ACC200 term 2 2019 Assignment

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Lecture9Chapter12.ppt

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Chapter 12
Flexible budgets,
direct cost variances
and management
control

PowerPoint to accompany:

Horngren’s Cost Accounting, 3rd Edition

Learning Objectives

Explain how standard costs can be useful for planning and control.

Distinguish a static budget from a flexible budget.

Prepare flexible budgets and calculate flexible-budget variances and sales-volume variances.

Calculate price variances and efficiency variances for direct materials and direct labour.

Use variance analysis to focus and direct continuous improvement.

Perform variance analysis in activity-based costing systems.

Describe benchmarking and explain its role in cost management.

The use of variances

Variance – deviation between planned and actual performance.
Variances are like the warning lights on your car – they provide a timely warning that action may be necessary.
Management by exception – the practice of focusing attention on the most significant deviations (often the largest variances).
The principles of variance analysis can also help to achieve social and environmental goals.

Standard costs

Standard cost is a standard quantity at a standard price.
Standard quantity is a carefully determined quantity of input required for one unit of output.
Standard price is a carefully determined price that a company expects to pay for a unit of input.
Standard cost is important for planning and control.

Developing standards:

Standard costs can be developed in a number of ways:

actual input data from past periods

data from other companies that have similar processes

engineering studies.

Standard costs (cont’d)

Practical versus ideal standards:

Practical standards provide realistic expectations, which makes them more appropriate for planning.
In an ideal standard, there is no allowance for wastage or labour inefficiency.
Ideal standards can stretch employees to continue to improve.

Standard costs (cont’d)

Explanation of standard costing and its variances, in six parts, can be found at:
https://www.accountingcoach.com/standard-costing/explanation/1
YouTube lecture ‘Standard Costs & Standard Cost Variances’ full lecture (approx 60 minutes) can be found at: http://www.youtube.com/watch?v=NFIbU-0BxFA

Standard costs – web links

The static budget, or master budget, is based on the level of output planned at the start of the budget period before actual sales are known.
The master budget is called a static budget because it is developed around a single (static) planned output level and the standard costs found in the standard cost sheet.

Static budgets and static-budget variances

Static-budget variance is the difference between the actual result and the corresponding static-budget amount.
Favourable variances (F) occur when actual revenues exceed budgeted revenues, or when actual costs are less than budgeted costs.
Unfavourable variances (U) occur when costs are higher, or revenues lower, than budget.

Static budgets and static-budget variances (cont’d)

YouTube lecture ‘Static Budget Performance Report’ can be found at:
http://www.youtube.com/watch?v=awfgwIlLD7U

Static budgets and static-budget variances – web link

A flexible budget calculates budgeted revenues and budgeted costs based on the actual output for the period.
The flexible budget uses the expected per unit costs found in the standard cost sheet, so the only difference to the static budget is that it is based on the actual sales volume.

Flexible budgets

Flexible budgets (cont’d)

Variance analysis may start out with the static-budget variances.
This level of analysis gives a super-macro view of operating results - it answers the question: ‘How much were we off?’
This is nothing more than the difference between actual and static-budget operating income.
The flexible budget allows for a more detailed analysis of the unfavourable static-budget variances.
The flexible budget shifts budgeted revenues and costs up and down based on actual operating results (activities).
Represents a blending of actual activities and budgeted dollar amounts.
Will allow for preparation of more detailed variances - it answers the question: ‘Why were we off?’

Flexible budgets (cont’d)

‘Static vs. Flexible Budgets for New Businesses’, explanation with additional links, can be found at: http://smallbusiness.chron.com/static-vs-flexible-budgets-new-businesses-20879.html

Flexible budgets (cont’d)

The flexible-budget variance is the difference between an actual result and the corresponding flexible-budget amount that reflects the sales and production levels that are now known.
Flexible-budget variances are a better measure of operating performance than static-budget variances, because they focus attention on whether standards have been achieved during the period.

Flexible-budget variances and sales-volume
variances

Flexible-budget variances and sales-volume
variances (cont’d)

Sales-volume variances:

the sales-volume variance is the difference between a flexible-budget amount and the corresponding static-budget amount

by using the budgeted selling price and standard costs, the sales-volume variance considers the impact of the change in sales volume as if those standards had all been achieved.

Sales volume variance for operating profit

= (Budgeted contribution per unit) x (Actual units sold – Static budget units sold)

= (Budgeted selling price – Budgeted variable cost per unit) x
(Actual units sold – Static budget units sold)

Flexible-budget variances and sales-volume
variances (cont’d)

Flexible budget variances:

flexible-budget variance = Actual result – Flexible-budget amount
the flexible-budget variance for revenues is called the selling-price variance and is the difference between the actual selling price and the budgeted selling price.

Selling price variance = (Actual selling price – Budgeted selling price) x Actual units sold

The flexible-budget variance for total variable costs will be
unfavourable because of one or both of the following:

greater quantities of inputs compared to the standard quantities as found in the standard cost sheet were used;
higher prices per unit for the inputs compared to the standard prices as found in the standard cost sheet were incurred.

Flexible-budget variances and sales-volume
variances (cont’d)

YouTube lecture ‘Investigating Variances’ can be found at: http://www.youtube.com/watch?v=l97lMJq3DT4

Flexible-budget variances and sales-volume
variances – web link

The flexible-budget variance for direct costs can be subdivided into

two more detailed variances:

A price variance reflects the difference between the actual price paid and the standard price. This difference is then multiplied by the quantity purchased to determine the magnitude of the impact caused by this price difference.
An efficiency variance reflects the difference between an actual quantity used and the quantity expected to be used, given the level of production (determined by standard quantity × units produced). This quantity difference is then multiplied by the standard price to determine the financial impact of the efficiency (if favourable) or inefficiency (if unfavourable).

Price variances and efficiency variances for
direct cost inputs

Price variances and efficiency variances for
direct cost inputs (cont’d)

Price variances:

the formula for calculating the price variance is

If actual costs are greater than budgeted costs, the variance is unfavourable.
It is important to seek out the root cause for the variance.

Price variance = (Actual price of input – Budgeted price of input) x Actual quantity of input

Price variances and efficiency variances for
direct cost inputs (cont’d)

Efficiency variances:

For any actual level of output, the efficiency variance is the difference between the actual quantity of input (direct materials or direct labour) and the budgeted quantities allowed (standard quantities × units produced) × budgeted price:

A company is:

inefficient if it uses a larger quantity of input than the budgeted quantity, given the number of units produced
efficient if it uses a smaller quantity of input than was budgeted for that output level.

Efficiency variance = (Actual quantity of input used – Budgeted quantity of input

allowed for actual output) x Budgeted price of input

Price variances and efficiency variances for
direct cost inputs (cont’d)

Summary of variances:

Journal entries using standard costs:

Each variance may be journalised.
Each variance has its own account.
Favourable variances are credits; unfavourable variances are debits.
Variance accounts are generally closed into cost of goods sold at the end of the period if immaterial.

Price variances and efficiency variances for
direct cost inputs (cont’d)

Journal entry 1A - Direct materials price variance

Direct materials control X
Direct materials price variance X
Accounts payable control X
To record direct materials purchased.

Journal entry 1B - Direct materials efficiency variance

Work-in-process control X
Direct materials efficiency variance X
Direct materials control X
To record direct materials used

Price variances and efficiency variances for
direct cost inputs (cont’d)

Journal entry 2 – direct manufacturing labour variances

Work-in-process control X
Direct manufacturing labour price variance X
Direct manufacturing labour efficiency variance X
Wages payable control X
To record liability for direct manufacturing labour costs

Price variances and efficiency variances for
direct cost inputs (cont’d)

At the end of the year:

Cost of goods sold X
Direct materials efficiency variance X
Direct manufacturing labour efficiency variance X
Direct materials price variance X
Direct materials price variance X
Direct materials efficiency variance X
Direct manufacturing labour price variance X
Direct manufacturing labour price variance X
Direct manufacturing labour efficiency variance X

Price variances and efficiency variances for
direct cost inputs (cont’d)

‘Analyze in Material Price and Efficiency Variances in Cost Accounting’ from Cost Accounting for Dummies can be found at:
http://www.dummies.com/how-to/content/analyze-in-material-price-and-efficiency-variances.html?cid=RSS_DUMMIES2_CONTENT

Price variances and efficiency variances for
direct-cost inputs – web link

Standard costing and information technology:

Both large and small firms are increasingly using computerised standard costing systems.
The direct materials efficiency variance is calculated as output is completed by comparing the standard quantity of direct materials that should have been used with the computerised request for direct materials submitted by an operator on the production floor.
Labour variances are calculated as employees log into production-floor terminals and punch in their employee numbers, start and end times, and the quantity of product they helped produce.

Implementing Standard Costing

Wide applicability of standard costing:

Manufacturing firms as well as firms in the service sector find standard costing to be a useful tool.
Companies implementing total quality management programs use standard costing to control materials costs.
Service-sector companies are labour-intensive and use standard costs to control labour costs.
Companies that have implemented computer integrated manufacturing (CIM) use flexible budgeting and standard costing to manage activities such as materials handling and set-ups.

Implementing Standard Costing (cont’d)

Managers must:

understand underlying causes of variances
recognise the interrelatedness of variances
use variances as a performance measurement
managers’ ability to be effective
managers’ ability to be efficient.

Multiple causes of variances

Managers:

must not interpret variances in isolation
must attempt to understand the root causes of the variances.

The cause may be inefficiencies in other firms in the supply chain.

Management uses of variances

Performance measurement using variances:

When evaluating the performance, two attributes of performance are

commonly evaluated:

effectiveness ‒ the degree to which a predetermined objective or target is met
efficiency ‒ the relative amount of inputs used to achieve a given output level.

Organisation learning

The goal of variance analysis is for managers to understand why variances arise, to learn and to improve future performance.

Management uses of variances (cont’d)

Financial and non-financial performance measures

Most companies use a combination of financial and non-financial performance measures for planning and control.
It takes time to produce accounting reports with variances reported in dollars.
Non-financial measures, such as number of units used, are easy to understand and can be produced quickly.

Management uses of variances (cont’d)

‘Ideal and Practical standards’ explained, with other links to relevant aspects of costing, can be found at: http://www.accounting4management.com/setting_standard_costs.htm

Management uses of variances – web link

ABC easily lends itself to budgeting and variance analysis:

budgets are built from the bottom up, with activities serving as the building blocks of the process. ABC systems classify the costs of various activities into a cost hierarchy
unit-level costs
batch-level costs
product-sustaining costs
organisation-sustaining costs
price and efficiency components of a flexible-budget variances
flexible-budget quantity calculations focus at the appropriate level of the cost hierarchy.

Variance analysis and activity-based costing

‘Activity-based variance analysis’, an article in Journal of Cost Management, can be found at: http://maaw.info/ArticleSummaries/ArtSumRuhl95.htm

Variance analysis and activity-based costing – web link

Benchmarking is the process of comparing performance against the best levels wherever they are found.
Best practice might be found in competing companies in the same industry or in companies in other industries that have similar processes.
If benchmarks based on best practice are achieved, managers can be sure that the company will be competitive in the marketplace.

Benchmarking and variance analysis

Benchmarking and variance analysis (cont’d)

Sales-mix and sales-quantity variances:

the sales-mix variance is the difference between
budgeted contribution margin for the actual sales mix, and
budgeted contribution margin for the budgeted sales mix
the sales-quantity variance is the difference between
budgeted contribution margin based on actual units sold of all products at the budgeted mix, and
contribution margin in the static budget (which is based on budgeted units of all products to be sold at budgeted mix).

Appendix 12-1: Further variances ‒ sales and substitutable inputs

Market-share and market-size variances:

The market-share variance is the difference in the budgeted contribution margin for actual market size in units caused solely by actual market share being different from budgeted market share.
The market-size variance is the difference in the budgeted contribution margin at budgeted market share caused solely by actual market size in units being different from budgeted market size in units.

Appendix 12-1: Further variances ‒ sales and substitutable inputs (cont’d)

Mix and yield variances for substitutable inputs:

Direct materials mix variance is the difference between:
budgeted cost for actual mix of actual total quantity of direct materials used, and
budgeted cost of budgeted mix of actual total quantity of direct materials used.
Direct materials yield variance (when the budgeted input mix is constant), is the difference between:
budgeted cost of direct materials based on actual total quantity of direct materials used, and
flexible-budget cost of direct materials based on budgeted total quantity of direct materials allowed for actual output produced.

Appendix 12-1: Further variances ‒ sales and substitutable inputs

Appendix 12-1: Further variances ‒ sales and substitutable inputs (cont’d)

A standard cost is a carefully determined cost based on the standard quantity and the standard price for the inputs.
After production is complete, the standards become a benchmark for judging performance.
A static budget is based on the level of output planned at the start of the budget period.
A flexible budget is adjusted (flexed) to recognise the actual output level of the budget period.
A flexible budget is created when the level of actual output is known.
The static-budget variance can be subdivided into a flexible-budget variance and a sales-volume variance.

Conclusions

The calculation of price and efficiency variances helps managers gain insight into two different – but not independent – aspects of performance.
Managers use variances for control, decision implementation, performance evaluation, organisation learning and continuous improvement.
Variance analysis can be applied to activity costs to gain insight into why actual activity costs differ from budgeted activity costs.
Benchmarking is the process of comparing the level of performance against the best levels of performance from within the organisation, competitors, or world best practice.

Conclusions (cont’d)