Slide 1
A short note on budgets and variance analysis
What is a budget?Why do we need budgets?PlanningCommunication
and coordinationAllocating resourcesPerformance evaluation and
incentives.Different types of budgets:Bottom up (participative) vs.
top down.Zero-based vs. incremental.Detailed vs. aggregate.Short
run vs. long run.Static vs. flexible.
Budgeted Income StatementCash BudgetSales of Services or
GoodsEndingInventoryBudgetWork in Processand
FinishedGoodsProductionBudgetDirectMaterialsBudgetSelling
andAdministrativeBudgetDirectLaborBudgetOverheadBudgetEndingInventoryBudgetDirect
MaterialsBudgeted Balance SheetBudgeted Statement of Cash FlowsThe
master budget comprises many separate budgets, or schedules, that
are interdependent. Based on the sales budget, a company develops a
set of operational budgets that specify how its operations will be
carried out to meet the demand for its goods or services. A
manufacturing company develops a production budget, which shows the
number of product units to be manufactured and ending inventory
budgets. From the production budget, a manufacturer develops
budgets for the direct materials, direct labor, and overhead that
will be required in the production process. A budget for selling
and administrative expenses also is prepared. The operational
portion of the master budget is similar in a merchandising firm,
but instead of a production budget for goods, a merchandiser
develops a budget for merchandise purchases. A merchandising firm
will not have a budget for direct materials. Based on the sales
budget for its services, a service industry firm develops a set of
budgets that show how the demand for those services will be met.
Every business prepares a cash budget. This budget shows expected
cash receipts, as a result of selling goods or services, and
planned cash disbursements, to pay the bills incurred by the firm.
The final portion of the master budget includes a budgeted income
statement, a budgeted balance sheet, and a budgeted statement of
cash flows. (LO2)
Activity-Based Costing versus Activity-Based
BudgetingResourcesCost objects:products and servicesproduced,
andcustomers served.ActivitiesResourcesForecast of productsand
services to beproduced andcustomers
served.ActivitiesActivity-BasedCosting (ABC)Activity-BasedBudgeting
(ABB)Applying ABC concepts to the budgeting process yields
activity-based budgeting or ABB. Under ABB, the first step is to
specify the products or services to be produced and the customers
to be served. Then the activities that are necessary to produce
these products and services are determined. Finally, the resources
necessary to perform the specified activities are quantified.
Conceptually, ABB takes the ABC model and reverses the flow of the
analysis. ABC assigns resource costs to activities, and then it
assigns activity costs to products and services produced and
customers served. ABB, on the other hand, begins by forecasting the
demand for products and services as well as the customers to be
served. These forecasts then are used to plan the activities for
the budget period and budget the resources necessary to carry out
the activities. (LO3)Static versus Flexible Budgets
Master/Static budgetex-ante analysis of what management expects
to happen in the future, consisting of:sales projectionsoperating
and financial budgetspro-forma financial statementsFlexible
budgetadjusts for changes in volume ONLYapplies estimate of
variable costs to new volume levelsfixed costs do NOT change, since
they do not fluctuate with changes in volume (within the relevant
range)often prepared for purposes of performance evaluation
An exampleStandards: P = $10/unit; VC = $5/unit; FC =
$3,000/period; Sales volume = 3,000 units; Actual sales = 2,000
units.Master/StaticActual Variance# Units3,0002,000Sales$30,000
$22,500 V. Costs$15,000 $11,000 CM$15,000 $11,500 FC$3,000 $4,000
Profit$12,000 $7,500 An exampleStandards: P = $10/unit; VC =
$5/unit; FC = $3,000/period; Sales volume = 3,000 units; Actual
sales = 2,000 units.
Master/StaticActual Flexible Variance# Units3,0002,000Sales$
30,000$ 22,500V. Costs$ 15,000$ 11,000CM$ 15,000$ 11,500FC$ 3,000$
4,000Profit$ 12,000$ 7,500
VARIANCE ANALYSISVariance = difference between actual results
and budgeted static budget variance = difference between actual
results and static budget (formulated at beginning of periodvolume
variancemarket share variance / Mix variancemarket volume
varianceflexible budget variance = difference between actual and
flexible budget (adjusted for realized production/sales)price
varianceefficiency variance(Effectiveness: Doing right things;
Efficiency: Doing things right)Total Variance Flexible Budget
Variance Volume Variance Price Efficiency Mkt. Share/Mix Mkt.
Volume Variance Variance Variance VarianceSTANDARD COST PRODUCTION
VARIANCESA.Variable Manufacturing Inputs (DM, DL, VOH)Incurred
Costs Flexible Budget Static Budget
AP x AQI SP x SQIAO SP x SQISO(Actual Costs of (Std. Costs given
(Std. Costs based onInputs) Actual Output) Std. Output)SP X AQI
(Std. Costs given Actual Inputs)
Price (Spending Variance Efficiency Variance Volume Variance=
(AP-SP) X AQI = (AQI SQIAO) X SP = (SQIAO SQISO) X SP
Flexible Budget Variance = AP X AQI SP X SQIAONotation:AP =
actual price paid for the input/resourceAQI = actual quantity of
input usedSP = standard price of input/resourceSQIAO = Standard
quantity of Input allowed given the Actual quantity of Output
produced/soldSQISO = Standard quantity of Input allowed given the
Standard quantity of Output produced/sold#ISB Sri S.
Sridharan11Variable Cost VariancesPrice/Spending Variance
Efficiency Variance
Results from paying moreor less than expected forinputs.Results
from using moreor less than expectedamounts of inputs. #ISB Sri S.
SridharanAn unfavorable spending variance simply means that the
total actual cost of variable overhead is greater than expected,
after adjusting for the actual quantity of process hours used. An
unfavorable spending variance could result from paying a
higher-than-expected price per unit for variable-overhead items. Or
the variance could result from using more of the variable-overhead
items than expected. The variable overhead efficiency variance is a
function of the cost driver selected. It does not reflect overhead
control. Therefore, the spending variance is the real control
variance for variable overhead. Managers can use the spending
variance to alert them if variable-overhead costs are out of line
with expectations. (LO5)
STANDARD COST PRODUCTION VARIANCESA.Variable Manufacturing
Inputs (DM, DL, VOH)Incurred Costs Flexible Budget Static
Budget
AP x AQI SP x SQIAO SP x SQISO(Actual Costs of (Std. Costs given
(Std. Costs based onInputs) Actual Output) Std. Output)SP X AQI
(Std. Costs given Actual Inputs)
Price (Spending Variance Efficiency Variance Volume Variance=
(AP-SP) X AQI = (AQI SQIAO) X SP = (SQIAO SQISO) X SP
Flexible Budget Variance = AP X AQI SP X SQIAONotation:AP =
actual price paid for the input/resourceAQI = actual quantity of
input usedSP = standard price of input/resourceSQIAO = Standard
quantity of Input allowed given the Actual quantity of Output
produced/soldSQISO = Standard quantity of Input allowed given the
Standard quantity of Output produced/sold#ISB Sri S.
Sridharan13INTERPRETATION OF OVERHEAD VARIANCES Variable OH
Variances:price variance = (AP SP ) x AQI efficiency variance =
(AQI SQIAO) x SP volume variance =( SQIAO SQISO ) x SP Fixed OH
Variances:budgeted variance in FOH = FOHact - FOHbudproduction
volume variance = FOHbud - FOHappIied
DMDLVOHStd. # units of input allowed to produce one unit of good
output211Actual # units purchased and used 3,0002,500?Actual cost
per unit of input $ 1.50.82Std. cost per unit of input $ 112#ISB
Sri S. Sridharan14