AF 3112

MANAGEMENT ACCOUNTING 2
The Flexible Budget and
Standard Costing

1
 AGENDA
Evaluation of efficiency and effectiveness
Flexible budget and flexible budget
variances
 Operating income flexible budget variance
 Selling price variance

 Cost variances

The concept of standard cost

2
Evaluating Operating Results

Performance is l

Bu
a
tu

d
c
evaluated by

ge
A

t
comparing actual
results with the
budget.

3
 Efficiency vs. Effectiveness

An An
operation operation
is effective if is efficient if it
it has attained has not wasted
or exceeded resources.
its goals.

An operation may be effective but inefficient,

and it may be efficient but ineffective.

4
 Assessing Effectiveness
Hmm! Comparing
actual results with
the master budget will help
Master budgets
me determine my
(Static budgets) effectiveness.
are prepared for a
single activity
level.
Comparing actual
results with the
master budget
reveals operating Consider the following example
income variances. from the Cheese Company . . .
5
 Assessing Effectiveness

Actual Master
Results Budget Variances
Unit sales 8,000 10,000 2,000 U
Sales revenue $ 80,000 $ 100,000 $ 20,000 U
Less variable costs:
Manufacturing 30,000
Marketing and admin. 20,000
Contribution margin 50,000
Less fixed costs:
Manufacturing 12,000
Marketing and admin. 13,000
Operating income $ 25,000

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 Assessing Effectiveness
Actual Master
Results Budget Variances
Unit sales 8,000 10,000 2,000 U
Sales revenue $ 80,000 $ 100,000 $ 20,000 U
Less variableUcosts:
= Unfavorable variances: Cheese
Manufacturing 30,000
Company was ineffective in achieving
Marketing and admin. 20,000
its budgeted level of sales.
Contribution margin 50,000
Less fixed costs:
Manufacturing 12,000
Marketing and admin. 13,000
Operating income $ 25,000

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 Assessing Effectiveness
Actual Master
Results Budget Variances
Unit sales 8,000 10,000 2,000 U
Sales revenue $ 80,000 $ 100,000 $ 20,000 U
Less variable costs:
Manufacturing 25,500 30,000 4,500 F
Marketing and admin. 17,100 20,000 2,900 F
Contribution margin 37,400 50,000 12,600 U
Less fixed costs:
Manufacturing 12,000 12,000 0
Marketing and admin. 13,000 13,000 0
Operating income $ 12,400 $ 25,000 $ 12,600 U

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 Assessing Effectiveness
Actual Master
Results Budget Variances
Unit sales 8,000 10,000 2,000 U
Sales revenue $ 80,000 $ 100,000 $ 20,000 U
Less variable costs:
U = Unfavorable
Manufacturing operating 30,000
25,500 income 4,500 F
variance:
Marketing and admin. Cheese
17,100Company was
20,000 2,900 F
Contributionineffective
margin 37,400
in achieving 50,000
its budgeted 12,600 U
Less fixed costs: operating income.
Manufacturing 12,000 12,000 0
Marketing and admin. 13,000 13,000 0
Operating income $ 12,400 $ 25,000 $ 12,600 U

9
 Assessing Effectiveness

Actual Master
Results Budget Variances
Unit sales 8,000 10,000 2,000 U
Sales revenue $ 80,000 $ 100,000 $ 20,000 U
Less variable costs:
Manufacturing 25,500 30,000 4,500 F
Marketing and admin. 17,100 20,000 2,900 F
Contribution margin 37,400 50,000 12,600 U
F = Favorable
Less fixed costs: variance: actual costs
Manufacturing 12,000 costs.12,000
are less than budgeted 0
Marketing and admin. 13,000 13,000 0
Operating income $ 12,400 $ 25,000 $ 12,600 U

10
 Assessing Effectiveness

Actual Master
Results Budget Variances
Unit sales 8,000 10,000 2,000 U
Sales revenue $ 80,000 $ 100,000 $ 20,000 U
Less variable costs:
Manufacturing 25,500 30,000 4,500 F
Marketing and admin. 17,100 20,000 2,900 F
Contribution margin 37,400 50,000 12,600 U
Since
Less cost
fixed variances are favorable, has
costs:
Manufacturing
Cheese Company done12,000
a good job 12,000
of 0
Marketing controlling
and admin. costs?
13,000 13,000 0
Operating income $ 12,400 $ 25,000 $ 12,600 U

11
 Assessing Effectiveness

I don’t think I can I do know that actual

answer the question sales are below budgeted
comparing actual results sales, which is unfavorable.
with the master budget. But shouldn’t variable costs
be lower if actual sales
are below budgeted sales?

12
 The Flexible Budget
 The relevant question is . . .
“How much of the favorable cost variance
is due to lower activity, and how much is
due to good cost control?”
 To answer the question, we must
the budget to the
actual activity.
 A will
help me evaluate efficiency.
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The Flexible Budget
Show revenues and expenses
that should have occurred at the
actual 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 was
for the period, I will tell you what your
costs and revenue should have been.

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 The Flexible Budget
To a budget for different activity
levels, we must know how costs behave
with changes in activity levels.
 Total variable costs change
in direct proportion to
changes in activity.
ble
 Total fixed costs aria
V
remain unchanged Fixed
within the relevant
range.

16
The Flexible Budget

Let’s prepare a
budget for the Chees
e
Company at 8,000 un
its.

17
 The Flexible Budget

Total
Per Unit Fixed Actual Flexible
Amount Costs Results Budget Variances
Unit sales 8,000 8,000 0
Sales revenue $ 10.00
Less variable costs:
Manufacturing 3.00 A flexible budget
Mkt. and Admin. 2.00 is prepared for the
Contribution margin 5.00 same activity level
Less fixed costs: (8,000 units) as
Manufacturing $12,000
Mkt. and Admin. 13,000
actually achieved.
Operating income

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 The Flexible Budget
Total
Per Unit Variable
Fixed costsFlexible
Actual are expressed as
Amount Costsa constant
Results amount
Budget per
Variances
unit.
Unit sales In the8,000
original 8,000 0
static budget,
Sales revenue $ 10.00 variable manufacturing costs
Less variable costs: were $30,000 for 10,000 units
Manufacturing 3.00 resulting in $3.00 per unit.
Mkt. and Admin. 2.00
Contribution margin 5.00
Less fixed costs:
Manufacturing $12,000
Mkt. and Admin. 13,000
Fixed
Operating income costs are expressed as a total amounts that
do not change within the relevant range of activity.
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 The Flexible Budget
Total
Per Unit Fixed Actual Flexible
Amount Costs Results Budget Variances
Unit sales 8,000 8,000 0
Sales revenue $ 10.00 $ 80,000
Less variable costs:
Manufacturing 3.00 24,000
Mkt. and Admin. 2.00 16,000
Contribution margin 5.00 40,000
Less fixed costs: 8,000 units × $3.00 per unit = $24,000
Manufacturing $12,000
Mkt. and Admin. 13,000
Operating income

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 The Flexible Budget
Total
Per Unit Fixed Actual Flexible
Amount Costs Results Budget Variances
Unit sales 8,000 8,000 0
Sales revenue $ 10.00 $ 80,000
Note: costs:
Less variable There is no flex
in the fixed costs.
Manufacturing 3.00 24,000
Mkt. and Admin. 2.00 16,000
Contribution margin 5.00 40,000
Less fixed costs:
Manufacturing $ 12,000 12,000
Mkt. and Admin. 13,000 13,000
Operating income $ 15,000

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 The Flexible Budget
Original actual
results for Cheese Total
Per Unit Fixed Actual Flexible
Company that we
Amount Costs Results Budget Variances
saw earlier.
Unit sales 8,000 8,000 0
Sales revenue $ 10.00 $ 80,000 $ 80,000 0
Less variable costs:
Manufacturing 3.00 25,500 24,000 1,500 U
Mkt. and Admin. 2.00 17,100 16,000 1,100 U
Contribution margin 5.00 37,400 40,000 2,600 U
Less fixed costs:
Manufacturing $12,000 12,000 12,000 0
Mkt. and Admin. 13,000 13,000 13,000 0
Operating income $ 12,400 $ 15,000 $ 2,600 U
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 The Flexible Budget
Total
Per Unit Fixed Actual Flexible
Amount Costs Results Budget Variances
Unit sales 8,000 8,000 0
Variable costs
Sales revenue have
$ 10.00 $ 80,000 $ 80,000 0
unfavorable
Less variable costs: variances
because actual3.00
Manufacturing costs 25,500 24,000 1,500 U
areAdmin.
Mkt. and more than2.00
the 17,100 16,000 1,100 U
Contribution margin
flexible budget 5.00
costs. 37,400 40,000 2,600 U
Less fixed costs:
Manufacturing $12,000 12,000 12,000 0
Mkt. and Admin. 13,000 13,000 13,000 0
Operating income $ 12,400 $ 15,000 $ 2,600 U

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Assessing Efficiency
Now we can answer
original question: “W our
hat part
of the variances is d
ue to
activity and what par
t is due
to cost control?”

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 Assessing Efficiency

Actual Master
Results Budget Variances
Unit sales 8,000 10,000 2,000 U
Recall
Sales the original
revenue $ 80,000 $ 100,000 $ 20,000 U
variances
Less resulting
variable costs:
Manufacturing
from the 25,500 30,000 4,500 F
Marketing and admin. 17,100 20,000 2,900 F
comparison of
Contrtibution margin 37,400 50,000 12,600 U
actual results with
Less fixed costs:
the master budget.
Manufacturing 12,000 12,000 0
Marketing and admin. 13,000 13,000 0
Operating income $ 12,400 $ 25,000 $ 12,600 U

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Assessing Efficiency

Now let’s insert our n

e w
tool, the b u d g et
for 8,000 units, into t
he
analysis.

26
 Assessing Efficiency
Variances due
to cost control Flexible Sales
Actual Budget Flexible Volume Master
Results Variance Budget Variance Budget
Unit sales 8,000 - 8,000 2,000 U 10,000
Sales revenue $ 80,000 $ - $ 80,000 20,000 U $ 100,000
Less variable costs:
Manufacturing 25,500 1,500 U 24,000 6,000 F 30,000
Mkt. and Admin. 17,100 1,100 U 16,000 4,000 F 20,000
Contribution margin 37,400 2,600 U 40,000 10,000 U 50,000
Less fixed costs:
Manufacturing 12,000 - 12,000 - 12,000
Mkt. and Admin. 13,000 - 13,000 - 13,000
Operating income $ 12,400 $ 2,600 U $ 15,000 10,000 U $ 25,000

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 Assessing Efficiency
Variances due
to activity change
Flexible Sales
Actual Budget Flexible Volume Master
Results Variance Budget Variance Budget
Unit sales 8,000 - 8,000 2,000 U 10,000
Sales revenue $ 80,000 $ - $ 80,000 20,000 U $ 100,000
Less variable costs:
Manufacturing 25,500 1,500 U 24,000 6,000 F 30,000
Mkt. and Admin. 17,100 1,100 U 16,000 4,000 F 20,000
Contribution margin 37,400 2,600 U 40,000 10,000 U 50,000
Less fixed costs:
Manufacturing 12,000 - 12,000 - 12,000
Mkt. and Admin. 13,000 - 13,000 - 13,000
Operating income $ 12,400 $ 2,600 U $ 15,000 10,000 U $ 25,000

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 Operating income Flexible
Budget Variance
Flexible Sales
Actual Budget Flexible Volume Master
Results Variance Budget Variance Budget
Unit sales 8,000 - 8,000 2,000 U 10,000
Sales revenue $ 80,000 $ - $ 80,000 20,000 U $ 100,000
Less variable costs:
Manufacturing 25,500 1,500 U 24,000 6,000 F 30,000
Mkt. and Admin. 17,100 1,100 U 16,000 4,000 F 20,000
Contribution margin 37,400 2,600 U 40,000 10,000 U 50,000
What
Less fixed factors
costs:
Manufacturing
contribute to 12,000 - 12,000 - 12,000
Mkt. and Admin. 13,000 - 13,000 - 13,000
this variance?
Operating income $ 12,400 $ 2,600 U $ 15,000 10,000 U $ 25,000

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 Operating Income Flexible
Budget Variance
The operating income flexible budget
variance can be explained by the following
variances:
 Selling price variance – deviation in selling price
 Variable costs variance

 Fixed cost variance

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 Master Budget Variance

Flexible Budget Sales Volume

Variance Variance

Selling Direct Direct Variable Fixed

Price Material Labor Factory Factory
Variance Variance Variance Overhead Overhead
Variance Variance
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 Selling Price Variance

A selling price variance is the difference between

the total sales revenue received and the
total sales revenue of the flexible budget.

In the Cheese Company example, the

budgeted
and actual selling price was $10 per unit.
Now assume that the selling price
changes to $11 per unit, with all other
information unchanged.
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 Selling Price Variance
8,000 units × $11 per unit 8,000 units × $10 per unit
Selling Flexible
Actual Price Budget Flexible
Results Variance Variance Budget
Unit sales 8,000 0 0 8,000
Sales revenue $ 88,000 $ 8,000 F 0 $ 80,000
Less variable costs:
Manufacturing 25,500 0 1,500 U 24,000
Mkt. and Admin. 17,100 0 1,100 U 16,000
Contribution margin 45,400 8,000 F 2,600 U 40,000
Less fixed costs:
Manufacturing 12,000 0 0 12,000
Mkt. and Admin. 13,000 0 0 13,000
Operating income $ 20,400 $ 8,000 F $ 2,600 U $ 15,000
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 Selling Price Variance
8,000 units × ($11 per unit – $10 per unit)
Selling Flexible
Actual Price Budget Flexible
Results Variance Variance Budget
Unit sales 8,000 - - 8,000
Sales revenue $ 88,000 $ 8,000 F - $ 80,000
Less variable costs:
Manufacturing 25,500 - 1,500 U 24,000
Mkt. and Admin. 17,100 - 1,100 U 16,000
Contribution margin 45,400 8,000 F 2,600 U 40,000
Less fixed costs:
Manufacturing 12,000 - - 12,000
Mkt. and Admin. 13,000 - - 13,000
Operating income $ 20,400 $ 8,000 F $ 2,600 U $ 15,000

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 Selling Price Variance
Flexible budget variances
are unchanged. Selling Flexible
Actual Price Budget Flexible
Results Variance Variance Budget
Unit sales 8,000 - - 8,000
Sales revenue $ 88,000 $ 8,000 F - $ 80,000
Less variable costs:
Manufacturing 25,500 - 1,500 U 24,000
Mkt. and Admin. 17,100 - 1,100 U 16,000
Contribution margin 45,400 8,000 F 2,600 U 40,000
Less fixed costs:
Manufacturing 12,000 - - 12,000
Mkt. and Admin. 13,000 - - 13,000
Operating income $ 20,400 $ 8,000 F $ 2,600 U $ 15,000

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 Standard Costing
Standard Costing is an important subtopic of cost
accounting.
Rather than assigning the actual costs of direct
material, direct labor, and manufacturing overhead to
a product, many manufacturers assign the expected
or standard cost.
This means that a manufacturer's inventories and
cost of goods sold will begin with amounts reflecting
the standard costs, not the actual costs, of a product.
Manufacturers, of course, still have to pay the actual
costs. As a result there are almost always differences
between the actual costs and the standard costs, and
those differences are known as Variances.
36
 Standard Costs

Based on carefully
predetermined amounts.

Cost
Standard Used for planning labor, material
Costs are and overhead requirements.

Benchmarks for
measuring performance.

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 Purpose of Standard Costs
To facilitate product costing
Planning future operations
Monitoring current operations
Motivating manager and employee behavior
Evaluating performance

38
 Standard Costs

Standard
Product Cost

A standard cost variance

is the amount by which
an actual cost differs from
the standard cost.

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 Standard Cost Variances
This variance is unfavorable
because the actual cost
exceeds the standard cost.

Standard
Product Cost

A standard cost variance

is the amount by which
an actual cost differs from
the standard cost.

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 Standard Cost Variances
Managers focus on quantities and costs
that exceed standards, a practice known as
management by exception.

Standard
Amount

Direct
Material
Direct
Labor

Type of Product Cost

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 Sources for Setting Standards

 Historical experience
 Engineering studies
 Input from operating
personnel
 Benchmarking
 Market expectation

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 Types of Standards

An ideal standard demands perfect implementation

and maximum efficiency in every aspect of the
operation
A currently attainable standard sets the
performance criterion at a level that a person with
proper training and experience can attain most of
the time without having to exert extraordinary
effort
Accountants, engineers, personnel administrators,
and production managers combine efforts to set
standards based on experience and expectations.

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 Types of Standards

Should we have I agree. Unattainable

standards that are standards are discouraging
difficult to achieve while standards that are too
easy to achieve provide little
or standards that can
motivation.
be achieved with
minimal effort? Standards should be set
at levels that are currently
attainable
with reasonable and
efficient effort.

44
 Standard Costs Sheet
SCHMIDT MACHINERY COMPANY
Standard Cost Sheet
Product: XV-1
Descriptions Quantity Unit Cost Subtotal Total
Direct materials
Aluminium 4 pounds $25 ?
PVC 1 pound 40 ? ?
Director labor 5 hours 40 ? ?
Factory Overhead (based on direct labor hours)
Variable 5 hours 12 ?
Fixed 5 hours 24 ? ?
Standard cost per unit ?
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 Standard Costs Sheet

SCHMIDT MACHINERY COMPANY

Standard Cost Sheet
Product: XV-1
Descriptions Quantity Unit Cost Subtotal Total
Direct materials
Aluminium 4 pounds $25 100
PVC 1 pound 40 40 140
Director labor 5 hours 40 200 200
Factory Overhead (based on direct labor hours)
Variable 5 hours 12 60
Fixed 5 hours 24 120 180
Standard cost per unit 520
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End of Topic

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