Horngren Ima16 Inppt08 Ed

Copyright © 2014 Pearson Education, Inc.
publishing as Prentice Hall 8-1

Chapter 8
Flexible Budgets and

Variance Analysis
Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8-2

Chapter 8 Learning Objectives
When you have finished studying this chapter, you

should be able to:
1.Identify variances and label them as favorable or
unfavorable.
2.Distinguish between flexible budgets and static
budgets.
3. Use flexible-budget formulas to construct a flexible
budget.
4. Compute and interpret static-budget variances,
flexible-budget variances, and sales-activity variances.

5. Understand how the setting of standards affects the
computation and interpretation of variances.
6. Compute and interpret price and quantity variances

for materials and labor.
7. Compute variable overhead spending and efficiency

variances.
8. Compute the fixed-overhead spending variance.

Learning Favorable and Unfavorable
Objective 1
Variances
Favorable variances arise when actual results

exceed budgeted.
Unfavorable variances arise when

actual results fall below budgeted.
Favorable (F) versus Unfavorable (U) Variances

Profits Revenue Costs
Actual > Expected F F U
Actual < Expected U U F
Types of Favorable and Unfavorable
Variances
Favorable profit variances arise when actual

profits exceed budgeted profits. Unfavorable
profit variance occurs when actual profit falls
below budgeted profit.
Actual revenues that exceed budgeted revenues

result in favorable revenue variances, and actual
revenues that fall short of budgeted revenues
result in unfavorable revenue variances.

Types of Favorable and Unfavorable
Variances
When actual costs exceed budgeted costs, we

have unfavorable cost variances; when actual
costs are less than budgeted costs, we have
favorable cost variances.
The favorable and unfavorable labels indicate

only the directional relationships summarized in
the charts—they do not indicate that the
explanation for the variance is necessarily good
or bad.
Favorable or Unfavorable Variance?
To determine whether a variance is

favorable or unfavorable,
use logic rather than memorizing a formula.
A price variance A quantity variance

is favorable if is favorable if the
the actual price actual quantity used
is less than the is less than the
standard. standard quantity
allowed.

Learning
Objective 2 Static and Flexible Budgets
A static budget is prepared for

only one expected level of activity.
A budget that adjusts to different

levels of activity is
a flexible budget/variable budget.

Learning
Objective 3 Flexible Budget Formulas
Managers determine revenue and cost

Behavior (within the relevant range) with
respect to cost drivers.
Note that the static budget is just

the flexible budget for a single
assumed level of activity.
Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8 - 10

Activity-Based Flexible Budget
Based on budgeted costs for

each activity and related cost driver.
For each activity, costs

depend on a different cost driver.

Activity-Based Flexible Budget

Learning Static-Budget Variances and
Objective 4
Flexible-Budget Variances
Differences between actual results and the

static budget for the original planned level
of output are static-budget variances.
Differences between actual results and the

flexible budget for the actual level of output
achieved are flexible-budget variances.
Flexible budget variances reflect how actual

results deviate from what was expected, given
the achieved activity level.

Static-Budget Variances and
Actual results may differ from

the master budget because...
sales and other cost-driver activities were

not the same as originally forecasted
revenue or variable costs per unit of activity

and fixed costs per period were not as expected.
Evaluation of Financial Performance
Actual Flexible
results at budget for
actual Flexible- actual Sales -
activity budget sales Static
Activity Budget
level* variances activity Variance
(1) (2)=(1)-(3) (3) (4)=(3)–(5) (5)
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

Flexible-budget variance
= Actual results – Flexible budget

Sales-Activity Variances
Sales –
Actual unit - Contribution
activity
Static budget margin per
income
units unit
variance
(9,000 – 7,000) $9.20
$18,400 Unfavorable
Falling short of the sales target by 2,000 units explains $18,400

of the shortfall of income relative to the amount initially
budgeted.

Learning Role of Standards in
Objective 5
Determining Variances
Static-budget variances and flexible-budget

variances depend on the costs used in the
budget formulas.
Budget formula costs are standard costs—
costs that should be achieved.
Standard costs are defined in different ways
by different companies.
The level at which standards are set will
affect the variances generated and the
incentives created.
Setting Standards
A standard cost is a
An expected cost is
carefully developed cost
the cost that is most
per unit that should be
likely to be attained.
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.
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.

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.

When to Investigate Variances
Many organizations have developed

such rules of thumb as “investigate
all variances exceeding either
$5,000 or 15% of expected cost.”

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.
Comparison with Prior Periods
Some organizations compare the most

recent budget period’s actual results with
last year’s results for the same period.
Even comparisons with the prior
month’s actual results may not be
as useful as comparisons with an
up-to-date flexible budget.
Flexible-Budget Variance in Detail
Flexible-budget amounts based on $10 per unit of

output for direct materials and $8 per unit for direct
labor.
Standard per unit of output:
Std. inputs Std. price Flexible

expected expected Budget Amount
Direct Material 5 pounds $ 2 /pound $10

Direct Labor ½ hour $16/hour $ 8
Variances for Material and Labor
Standards
Standard Costs Allowed:
Direct material Cost allowed
7,000 units X 5 pounds X $2.00 per pound = $70,000
Direct labor Cost allowed
7,000 units X 1/2 hour X $16.00 per hour = $56,000

Standards
Actual results for 7,000 units produced:
Direct material Pounds purchased and used:

36,800 Price/pound X $1.90 = Total actual cost $69,920
Direct labor Hours used:

3,750 X Actual price (rate) X $16.40 = Total actual cost
$61,500
Standards
Flexible Budget or Total Standard Cost

Allowed
Units of Input Standard
×
good allowed unit
= output
achieved
× per unit
of output
price of
input

Standards
Flexible-budget cost is the standard quantity allowed

for the actual level of activity multiplied by the
standard price per unit.
Flexible-budget variances for direct material and
direct labor: $80 F and $5,500 U, respectively.
(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
Learning
Objective 6 Price and Quantity Variances
(Actual price – Standard Price) × Actual quantity used
(Actual quantity used – standard quantity allowed

for actual output) × Standard price

Quantity (Usage) Variance
Computations
[36,800 – (7,000 × 5)] pounds

× $2 per pound = $3,600 U
[3,750 – (7,000 × ½)] hours

× $16 per hour = $4,000 U

Price Variance Computations
($1.90 – $2.00) per pound

× 36,800 pounds = $3,680 F
($16.40 – $16.00) per hour

× 3,750 hours = $1,500 U

Direct Materials Flexible Budget
Variance
The sum of the direct-labor price and quantity

variances equals the direct-labor flexible-budget
variance. Similarly, the sum of the direct-materials
price and quantity variances equals the total direct-
materials flexible-budget variance.
Direct-Labor Direct-Materials
Flexible-budget variance: Flexible-budget variance:
$1,500 unfavorable $3,680 favorable

+ $4,000 unfavorable + $3,600 unfavorable
= $5,500 unfavorable = $80 favorable
Interpretation of Price and
Quantity Variances
By dividing flexible-budget variances into price and

quantity variances, managers can be better evaluated
on variances that they can control.
Price and quantity 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.
Learning Variable-Overhead Spending
Objective 7
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.
Variable-Overhead Variances
variable- actual standard standard
- X
overhead cost-driver cost-driver variable-overhead
efficiency
= activity activity rate per
variance allowed cost-driver unit
variable- actual standard actual

overhead
spending
variance
= variable
overhead - variable-overhead
rate per unit
of cost-driver
X cost-driver
activity
used

Learning
Objective 8 Fixed Overhead Spending Variance
The flexible budget based on actual use of the cost

driver and the flexible budget based on standard
use of the cost driver are always the same because
fixed overhead does not vary with the level of use
of the cost driver.
Therefore . . .
The difference between actual fixed
overhead and budgeted fixed overhead
is the fixed overhead spending variance.

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Copyright © 2014 Pearson Education, Inc.

publishing as Prentice Hall 8-1

Flexible Budgets and

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8-2

When you have finished studying this chapter, you

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8-3

6. Compute and interpret price and quantity variances

7. Compute variable overhead spending and efficiency

8. Compute the fixed-overhead spending variance.

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8-4

Favorable variances arise when actual results

Unfavorable variances arise when

Favorable (F) versus Unfavorable (U) Variances

Favorable profit variances arise when actual

Actual revenues that exceed budgeted revenues

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8-6

When actual costs exceed budgeted costs, we

The favorable and unfavorable labels indicate

To determine whether a variance is

A price variance A quantity variance

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8-8

A static budget is prepared for

A budget that adjusts to different

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8-9

Managers determine revenue and cost

Note that the static budget is just

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8 - 10

Based on budgeted costs for

For each activity, costs

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8 - 11

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8 - 12

Differences between actual results and the

Differences between actual results and the

Flexible budget variances reflect how actual

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8 - 13

Actual results may differ from

sales and other cost-driver activities were

revenue or variable costs per unit of activity

Units 7,000 – 7,000 2,000U 9,000

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8 - 15

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8 - 16

Falling short of the sales target by 2,000 units explains $18,400

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8 - 17

Static-budget variances and flexible-budget

are levels of performance that

They make allowances for normal

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8 - 20

Improvements in one area could lead to

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8 - 21

Many organizations have developed

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8 - 22

Effectiveness is the degree to which

Some organizations compare the most

Flexible-budget amounts based on $10 per unit of

Standard per unit of output:

Std. inputs Std. price Flexible

Direct Material 5 pounds $ 2 /pound $10

Standard Costs Allowed:

Direct material Cost allowed

7,000 units X 5 pounds X $2.00 per pound = $70,000

Direct labor Cost allowed

7,000 units X 1/2 hour X $16.00 per hour = $56,000

Actual results for 7,000 units produced:

Direct material Pounds purchased and used: