Chapter 9 Flexible Budgets Variance Analysis M 11

Chapter 9. Flexible Budgets. Variance Analysis. M 11 -Chp-10 -1 -Flex-Bud-Variances-2011 -0514 Edited May 24, 2011. Copyright © 2011, Dr. Howard Godfrey This file contains illustrative problems that will be used in the lecture to illustrate important concepts and procedures. Copyright 2011. Dr. Howard Godfrey – M 11 -Chp-9 -1 -Flex-Bud-Variances-2011 -0514 1

After studying Chapter 9, you should be able to: LO 1 Prepare a flexible budget. LO 2 Prepare a report showing activity variances. LO 3 Prepare a report showing revenue and spending variances. LO 4 Prepare a performance report that combines activity variances and revenue and spending variances. LO 5 Prepare a flexible budget with more than one cost driver. LO 6 Understand common errors made in preparing performance reports based on budgets and actual results. 2

1: Prepare a flexible budget 3

I planned a vacation to Orlando, which is 400 miles, or 800 miles round trip. Auto gets 20 miles per gallon, so I expected to buy 40 gallons at $3. 00 per gallon. My budget for gas cost for this vacation was $120. I changed my mind and went to Atlanta which is 400 miles, round trip. My gas cost was $69. 20 for 21 gallons, and I am bragging about keeping my gas price below the budgeted amount of $120. How was my efficiency going to Atlanta? 4

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2: Activity variances 14

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Raleigh Corp. has developed the following flexible -budget formulas for annual indirect-labor cost: Total annual indirect labor cost = $4, 800 + $0. 50 per machine hour. Operating budgets for the current month are based upon 19, 200 hours of planned machine time. Indirect-labor costs included in this monthly planning budget are: a. $14, 800 b. $10, 000 c. $14, 400 d. $10, 400 19

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3: Revenue and spending variances 22

Performance Report • Please look at each line in the report on the next page and give an evaluation of whether the company did a good job in controlling the expense. • If they sell less than they planned, would you expect that to be a reason for lower expenses, such as lower sales commissions? • This is the idea of a flexible budget. 23

Performance Report -1 -Not good 24

Performance Report -2 25

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Flexible Budget- Income Statement Notice that variable costs are budgeted at lower amounts for lower levels of sales. Fixed costs remain fixed at all levels of sales within the relevant range. A reduction of 10% in sales is expected to result in more than a 10% reduction in net income. Why? 30

4: Flexible budget performance report 31

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5: More than one cost driver 35

6: Common errors 36

7: Budget for overhead 37

Flexible Budget for Overhead-1 • The exhibit on the second following page shows a flexible budget. The overhead application rate for variable overhead should be unchanged within the relevant range. • The overhead rate for fixed overhead depends on the “denominator level. ” (like how many students come to the dance to cover fixed band costs – earlier example. ) • The total overhead rate also depends on the denominator level. 38

Flexible Budget for Overhead-2 • The exhibit on the next page shows a flexible budget. • Recall from our earlier use of this problem that we used the high-low method to compute the fixed cost element of overhead and compute the variable overhead rate. 39

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Flexible Budget for Overhead-4 41

Flexible Budget for Overhead-5 • Note on the next page that we budgeted fixed overhead to be $6, 400. When the period was over, we found that we spent $6, 500 for fixed overhead items. That is a spending problem. • We produced enough product to justify using 900 hours of labor, but we actually used 910 hours of labor. That is an efficiency problem. This involves a waste of payroll dollars, but it also involves a waste of support costs (the support costs for the extra 10 hours of work that wasted. ) Etc. 42

Flexible Budget for Overhead-6 • Our total overhead for 900 good hours of work should be: (900 good hours X ($6. 40 + $1. 40)) That would be $7, 020. • We actually spent $8, 000 for overhead ($1, 500 + $6, 500) • Our overall budget variance is $980. • What are the specific reasons for this variance. • One reason: we planned on operating 1, 000 hours, but only had 900 standard hours of work. (Too few persons came to the dance) 43

Flexible Budget for Overhead-7 44

Flexible Budget for Overhead Adams Corporation has developed the following flexible -budget formulas for annual indirect-labor cost: Annual indirect labor cost = $4, 800 + $0. 50 per machine hour Operating budgets for the current month are based upon 20, 000 hours of planned machine time. Indirect-labor costs included in this monthly planning budget are: a. $14, 800 b. $10, 000 c. $14, 400 d. $10, 400 45

Flexible Budget for Overhead When using a flexible budget, what will occur to variable costs (on a per unit basis) as production increases within the relevant range? a. Variable costs are not considered in flexible budgeting. b. Variable costs per unit will decrease. c. Variable costs per unit will increase. d. Variable costs per unit will remain unchanged. 46

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