efficiency VariancesPrice and Efficiency Variances
Static-Budget Variance
Flexible-Budget Variance Sales-Volume (Planning) Variance
Price Variance Efficiency Variance
A General Model for Variance A General Model for Variance Analysis Analysis
AQ x (AP – SP) (AQ – SQ) x SP
AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity
Price Variance Quantity Variance
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
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Direct Material Variances Direct Material Variances Quantity variance = (AQ - SQ) x SP
Where:AQ = actual quantity of materials usedSQ = standard quantity of materials allowedSP = standard price of materials
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Direct Material Variances Direct Material Variances Price variance = (AP - SP) x AQ
Where:
•AP = actual price of materialsSP = standard price of materials AQ = actual quantity of materials used
– The price variance may be calculated using the quantity purchased rather than the quantity used
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Direct Labor VariancesDirect Labor Variances Efficiency variance = (AH - SH) x SR Rate variance = (AR - SR) x AH
Where:AH = actual number of direct labor hoursAR = actual wage rate SR = standard rateSH = standard number of direct labor hours allowed
The sum of the rate variance and the efficiency variance equals the total flexible budget direct labor variance
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Support ActivitySupport ActivityCost VariancesCost Variances
Support costs can reflect either flexible or fixed costs
The quantity of fixed costs may not change from period to period, but the spending on them may fluctuate
Monitoring spending variances on fixed costs is possible and desirable
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Support Activity Support Activity Cost VariancesCost Variances
Flexible support costs reflect behind-the-scenes operations that are proportional to the volume of activity but are not directly a part of the product or service provided to the customer
Flexible support costs consist of a quantity (or usage) component and a price component
Flexible support cost variances may be analyzed in a manner similar to direct material or direct labor variances
Sales VariancesSales Variances Sales volume effects
– Sales mix variance
– Sales quantity variance
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Actual total Actual PlannedPlanned
= units of all x sales – sales xrevenue
products sold mix % mix %per unit
Actual total Planned total PlannedPlanned
= units of all – units of all x sales xrevenue products sold products mix % per unit
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Profitability VariancesProfitability Variances
Static-Budget Variance
Flexible-Budget Variance Sales-Volume (Planning) Variance
Sales-Volume Variance= (Actual unit sales –
Budgeted unit sales) x Budgeted contribution margin per unit
Sales-MixVariance
Sales-QuantityVariance
Level 1
Level 2
Level 3
Sales VariancesSales Variances Sales price effects
– Sales price variance Actual number of units sold x (Actual price per unit
– Planned price per unit)
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Actual number Actual Plannedof units x price per –
price soldunit per unit