# Chapter 7 Flexible Budget

CHAPTER 7 FLEXIBLE BUDGETS, DIRECT-COST VARIANCES, AND MANAGEMENT CONTROL 7-1Management by exception is the practice of concentrating on areas not operating as expected and giving less attention to areas operating as expected. Variance analysis helps managers identify areas not operating as expected. The larger the variance, the more likely an area is not operating as expected. 2. Two sources of information about budgeted amounts are (a) past amounts and (b) detailed engineering studies. . A favorable variance––denoted F––is a variance that has the effect of increasing operating income relative to the budgeted amount. An unfavorable variance––denoted U––is a variance that has the effect of decreasing operating income relative to the budgeted amount. 4. The key difference is the output level used to set the budget. A static budget is based on the level of output planned at the start of the budget period.

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Evidence on the costs of other companies is one input managers can use in setting the performance measure for next year. However, caution should be taken before choosing such an amount as next year’s performance measure. It is important to understand why cost differences across companies exist and whether these differences can be eliminated. It is also important to examine when planned changes (in, say, technology) next year make even the current low-cost producer not a demanding enough hurdle. 7-16 (20–30 min. )Flexible budget. |Actual Results |Flexible-Budget |Flexible Budget |Sales-Volume |Static Budget | | |(1) |Variances |(3) |Variances |(5) | | | |(2) = (1) – (3) | |(4) = (3) – (5) | | |Units sold | 2,800g | 0 | 2,800 | 200 U | 3,000g | |Revenues |\$313,600a |\$ 5,600 F | \$308,000b |\$22,000 U | \$330,000c | |Variable costs | 229,600d | 22,400 U | 207,200e | 14,800 F | 222,000f | |Contribution margin |84,000 | 16,800 U | 100,800 | 7,200 U | 108,000 | |Fixed costs | 50,000g | 4,000 F | 54,000g | 0 | 54,000g | |Operating income |\$ 34,000 |\$12,800 U | \$ 46,800 |\$ 7,200 U | \$ 54,000 | \$12,800 U\$ 7,200 U Total flexible-budget variance Total sales-volume variance \$20,000 U Total static-budget variance a \$112 ? 2,800 = \$313,600 b \$110 ? 2,800 = \$308,000 c \$110 ? 3,000 = \$330,000 d Given. Unit variable cost = \$229,600 ? 2,800 = \$82 per tire e \$74 ? 2,800 = \$207,200 f \$74 ? 3,000 = \$222,000 g Given 2. The key information items are: | |Actual |Budgeted | |Units |2,800 |3,000 | |Unit elling price |\$ 112 |\$ 110 | |Unit variable cost |\$ 82 |\$ 74 | |Fixed costs |\$50,000 |\$54,000 | The total static-budget variance in operating income is \$20,000 U. There is both an unfavorable total flexible-budget variance (\$12,800) and an unfavorable sales-volume variance (\$7,200). The unfavorable sales-volume variance arises solely because actual units manufactured and sold were 200 less than the budgeted 3,000 units.

The unfavorable flexible-budget variance of \$12,800 in operating income is due primarily to the \$8 increase in unit variable costs. This increase in unit variable costs is only partially offset by the \$2 increase in unit selling price and the \$4,000 decrease in fixed costs. 7-17 (15 min. ) Flexible budget. The existing performance report is a Level 1 analysis, based on a static budget. It makes no adjustment for changes in output levels. The budgeted output level is 10,000 units––direct materials of \$400,000 in the static budget ? budgeted direct materials cost per attache case of \$40. The following is a Level 2 analysis that presents a flexible-budget variance and a sales-volume variance of each direct cost category: | |Flexible- | |Sales- | | | |Actual |Budget |Flexible |Volume |Static | | |Results |Variances |Budget |Variances |Budget | | |(1) |(2) = (1) – (3) |(3) |(4) = (3) – (5) |(5) | |Output units | 8,800 | 0 | 8,800 | 1,200 U | 10,000 | |Direct materials |\$364,000 |\$12,000 U |\$352,000 |\$48,000 F |\$400,000 | |Direct manufacturing labor |78,000 |7,600 U |70,400 |9,600 F |80,000 | |Direct marketing labor |110,000 |4,400 U |105,600 |14,400 F |120,000 | |Total direct costs |\$552,000 |\$24,000 U |\$528,000 |\$72,000 F |\$600,000 | 24,000 U\$72,000 F Flexible-budget variance Sales-volume variance \$48,000 F Static-budget variance The Level 1 analysis shows total direct costs have a \$48,000 favorable variance. However, the Level 2 analysis reveals that this favorable variance is due to the reduction in output of 1,200 units from the budgeted 10,000 units. Once this reduction in output is taken into account (via a flexible budget), the flexible-budget variance shows each direct cost category to have an unfavorable variance indicating less efficient use of each direct cost item than was budgeted, or the use of more costly direct cost items than was budgeted, or both.

Each direct cost category has an actual unit variable cost that exceeds its budgeted unit cost: | |Actual |Budgeted | |Units | 8,800 | 10,000 | |Direct materials |\$41. 36 |\$ 40 | |Direct manufacturing labor |\$ 8. 86 |\$ 8 | |Direct marketing labor |\$12. 50 |\$ 12 | Analysis of price and efficiency variances for each cost category could assist in further the identifying causes of these more aggregated (Level 2) variances. 7-18 (25–30 min. ) Flexible-budget preparation and analysis. 1. Variance Analysis for Bank Management Printers for September 2007 Level 1 Analysis |Actual |Static-Budget |Static | | |Results |Variances |Budget | | |(1) |(2) = (1) – (3) |(3) | |Units sold | 12,000 | 3,000 U | 15,000 | |Revenue |\$252,000a |\$ 48,000 U |\$300,000c | |Variable costs | 84,000d | 36,000 F | 120,000f | |Contribution margin |168,000 |12,000 U |180,000 | |Fixed costs |150,000 |5,000 U |145,000 | |Operating income |\$ 18,000 |\$ 17,000 U |\$ 35,000 | \$17,000 U Total static-budget variance 2. Level 2 Analysis | |Flexible- | |Sales | | | | |Budget | |Volume | | | |Actual |Variances |Flexible |Variances |Static | | |Results |(2) = (1) – (3) |Budget |(4) = (3) – (5) |Budget | | |(1) | |(3) | |(5) | |Units sold | 12,000 | 0 | 12,000 | 3,000 U | 15,000 | |Revenue | \$252,000a |\$12,000 F |\$240,000b \$60,000 U |\$300,000c | |Variable costs | 84,000d | 12,000 F | 96,000e | 24,000 F | 120,000f | |Contribution margin | 168,000 |24,000 F | 144,000 |36,000 U | 180,000 | |Fixed costs | 150,000 | 5,000 U | 145,000 | 0 | 145,000 | |Operating income |\$ 18,000 |\$19,000 F |\$ (1,000) |\$36,000 U |\$ 35,000 | \$19,000 F\$36,000 U Total flexible-budgetTotal sales-volume variance variance \$17,000 U Total static-budget variance a 12,000 ? \$21 = \$252,000 d 12,000 ? \$7 =\$ 84,000 b 12,000 ? \$20 = \$240,000 e 12,000 ? \$8 =\$ 96,000 c 15,000 ? \$20 = \$300,000 f 15,000 ? \$8 =\$120,000 3. Level 2 analysis provides a breakdown of the static-budget variance into a flexible-budget variance and a sales-volume variance. The primary reason for the static-budget variance being unfavorable (\$17,000 U) is the reduction in unit volume from the budgeted 15,000 to an actual 12,000.

One explanation for this reduction is the increase in selling price from a budgeted \$20 to an actual \$21. Operating management was able to reduce variable costs by \$12,000 relative to the flexible budget. This reduction could be a sign of efficient management. Alternatively, it could be due to using lower quality materials (which in turn adversely affected unit volume). 7-19(30 min. )Flexible budget, working backward. 1. | | |Flexible- | | | | | |Actual |Budget |Flexible |Sales-Volume |Static Budget | | Results |Variances |Budget |Variances |(5) | | |(1) |(2)=(1)((3) |(3) |(4)=(3)((5) | | |Units sold | 650,000 | 0 | 650,000 | 50,000 F | 600,000 | |Revenues |\$3,575,000 |\$1,300,000 F | \$2,275,000a |\$175,000 F |\$2,100,000 | |Variable costs | 2,575,000 | 1,275,000 U | 1,300,000b | 100,000 U | 1,200,000 | |Contribution margin |1,000,000 | 25,000 F | 975,000 |75,000 F |900,000 | |Fixed costs | 700,000 | 100,000 U | 600,000 | 0 | 600,000 | |Operating income |\$ 300,000 |\$ 75,000 U | \$ 375,000 |\$ 75,000 F |\$ 300,000 | a 650,000 ? \$3. 50 = \$2,275,000; \$2,100,000 [pic]600,000 = \$3. 50 b 650,000 ? \$2. 0 = \$1,300,000; \$1,200,000 [pic]600,000 = \$2. 00 2. Actual selling price:\$3,575,000(650,000=\$5. 50 Budgeted selling price:2,100,000? 600,000=\$3. 50 Actual variable cost per unit: 2,575,000? 650,000=\$3. 96 Budgeted variable cost per unit:1,200,000? 600,000=\$2. 00 3. The CEO’s reaction was inappropriate. A zero total static-budget variance may be due to offsetting total flexible-budget and total sales-volume variances. In this case, these two variances exactly offset each other: Total flexible-budget variance\$75,000 Unfavorable Total sales-volume variance\$75,000 Favorable A closer look at the variance components reveals some major deviations from plan.

Actual variable costs increased from \$2. 00 to \$3. 96, causing an unfavorable flexible-budget variable cost variance of \$1,275,000. Such an increase could be a result of, for example, a jump in direct material prices. Spencer was able to pass most of the increase in costs onto their customers—actual selling price increased by 57% [(\$5. 50 – \$3. 50)[pic]\$3. 50], bringing about an offsetting favorable flexible-budget revenue variance in the amount of \$1,300,000. An increase in the actual number of units sold also contributed to more favorable results. The company should examine why the units sold increased despite an increase in direct material prices.

For example, Spencer’s customers may have stocked up, anticipating future increases in direct material prices. Alternatively, Spencer’s selling price increases may have been lower than competitors’ price increases. Understanding the reasons why actual results differ from budgeted amounts can help Spencer better manage its costs and pricing decisions in the future. 4. The most important lesson learned here is that a superficial examination of summary level data (Levels 0 and 1) may be insufficient. It is imperative to scrutinize data at a more detailed level (Level 2). Had Spencer not been able to pass costs on to customers, losses would have been considerable. 7-20 1. and 2. Performance Report, June 2007 | | |Actual |Flexible Budget |Flexible Budget |Sales Volume |Static Budget |Static |Static Budget Variance as| | | |Variances | |Variances | |Budget Variance | | | | | | | | | |% of Static Budget | |  |(1) |(2) = (1) – (3) |(3) |(4) = (3) – (5) |(5) |(6) = (1) – (5) | (7) = (6) [pic](5) | |Units (pounds) | 525,000 | – | |Output units (scones) | 60,800 | 60,000 | |Input units (pounds of pumpkin) |16,000 |15,000 | |Cost per input unit |\$ 0. 82 |\$ 0. 89 | Peterson budgets to obtain 4 pumpkin scones from each pound of pumpkin. The flexible-budget variance is \$408 F. | |Flexible- | | | | | |Actual |Budget |Flexible |Sales-Volume Variance |Static | | |Results |Variance |Budget |(4) = (3) – (5) |Budget | | |(1) |(2) = (1) – (3) |(3) | |(5) | |Pumpkin costs |\$13,120a |\$408 F |\$13,528b |\$178 U |\$13,350c | a16,000 ? \$0. 82 = \$13,120 b 60,800 ? 0. 25 ? \$0. 89 = \$13,528 c 60,000 ? 0. 25 ? \$0. 89 = \$13,350 |2. | | |Flexible Budget | | |Actual Costs | |(Budgeted Input | | |Incurred | |Qty. Allowed for | | |(Actual Input Qty. |Actual Input Qty. |Actual Output | | |? Actual Price) |? Budgeted Price |?

Budgeted Price) | | |\$13,120a |\$14,240b |\$13,528c | \$1,120 F\$712 U Price varianceEfficiency variance \$408 F Flexible-budget variance a 16,000 ? \$0. 82 = \$13,120 b16,000 ? \$0. 89 = \$14,240 c 60,800 ? 0. 25 ? \$0. 89 = \$13,528 3. The favorable flexible-budget variance of \$408 has two offsetting components: (a)favorable price variance of \$1,120––reflects the \$0. 82 actual purchase cost being lower than the \$0. 89 budgeted purchase cost per pound. (b)unfavorable efficiency variance of \$712–reflects the actual materials yield of 3. 80 scones per pound of pumpkin (60,800 ? 16,000 = 3. 80) being less than the budgeted yield of 4. 0 (60,000 ? 15,000 = 4. 00). The company used more pumpkins (materials) to make the scones than was budgeted. One explanation may be that Peterson purchased lower quality pumpkins at a lower cost per pound. 7-22 (15 min. ) Materials and manufacturing labor variances. | | | |Flexible Budget | | |Actual Costs | |(Budgeted Input | | |Incurred | |Qty. Allowed for | | |(Actual Input Qty. Actual Input Qty. |Actual Output | | |? Actual Price) |? Budgeted Price |? Budgeted Price) | |Direct |\$200,000 |\$214,000 |\$225,000 | |Materials | | | | \$14,000 F\$11,000 F Price varianceEfficiency variance \$25,000 F Flexible-budget variance Direct \$90,000\$86,000\$80,000 Mfg. Labor\$4,000 U\$6,000 U Price varianceEfficiency variance \$10,000 U Flexible-budget variance 7-23(30 min. )Price and efficiency variances. 1. | | |Flexible | | | | |Actual | |Budget | |Flexible | | |Results | |Variances | |Budget | | |(1) | |(2) = (1) – (3) | |(3) | |Direct materials |\$429,000 | |\$57,750 U | |\$371,250 | |Direct labor | 99,200 | | 9,200 U | | 90,000 | Actual Results Direct materials: 8,580,000a minutes ? \$0. 05 per minute= \$429,000 Direct labor:1,600 hours ? \$62 per minute = \$99,200 a 7,800,000 minutes ? 110% purchase = 8,580,000 CellOne commits to purchase 110% of the budgeted amount of time. Due to the forward commitment of time purchase, the actual time purchased will be the same as the budgeted amount of time to be purchased. Flexible Budget Direct materials: 8,250,000a ? \$0. 045 = \$371,250

Direct labor: 1,500 ? \$60 = \$90,000 a 7,500,000 minutes ? 110% to be purchased = 8,250,000 minutes b 7,500,000 minutes sold ( 5,000 minutes per hour = 1,500 hours 2. | | | | | |Flexible Budget | | |Actual | | | |(Budgeted Input | | |Incurred | | | |Qty. Allowed for | | |(Actual Input Qty. | |Actual Input Qty. |Actual Output | | |? Actual Price) | |? Budgeted Price | |? Budgeted Price) | | |(1) | |(2) | |(3) | | |(8,580,000 ? \$0. 05) | | (8,580,000 ? \$0. 045) |(8,250,000 ? \$0. 045) | |Direct materials |\$429,000 | |\$386,100 | |\$371,250 | \$42,900 U\$14,850 U Price variance Efficiency variance \$57,750 U Flexible-budget variance Direct |(1,600 ? \$62) |(1,600 ? \$60) |(1,500 ? \$60) | |Labor |\$99,200 |\$96,000 |\$90,000 | \$3,200 U\$6,000 U Price varianceEfficiency variance \$9(200 U Flexible-budget variance Students may question why the flexible budget is 8,250,000 minutes. Had the “actual output” of 7,500,000 minutes been used in the static budget, CellOne would have planned to purchase 8,250,000 (7,500,000 ? 1. 10) minutes. 7-24(30 min. )Direct materials and direct manufacturing labor variances. 1. June 2007 |Actual |Price |Actual Quantity [pic] |Efficiency Variance |Flexible Budget | | |Results |Variance |Budgeted Price | | | |  |(1) |(2) = (1)–(3) |(3) |(4) = (3) – (5) |(5) | |Units |550 | | | | |550 | |Direct materials |\$12,705. 00 | \$1,815. 00 |U | \$10,890. 00a | \$990. 00 |U |\$9,900. 00b | |Direct manuf. labor |\$ 8,464. 50 | \$ 104. 50 |U | \$ 8,360. 00c | \$440. 00 |F |\$8,800. 00d | |Total price variance | |\$1,919. 0 |U | | | | | |Total efficiency variance | | | | |\$550. 00 |U | | a 7,260 meters [pic]\$1. 50 per meter = \$10,890 b550 lots [pic]12 meters per lot [pic]\$1. 50 per meter = \$9,900 c 1,045 hours [pic]\$8. 00 per hour = \$8,360 d 550 lots [pic]2 hours per lot [pic]\$8 per hour = \$8,800 Total flexible-budget variance for both inputs = \$1,919. 50U + \$550U = \$2,469. 50U Total flexible-budget cost of direct materials and direct manuf. labor = \$9,900 + \$8,800 = \$18,700 Total flexible-budget variance as % of total flexible-budget costs = \$2,469. 50[pic]\$18,700 = 13. 21%  2. June |Actual Results |Price |Actual Quantity |Efficiency |Flexible Budget | |2008 | |Variance |[pic] Budgeted Price|Variance | | |  |(1) |(2) = (1) – (3) |(3) |(4) = (3) – (5) |(5) | |Units |550 | | | | |550 | |Direct materials |\$11,828. 36a | \$1,156. 6 |U | \$10,672. 20b |\$772. 20 |U |\$9,900. 00c | |Direct manuf. labor |\$ 8,295. 21d | \$ 102. 41 |U | \$ 8,192. 80e |\$607. 20 |F |\$8,800. 00c | | Total price variance | | \$1,258. 57 |U | | | | | |Total efficiency variance | | | | |\$165. 00 |U | | a Actual dir. mat. cost, June 2008 = Actual dir. mat. cost, June 2007 [pic] 0. 98 [pic] 0. 95 = \$12,705 [pic] 0. 8 [pic] 0. 95 = \$11. 828. 36 Alternatively, actual dir. mat. cost, June 2008 = (Actual dir. mat. quantity used in June 2007 [pic]0. 98) [pic](Actual dir. mat. price in June 2007 [pic]0. 95) = (7,260 meters [pic]0. 98) [pic](\$1. 75/meter [pic]0. 95) = 7,114. 80 [pic] \$1. 6625 = \$11,828. 36 b (7,260 meters [pic]0. 98) [pic]\$1. 50 per meter = \$10,672. 20 c Unchanged from 2007. d Actual dir. manuf. labor cost, June 2008 = Actual dir. manuf. cost June 2007 [pic]0. 98 = \$8,464. 50 [pic]0. 98 = \$8,295. 21 Alternatively, actual dir. manuf. labor cost, June 2008 = (Actual dir. manuf. labor quantity used in June 2007 [pic]0. 98) [pic]Actual dir. manuf. abor price in 2007 = (1,045 hours [pic] 0. 98) [pic] \$8. 10 per hour = 1,024. 10 hours [pic] \$8. 10 per hour = \$8,295. 21 e (1,045 hours [pic]0. 98) [pic]\$8. 00 per hour = \$8,192. 80 Total flexible-budget variance for both inputs = \$1,258. 57U + \$165U = \$1,423. 57U  Total flexible-budget cost of direct materials and direct labor = \$9,900 + \$8,800 = \$18,700   Total flexible-budget variance as % of total flexible-budget costs = \$1,423. 57[pic]\$18,700 = 7. 61% 3. Efficiencies have improved in the direction indicated by the production manager—but, it is unclear whether they are a trend or a one-time occurrence. Also, overall, variances are still 7. 6% of flexible input budget.

GloriaDee should continue to use the new material, especially in light of its superior quality and feel, but it may want to keep the following points in mind: • The new material costs substantially more than the old (\$1. 75 in 2007 and \$1. 6625 in 2008 vs. \$1. 50 per meter). Its price is unlikely to come down even more within the coming year. Standard material price should be re-examined and possibly changed. • GloriaDee should continue to work to reduce direct materials and direct manufacturing labor content. The reductions from June 2007 to June 2008 are a good development and should be encouraged. 7-25 (30 min. ) Price and efficiency variances, journal entries. 1.

Direct materials and direct manufacturing labor are analyzed in turn: | | | |Flexible Budget | | |Actual Costs | |(Budgeted Input | | |Incurred | |Qty. Allowed for | | |(Actual Input Qty. |Actual Input Qty. |Actual Output | | |? Actual Price) |? Budgeted Price |? Budgeted Price) | | | | Purchases Usage | | |Direct |(100,000 ? \$3. 10a) |(100,000 ? \$3. 00) (98,073 ? \$3. 00) |(9,810 ? 10 ? \$3. 0) | |Materials |\$310,000 |\$300,000 \$294,219 |\$294,300 | \$10,000 U\$81 F Price varianceEfficiency variance | | | | | | | |Direct | | | | |(9,810 ? 0. 5 ? \$20) or | |Manufacturing |(4,900 ? \$21b) | |(4,900 ? \$20) | |(4,905 ? \$20) | |Labor |\$102,900 | |\$98,000 | |\$98,100 | \$4,900 U\$100 F

Price varianceEfficiency variance a \$310,000 ? 100,000 = \$3. 10 b \$102,900 ? 4,900 = \$21 2. Direct Materials Control 300,000 Direct Materials Price Variance10,000 Accounts Payable or Cash Control 310,000 Work-in-Process Control 294,300 Direct Materials Control 294,219 Direct Materials Efficiency Variance 81 Work-in-Process Control 98,100 Direct Manuf. Labor Price Variance4,900 Wages Payable Control 102,900 Direct Manuf. Labor Efficiency Variance100 3. Some students’ comments will be immersed in conjecture about higher prices for materials, better quality materials, higher grade labor, better efficiency in use of materials, and so forth.

A possibility is that approximately the same labor force, paid somewhat more, is taking slightly less time with better materials and causing less waste and spoilage. A key point in this problem is that all of these efficiency variances are likely to be insignificant. They are so small as to be nearly meaningless. Fluctuations about standards are bound to occur in a random fashion. Practically, from a control viewpoint, a standard is a band or range of acceptable performance rather than a single-figure measure. 4. The purchasing point is where responsibility for price variances is found most often. The production point is where responsibility for efficiency variances is found most often. Chemical, Inc. may calculate variances at different points in time to tie in with these different responsibility areas. 7-26(20 min. )Continuous improvement (continuation of 7-25). 1. Standard quantity input amounts per output unit are: | |Direct |Direct | | |Materials |Manufacturing Labor | | |(pounds) |(hours) | |January |10. 0000 |0. 5000 | |February (Jan. ? 0. 997) |9. 9700 |0. 985 | |March (Feb. ? 0. 997) |9. 9401 |0. 4970 | 2. The answer to requirement 1 of Question 7-25 is identical except for the flexible- budget amount. | |Actual Costs | |Flexible Budget | | |Incurred | |(Budgeted Input Qty. Allowed | | |(Actual Input Qty. |Actual Input Qty. |for Actual Output | | |?

Actual Price) |? Budgeted Price |? Budgeted Price) | | | | Purchases Usage | | |Direct |(100,000 ? \$3. 10a) |(100,000 ? \$3. 00) (98,073 ? \$3. 00) |(9,810 ? 9. 940 ? \$3. 00) | |Materials |\$310,000 |\$300,000 \$294,219 |\$292,534 | \$10,000 U \$1,685 U Price variance Efficiency variance Direct | | | | | | |Manuf. |(4,900 ? \$21b) | |(4,900 ? \$20) | |(9,810 ? 0. 497 ? \$20) | |Labor |\$102,900 | |\$98,000 | |\$97,511 | \$4,900 U \$489 U Price variance Efficiency variance a \$310,000 ? 100,000 = \$3. 10 b \$102,900 ? 4,900 = \$21 Using continuous improvement standards sets a tougher benchmark.

The efficiency variances for January (from Exercise 7-25) and March (from Exercise 7-26) are: | |January |March | |Direct materials |\$ 81 F |\$1,685 U | |Direct manufacturing labor |\$100 F |\$ 489 U | Note that the question assumes the continuous improvement applies only to quantity inputs. An alternative approach is to have continuous improvement apply to budgeted input cost per output unit (\$30 for direct materials in January and \$10 for direct manufacturing labor in January).

This approach is more difficult to incorporate in a Level 2 variance analysis, because Level 2 requires separate amounts for quantity inputs and the cost per input. 7-27(20(30 min. )Materials and manufacturing labor variances, standardcosts. 1. Direct Materials | | |Flexible Budget | |Actual Costs | |(Budgeted Input | |Incurred | |Qty. Allowed for | |(Actual Input Qty. |Actual Input Qty. |Actual Output | |?

Actual Price) |? Budgeted Price |? Budgeted Price) | | | | (20,000 ? 2 ? \$10. 00) | |(37,000 sq. yds. ? \$10. 20) |(37,000 sq. yds. ? \$10. 00) |(40,000 sq. yds. ? \$10. 00) | |\$377,400 |\$370,000 |\$400,000 | \$7,400 U\$30,000 F Price varianceEfficiency variance \$22,600 F Flexible-budget variance The unfavorable materials price variance may be unrelated to the favorable materials efficiency variance.

For example, (a) the purchasing officer may be less skillful than assumed in the budget, or (b) there was an unexpected increase in materials price per square yard due to reduced competition. Similarly, the favorable materials efficiency variance may be unrelated to the unfavorable materials price variance. For example, (a) the production manager may have been able to employ higher-skilled workers, or (b) the budgeted materials standards were set too loosely. It is also possible that the two variances are interrelated. The higher materials input price may be due to higher quality materials being purchased. Less material was used than budgeted due to the high quality of the materials. Direct Manufacturing Labor | |Flexible Budget | |Actual Costs | |(Budgeted Input | |Incurred | |Qty. Allowed for | |(Actual Input Qty. |Actual Input Qty. |Actual Output | |? Actual Price) |? Budgeted Price |? Budgeted Price) | | | |(20,000 ? 0. 5 ? \$20. 00) | |(9,000 hrs. ? \$19. 60) |(9,000 hrs. ? \$20. 0) |(10,000 hrs. ? \$20. 00) | |\$176,400 |\$180,000 |\$200,000 | \$3,600 F\$20,000 F Price varianceEfficiency variance \$23,600 F Flexible-budget variance The favorable labor price variance may be due to, say, (a) a reduction in labor rates due to a recession, or (b) the standard being set without detailed analysis of labor compensation. The favorable labor efficiency variance may be due to, say, (a) more efficient workers being employed, (b) a redesign in the plant enabling labor to be more productive, or (c) the use of higher quality materials. 2. | | |Flexible Budget | | |Actual Costs | |(Budgeted Input | | |Incurred | |Qty. Allowed for | | |(Actual Input Qty. |Actual Input Qty. |Actual Output | |Control Point |? Actual Price) |? Budgeted Price |? Budgeted Price) | |Purchasing |(60,000 sq. yds.? \$10. 20) |(60,000 sq. yds. ? \$10. 00) | | | |\$612,000 |\$600,000 | | \$12,000 U Price variance |Production | |(37,000 sq. yds.? \$10. 00) |(20,000 ? 2 ? \$10. 0) | | | |\$370,000 |\$400,000 | \$30,000 F Efficiency variance Direct manufacturing labor variances are the same as in requirement 1. 7-28(15(25 min. )Journal entries and T-accounts (continuation of 7-27). Requirement 1 from Exercise 7-27: a. Direct Materials Control 370,000 Direct Materials Price Variance7,400 Accounts Payable Control377,400 To record purchase of direct materials. b. Work-in-Process Control400,000 Direct Materials Efficiency Variance 30,000 Direct Materials Control370,000 To record direct materials used. c. Work-in-Process Control 200,000

Direct Manufacturing Labor Price Variance 3,600 Direct Manufacturing Labor Efficiency Variance20,000 Wages Payable Control176,400 To record liability for and allocation of direct labor costs. |Direct | |Direct Materials | |Direct Materials | |Materials Control | |Price Variance | |Efficiency Variance | |(a) 370,000 |(b) 370,000 | |(a) 7,400 | | | |(b) 30,000 | | | |Direct Manufacturing Labor Price | |Direct Manuf.

Labor | |Work-in-Process Control | |Variance | |Efficiency Variance | |(b) 400,000 | | | |(c) 3,600 | | |(c) 20,000 | |(c) 200,000 | | | | | | | | |Wages Payable Control | |Accounts Payable Control | | |(c) 176,400 | | |377,400 (a) | Requirement 2 from Exercise 7-27: The following journal entries pertain to the measurement of price and efficiency variances when 60,000 sq. yds. of direct materials are purchased: a1. Direct Materials Control 600,000 Direct Materials Price Variance12,000 Accounts Payable Control 612,000 To record direct materials purchased. a2. Work-in-Process Control 400,000 Direct Materials Control 370,000 Direct Materials Efficiency Variance30,000 To record direct materials used. Direct | |Direct Materials | |Materials Control | |Price Variance | |(a1) 600,000 |(a2) 370,000 | |(a1) 12,000 | | | | | | |Accounts Payable Control | |Work-in-Process Control | | |(a1) 612,000 | |(a2) 400,000 | | |Direct Materials | |Efficiency Variance | | |(a2) 30,000 |

The T-account entries related to direct manufacturing labor are the same as in requirement 1. The difference between standard costing and normal costing for direct cost items is: | |Standard Costs |Normal Costs | |Direct Costs |Standard price(s) |Actual price(s) | | |? Standard input |? Actual input | | |allowed for actual | | | |outputs achieved | | These journal entries differ from the normal costing entries because Work-in-Process Control is no longer carried at “actual” costs.

Furthermore, Direct Materials Control is carried at standard unit prices rather than actual unit prices. Finally, variances appear for direct materials and direct manufacturing labor under standard costing but not under normal costing. 7-29 (25 min. ) Flexible budget (Refer to date in Exercise 7-27). The manager’s glee may be warranted, but the magnitude of the favorable variances may be deceptively large. Furthermore, if the manager had aimed at a scheduled production of 24,000 units, he or she may be troubled at the inability to obtain that output target. A more detailed analysis underscores the fact that the world of variances may be divided into three general parts: price, efficiency, and what is labeled here as a sales-volume variance.

Failure to pinpoint these three categories muddies the analytical task. The clearer analysis follows (in dollars): | |Actual Costs | |Flexible Budget | | | |Incurred | |(Budgeted Input | | | |(Actual Input Qty. | |Qty. Allowed for | | | |? Actual Price) |Actual Input Qty. |Actual Output |Static | | | |? Budgeted Price |?

Budgeted Price) |Budget | |Direct | | | | | |Materials |\$377,400 |\$370,000 |\$400,000 |\$480,000 | (a) \$7,400 U(b) \$30,000 F(c) \$80,000 F |Direct | | | | | |Manuf. | | | | | |Labor |\$176,400 |\$180,000 |\$200,000 |\$240,000 | (a) \$3,600 F(b) \$20,000 F(c) \$40,000 F (a)Price variance b)Efficiency variance (c)Sales-volume variance The sales-volume variances are favorable here in the sense that less cost would be expected solely because the output level is less than budgeted. However, this is an example of how variances must be interpreted cautiously. The general manager may be incensed at the failure to reach scheduled production (it may mean fewer sales) even though the 20,000 units were turned out with supreme efficiency. Sometimes this phenomenon is called being efficient but ineffective, where effectiveness is defined as the ability to reach original targets and efficiency is the optimal relationship of inputs to any given outputs.

Note that a target can be reached in an efficient or inefficient way; similarly, as this problem illustrates, a target can be missed but the given output can be attained efficiently. 7-30(45–50 min. )Activity-based costing, flexible-budget variances for finance-function activities. 1. Receivables Receivables is an output unit level activity. Its flexible-budget variance can be calculated as follows: = – = (\$0. 75 ? 948,000) – (\$0. 639 ? 948,000) = \$711,000 – \$605,772 = \$105,228 U Payables Payables is a batch level activity. Static-budgetActual AmountsAmounts a. Number of deliveries1,000,000948,000 b. Batch size (units per batch)54. 468 c. Number of batches (a ? b) 200,000212,175 d.

Cost per batch \$2. 90 \$2. 80 e. Total payables activity cost (c ? d) \$580,000\$594,090 Step 1:The number of batches in which payables should have been processed = 948,000 actual units ? 5 budgeted units per batch = 189,600 batches Step 2:The flexible-budget amount for payables = 189,600 batches ? \$2. 90 budgeted cost per batch = \$549,840 The flexible-budget variance can be computed as follows: Flexible-budget variance = Actual costs – Flexible-budget costs = (212,175 ? \$2. 80) – (189,600 ? \$2. 90) = \$594,090 – \$549,840 = \$44,250 U Travel expenses Travel expenses is a batch level activity. Static-BudgetActual AmountsAmounts a.

Number of deliveries1,000,000948,000 b. Batch size (units per batch) 500501. 587 c. Number of batches (a ? b) 2,000 1,890 d. Cost per batch \$7. 60 \$7. 40 e. Total travel expenses activity cost (c ? d) \$15,200\$13,986 Step 1:The number of batches in which the travel expense should have been processed = 948,000 actual units ? 500 budgeted units per batch = 1,896 batches Step 2: The flexible-budget amount for travel expenses = 1,896 batches ? \$7. 60 budgeted cost per batch = \$14,410 The flexible budget variance can be calculated as follows: Flexible budget variance = Actual costs – Flexible-budget costs = (1,890 ? 7. 40) – (1,896 ? \$7. 60) = \$13,986 – \$14,410 = \$424 F 2. The flexible budget variances can be subdivided into price and efficiency variances. Price variance = – ? Efficiency variance = – [pic] ? Receivables Price Variance =(\$0. 750 – \$0. 639) ? 948,000 =\$105,228 U Efficiency variance=(948,000 – 948,000) ? \$0. 639 =\$0 Payables Price variance =(\$2. 80 – \$2. 90 ) ? 212,175 =\$21,218 F Efficiency variance=(212,175 – 189,600) ? \$2. 90 =\$65,468 U Travel expenses Price variance =(\$7. 40 – \$7. 60) ? 1,890 =\$378 F Efficiency variance=(1,890 – 1,896) ? \$7. 60 =\$46 F 7-31(20 min. ) Price and efficiency variances, benchmarking. 1. |Mineola Plant | | |Prices and quantities |Cost per lot | |Direct materials |13. 50 |lbs |@ |\$ 9. 20 |per lb |\$124. 20 | |Direct labor |3 |hrs |@ |\$10. 15 |per hr | 30. 45 | |Variable overhead |  |  |  |  |  | 12. 00 | |Budgeted variable cost |  |  |  |  |  |\$166. 65 | |Bayside Plant | | |Prices and quantities |Cost per lot | |Direct materials |14. 00 |lbs |@ |\$ 9. 00 |per lb |\$126. 00 | |Direct labor |2. 7 |hrs |@ |\$10. 20 |per hr | 27. 54 | |Variable overhead |  |  |  |  |  | 11. 00 | |Budgeted variable cost |  |  |  |  |  |\$164. 54 | |Miraclo | | |Prices and quantities |Cost per lot | |Direct materials |13. 00 |lbs |@ |\$ 8. 80 |per lb |\$114. 40 | |Direct labor |2. 5 |hrs |@ |\$10. 00 |per hr | 25. 00 | |Variable overhead |  |  |  |  |  | 11. 00 | |Budgeted variable cost |  |  |  |  |  |\$150. 40 | 2. Mineola Plant Actual Quantity [pic] ActualPriceBudgeted Efficiency Flexible

ResultsVariancePriceVarianceBudgeta (1)(2) = (1) – (3)(3)(4) = (3) – (5)(5) Lots 1,000 1,000 Direct materials\$124,200\$5,400 U\$118,800b\$4,400 U \$114,400 Direct labor\$ 30,450\$ 450 U\$ 30,000c\$5,000 U \$ 25,000 aUsing Miraclo’s prices and quantities as the standard: Direct materials: (13 lbs. /lot [pic]1,000 lots) [pic]\$8. 80/lb. = \$114,400 (2. 5 hrs. /lot [pic]1,000 lots) [pic] \$10. 00/hr.. = \$25,000 b(13. 50 lbs. /lot [pic]1,000 lots) [pic]\$8. 80 per lb. = \$118,800 c(3 hours/lot [pic]1,000 lots) [pic]\$10/hr. = \$30,000 Bayside Plant Actual Quantity [pic] ActualPriceBudgeted Efficiency Flexible ResultsVariancePriceVarianceBudgeta 1)(2) = (1) – (3)(3)(4) = (3) – (5)(5) Lots 1,000 1,000 Direct Materials\$126,000\$2,800 U\$123,200b\$8,800 U \$114,400 Direct Labor\$ 27,540\$ 540 U\$ 27,000c\$2,000 U \$ 25,000 aUsing Miraclo’s prices and quantities as the standard: Direct materials: (13 lb. /lot [pic]1,000 lots) [pic]\$8. 80/lb. = \$114,400 (2. 5 hrs. /lot [pic]1,000 lots) [pic]\$10. 00/lb. = \$25,000 b(14 lbs. /lot [pic]1,000 lots) [pic]\$8. 80 per lb. = \$123,200 c(2. 7 hours/lot [pic]1,000 lots) [pic]\$10/hr. = \$27,000 3. Using an objective, external benchmark, like that of a competitor, will preempt the possibility of any one plant feeling that the other is being favored.

That this competitor, Miraclo, is successful will also put positive pressure on the two plants to improve (note that all variances are unfavorable). Issues that Garden Art should keep in mind include the following: • Ensure that Miraclo is indeed the best and most relevant standard (for example, is there another competitor in the marketplace which should be considered? ) • Ensure that the data is reliable • Ensure that Miraclo is similar enough to use as a standard (if Miraclo has a different business model, for example, it may be following a strategy of lowering costs that Garden Art may not want to emulate because Garden Art is trying to differentiate its products) 7-32(30 min. ) Flexible budget, direct materials and direct manufacturing labor variances.

Flexible-Sales- 1. ActualBudgetFlexibleVolume Static ResultsVariancesBudgetVariances Budget (1) (2) = (1) – (3) (3)(4) = (3) – (5) (5) Units sold 6,000a 0 6,000 1,000 F 5,000a Direct materials\$ 594,000\$ 6,000 F\$ 600,000 b \$100,000 U \$ 500,000c Direct manufacturing labor 950,000a10,000 F 960,000d160,000 U 800,000e Fixed costs 1,005,000a 5,000 U 1,000,000a 0 1,000,000a Total costs\$2,549,000\$11,000 F \$2,560,000 \$260,000 U \$2,300,000 \$11,000 F\$260,000 U Flexible-budget varianceSales-volume variance \$249,000 U Static-budget variance a Given b \$100 ? 6,000 = \$600,000 \$100 ? 5,000 = \$500,000 d \$160 ? 6,000 = \$960,000 e \$160 ? 5,000 = \$800,000 2. Flexible Budget (Budgeted Input Actual Incurred Qty. Allowed for (Actual Input Qty. Actual Input Qty. Actual Output ? ? Actual Price) ? Budgeted PriceBudgeted Price) Direct materials\$594,000a\$540,000b\$600,000c \$54,000 U \$60,000 F Price variance Efficiency variance \$6,000 F Flexible-budget variance Direct manufacturing labor\$950,000a \$1,000,000e\$960,000f \$50,000 F\$40,000 U Price varianceEfficiency variance \$10,000 F Flexible-budget variance a 54,000 pounds ? \$11/pound = \$594,000 b 54,000 pounds ? \$10/pound = \$540,000 c 6,000 statues ? 10 pounds/statue ? 10/pound = 60,000 pounds ? \$10/pound = \$600,000 d 25,000 pounds ? \$38/pound = \$950,000 e 25,000 pounds ? \$40/pound = \$1,000,000 f 6,000 statues ? 4 hours/statue ? \$40/hour = 24,000 hours ? \$40/hour = \$960,000 7-33(50 min. ) Static budget, flexible budget, service sector, professional labor efficiency, and effectiveness. Static Budget 1. Revenue (90 ? 0. 5% ? \$200,000) \$90,000 Variable costs: Professional labor (6 ? \$40 ? 90) 21,600 Loan filing fees (\$100 ? 90) 9,000 Credit-worthiness checks (\$120 ? 90) 10,800 Courier mailings (\$50 ? 90) 4,500 Total variable costs 45,900 Contribution margin 44,100 Fixed costs 31,000 Operating income \$13,100 2.

Flexible budget for November 2007: Revenue (120 ? 0. 5% ? \$200,000)\$120,000 Variable costs: Professional labor (6 ? \$40 ? 120) 28,800 Loan filing fees (\$100 ? 120) 12,000 Credit-worthiness checks (\$120 ? 120) 14,400Courier mailings (\$50 ? 120) 6,000Total variable costs 61,200 Contribution margin 58,800 Fixed costs 31,000 Operating income\$ 27,800 Level 2 Analysis Flexible-Sales- ActualBudgetFlexibleVolume Static ResultsVariancesBudgetVariancesBudget (1) (1) – (3) (3) (3) – (5) (5) Loans 120 0 120 30 F 90 Revenue\$134,400\$14,400 F\$120,000\$30,000 \$90,000 Variable costs:

Professional labor 36,288 7,488 U 28,800 7,200 U 21,600 Loan filing fees 12,000 0 12,000 3,000 U 9,000 Credit-worthiness checks 15,000 600 U 14,400 3,600 U 10,800 Courier mailings 6,480 480 U 6,000 1,500 U 4,500 Total variable costs 69,768 8,568 U 61,200 15,300 U 45,900 Contribution margin 64,632 5,832 F 58,800 14,700 F 44,100 Fixed costs 33,500 2,500 U 31,000 0 31,000 Operating income\$ 31,132\$ 3,332 F\$ 27,800\$14,700 F\$13,100 \$3,332 F\$14,700 F Total flexible-Total sales- budget variancevolume variance \$18,032 F Total static-budget variance 3. Flexible Budget Actual Costs(Budgeted Input IncurredQty. Allowed for Actual Input Qty. Actual Input Qty. Actual Output ? Actual Price)? Budgeted Price? Budgeted Price) (1) (2)(3) (120 ? 7. 2 ? \$42) (120 ? 7. 2 ? \$40)(120 ? 6. 0 ? \$40) 864 hrs. ? \$42/hr. 864 hrs. ? \$40/hr. 720 hrs. ?\$40/hr. \$36,288 \$34,560\$28,800 \$1,728 U\$5,760 U Price varianceEfficiency variance \$7,488 U Flexible-budget variance 4. Effectiveness refers to the degree to which a predetermined objective is accomplished. One objective of Meridian Finance professional labor is to maximize loan-based revenue (0. 5% of loan amount ? number of loans). The professional staff has increased number of loans from a budgeted 90 to 120, a significant increase.

Additionally, the average loan amount increased from a budgeted \$200,000 to \$224,000. The result is an increase in revenue from the budgeted \$90,000 to actual \$134,400. With both a higher number of loans and a higher average amount per loan, there was an increase in the effectiveness of professional labor in November 2007. 7-34(60 min. )Comprehensive variance analysis, responsibility issues. 1a. Actual selling price = \$82. 00 Budgeted selling price = \$80. 00 Actual sales volume = 4,850 units Selling price variance = (Actual sales price ( Budgeted sales price) ? Actual sales volume = (\$82 ( \$80) ? 4,850 = \$9,700 Favorable 1b. Development of Flexible Budget | |Budgeted Unit |Actual Volume |Flexible Budget | | | |Amounts | |Amount | |Revenues | |\$80. 00 |4,850 |\$388,000 | |Variable costs | | | | | | DM(Frames |\$2. 20/oz. ? 3. 00 oz. | 6. 60a |4,850 | 32,010 | | DM(Lenses |\$3. 10/oz. ? 6. 00 oz. | 18. 60b |4,850 | 90,210 | | Direct manuf. labor |\$15. 00/hr. ? 1. 20 hrs. | 18. 0c |4,850 | 87,300 | | Total variable manufacturing costs | | | 209,520 | |Fixed manufacturing costs | | | 75,000 | |Total manufacturing costs | | | 284,520 | |Gross margin | | | |\$103,480 | a\$33,000 ? 5,000 units; b\$93,000 ? 5,000 units; c\$90,000 ? 5,000 units | |Flexible- | |Sales – | | | |Actual |Budget |Flexible |Volume |Static | | |Results |Variances |Budget |Variance |Budget | | |(1) |(2)=(1)-(3) |(3) |(4)=(3)-(5) |(5) | |Units sold | 4,850 | | 4,850 | | 5,000 | | | | | | | | |Revenues |\$397,700 | \$ 9,700 F |\$388,000 | \$ 12,000 U |\$400,000 | |Variable costs | | | | | | | DM(frames | 37,248 | 5,238 U | 32,010 | 990 F | 33,000 | | DM(lens | 100,492 | 10,282 U | 90,210 | 2,790 F | 93,000 | | Direct labor | 96,903 | 9,603 U | 87,300 | 2,700 F | 90,000 | | Total variable costs | 234,643 | 25,123 U | 209,520 | 6,480 F | 216,000 | |Fixed manuf. osts | 72,265 | 2,735 F | 75,000 | 0 | 75,000 | |Total costs | 306,908 | 22,388 U | 284,520 | 6,480 F | 291,000 | |Gross margin |\$ 90,792 | \$12,688 U |\$103,480 | \$ 5,520 U |\$109,000 | Level 2 \$12,688 U \$ 5,520 U Flexible-budget varianceSales-volume variance Level 1\$18,208 U Static-budget variance 1c. Price and Efficiency Variances DM(Frames(Actual ounces used = 3. 20 per unit ? 4,850 units = 15,520 oz. Price per oz. = \$37,248 [pic]15,520 = \$2. 40 DM(Lenses(Actual ounces used = 7. 00 per unit ? 4,850 units = 33,950 oz. Price per oz. = \$100,492 [pic]33,950 = \$2. 96 Direct Labor(Actual labor hours = \$96,903[pic]14. 80 = 6,547. 5 hours L

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