Flexible Budgets and Standard Costs Chapter 23 HORNGREN

Flexible Budgets and Standard Costs Chapter 23 HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT

Objectives 1. Prepare a flexible budget for the statement of financial performance 2. Prepare a financial performance report 3. Identify the benefits of standard costing 4. Calculate standard cost variances for direct material and direct labour 5. Analyse manufacturing overhead in a standard cost system 6. Record transactions at standard cost 7. Prepare a standard cost statement of financial performance for management Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 2

Objective 1 Prepare a flexible budget for the statement of financial performance. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 3

Static versus Flexible Budgets Kool-Time Pools Comparison of Actual Results with Static Budget For the Month Ended June 30, 2004 Actual Static Results Budget Variance Pools 10 8 2 F Revenues $120, 000 $ 96, 000 $24, 000 F Expenses 105, 000 84, 000 $21, 000 U Net Profit $ 15, 000 $ 12, 000 $ 3, 000 F Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 4

Static versus Flexible Budgets Static Budget (8 Pools) Expected Output Volume Only Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 5

Static versus Flexible Budget (5 Pools) (8 Pools) (11 Pools) Range of Output Volumes Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 6

Flexible Budgets Budgeted sales price per pool is $12, 000. Budgeted variable expenses per pool are $8, 000. Total budgeted fixed cost is $20, 000. What are the flexible budgets for Kool-Time Pools when expected volume is 5, 8, and 11 pools? Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 7

Flexible Budgets Kool-Time Pools Flexible Budgets Units 5 Sales revenue $60, 000 Variable expenses 40, 000 Fixed expenses 20, 000 Net Profit $ 0 8 11 $ 96, 000 $132, 000 64, 000 88, 000 20, 000 $ 12, 000 $ 24, 000 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 8

Graphing the Flexible Budget Formula Total cost line $84, 000 $60, 000 $20, 000 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia Variable cost $8, 000 per pool installed Fixed cost $20, 000 per month 23 - 9

Graphing the Flexible Budget Formula The flexible budget graph shows budgeted expenses for 10 pools. Variable expenses Fixed expenses Total expenses $ 80, 000 20, 000 $100, 000 June actual expenses were $105, 000. They exceeded the budgeted by $5, 000. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 10

Objective 2 Prepare a financial performance report. Horngren ♦ Harrison ♦ Bamber ♦ Best

Kool-Time Pools Performance Report Pools Revenues Variable expenses Fixed expenses Total expenses Net Profit Actual Results 10 $120, 000 83, 000 22, 000 105, 000 $ 15, 000 Flexible Budget 10 $120, 000 80, 000 20, 000 100, 000 $ 20, 000 Static Budget 8 $ 96, 000 64, 000 20, 000 84, 000 $ 12, 000 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 12

Kool-Time Pools Performance Report Actual Results $15, 000 Flexible Budget $20, 000 $5, 000 U Static Budget $12, 000 $8, 000 F Flexible Budget Variance Sales Volume Variance Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 13

Kool-Time Pools Performance Report Actual Results $15, 000 Static Budget $12, 000 $3, 000 F Static Budget Variance Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 14

The Flexible Budget and Variance Analysis The flexible budget variance is the difference between what the company spent at the actual level of output and what it should have spent to obtain the actual level of output. l It highlights the difference between actual costs and flexible budget costs. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 15

The Flexible Budget and Variance Analysis Kool-Time Pools actually incurred $83, 000 of variable costs to install the 10 pools. l This was $3, 000 more than the $80, 000 budgeted variable cost for 10 pools. l Kool-Time Pools also spent $2, 000 more than budgeted on fixed expenses ($22, 000 – $20, 000). l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 16

Objective 3 Identify the benefits of standard costs. Horngren ♦ Harrison ♦ Bamber ♦

Benefits of Standard Costs Standard costs are carefully predetermined costs. l They help managers plan by providing the unit amounts, which are the building blocks of budgeting. l They help simplify record keeping. l Standard quantity often is referred to as the quantity that should have been used. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 18

Benefits of Standard Costs l Standards costs are different to flexible budgets because; ä Flexible budgets keep fixed costs constant, within the relevant range. ä Standard costs are on a per unit basis and allocate an amount of fixed costs to each unit. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 19

Objective 4 Calculate standard cost variances for direct materials and direct labour. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 20

Direct Material and Direct Labour Variances 1 2 Price, or rate, which measures how well the business keeps unit prices of materials and labour within standards. Efficiency, or quantity, which measures whether the quantity of materials or labour used to make the actual number of outputs is within the budget. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 21

Price Variance. . . is the difference between the actual price and standard price of inputs used multiplied by the actual quantity of inputs. l Price variance = (Actual quantity × Actual price) – (Actual quantity × Standard price) or. . . l Actual quantity × (AP – SP) – Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 22

Efficiency Variance. . . is the difference between the actual and standard quantity of inputs allowed multiplied by the standard price of input. l Efficiency variance = (Actual quantity × Standard price) – (Standard quantity × Standard price) or. . . l Standard price × (AQ – SQ) – Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 23

Example of Standard Costing Variance analysis begins with a total variance to be explained – in this example, $5, 000. Actual variable expenses Flexible budget Difference $ 83, 000 – 80, 000 3, 000 Actual fixed expenses were $2, 000 more than budgeted. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 24

Materials Variances Standards Direct materials cost was $2. 00 per cubic metre. SQ of materials allowed (gunite) was 1, 000 cubic metre per pool. Actual Results (10 pools were built) AP paid per cubic metre = $1. 93 AQ of materials used = 11, 969 cubic feet Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 25

Materials Variances Price variance: 11, 969 ($1. 93 – $2. 00) = $838 favourable Efficiency variance: $2. 00 (11, 969 – 10, 000) = $3, 938 unfavourable Flexible budget variance: $838 – $3938 = $3, 100 unfavourable Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 26

Materials Variances Actual cost incurred: (Actual inputs × Actual price) = 11, 969 × $1. 93 = $22, 100 l Standard cost of actual inputs: (Actual inputs × Standard price) = 11, 969 × $2 = $23, 938 l Flexible budget: (Standard inputs × Standard price) = 10, 000 × $2 = $20, 000 l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 27

Labour Variances Standards Direct labour cost was $4, 200 per pool. SP (rate) was $10. 50 per hour. Standard hours per pool was 400. Actual Results (10 pools were built) AP (actual rate) was $11. 00 per hour. AQ (actual hours) was 3, 800. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 28

Labour Variances Price (or rate) variance: 3, 800($11. 00 – $10. 50) = $1, 900 unfavourable Efficiency variance: $10. 50(3, 800 – 4, 000) = $2, 100 favourable Flexible budget variance: $2, 100 – $1, 900 = $200 favourable Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 29

Labour Variances Actual cost incurred: (Actual inputs × Actual price) = 3, 800 × $11 = $41, 800 l Standard cost of actual inputs: (Actual inputs × Standard price) = 3, 800 × $10. 50 = $39, 900 l Flexible budget: (Standard inputs × Standard price) = 4, 000 × $10. 50 = $42, 000 l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 30

Flexible Budget Variances for Materials and Labour Flexible budget variance for materials $3, 100 U Flexible budget variance for labour 200 F Total variances $2, 900 U Total flexible budget variance Materials and labour variances Flexible budget overhead variances $5, 000 U 2, 900 U $2, 100*U *Flexible budget man. O/H variance $1, 300 U *Marketing and admin. O/H variance $ 800 U (see Exhibit 23 -9 page 1005 textbook) Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 31

Objective 5 Analyse manufacturing overhead in a standard cost system. Horngren ♦ Harrison ♦

Manufacturing Overhead Variances l l The flexible budget variance for manufacturing overhead shows whether managers are keeping total overhead costs within the budgeted amount for the actual production of the period (actual – flexible). The production volume variance (this is a new concept and not part of the total flexible budget variance ) arises when actual production differs from the level in the static budget (allocated – flexible). Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 33

Allocating Overhead to Production Kool-Time Pools allocates manufacturing overhead to production based on standard direct labour hours for the actual number of outputs. l The static budget, which is based on expected output of 8 pools, is known at the beginning of the period. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 34

Allocating Overhead to Production Standards Variable overhead cost was $800 per pool. Standard hours per pool were 400. Fixed overhead cost was $12, 000. Actual Results (10 pools were built) Actual variable overhead was $9, 000. Actual hours were 3, 800 fixed overhead was $12, 300 and total overhead was $21, 300. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 35

Allocating Overhead to Production In a standard cost system, manufacturing overhead is allocated to production based on a predetermined overhead rate. l Most companies base their predetermined overhead rates on amounts from the static (master) budget which is known at the beginning of the year (month). l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 36

Allocating Overhead to Production Kool-Time Pools Budget Data for the Month Ended June 30, 2004 Budget type Static Flexible Pools 8 10 Standard direct labour hours 3, 200 4, 000 Overhead cost: Variable $ 6, 400 $ 8, 000 Fixed 12, 000 Total $18, 400 $20, 000 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 37

Allocating Overhead to Production Standard variable overhead rate per hour: $6, 400 ÷ 3, 200 = $2. 00 Standard fixed overhead rate per hour: $12, 000 ÷ 3, 200 = $3. 75 Total overhead rate per hour: $2. 00 + $3. 75 = $5. 75 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 38

Total Manufacturing Overhead Variance. . . is the amount of underallocated or overallocated manufacturing overhead. l This is the difference between actual manufacturing overhead and allocated manufacturing overhead. – Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 39

Total Manufacturing Overhead Variance How much standard overhead is allocated to production? 4, 000 × $2. 00 4, 000 × $3. 75 Total $ 8, 000 variable 15, 000 fixed $23, 000 Total manufacturing overhead cost variance is allocated minus actual: $23, 000 – $21, 300 = $1, 700 favourable Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 40

Total Manufacturing Overhead Variance The total manufacturing overhead variance is split into the manufacturing flexible budget variance and the production volume variance: l Flexible budget overhead for actual production = $12, 000 + (4, 000 × $2) = $20, 000. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 41

Overhead Flexible Budget Variance Kool-Time Pools – a comparison of actual results with the flexible budget overhead for actual production: Actual Results Flexible Budget Variance Pools 10 Overhead cost: Variable $ 9, 000 Fixed 12, 300 Total $21, 300 10 $ 8, 000 12, 000 $20, 000 $1, 000 U $ 300 U $1, 300 U Overhead flexible variance is $1, 300 unfavourable. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 42

Production Volume Variance. . . – l l is the difference between the fixed overhead cost in the flexible budget for actual production and the standard fixed overhead allocated to production. 4, 000 × $3. 75 = $15, 000 allocated. How much is the volume variance? $12, 000 – $15, 000 = $3, 000 favourable volume variance. It is because they produced more than expected and therefore allocated more fixed overhead to production. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 43

Flexible Budget Variance Flexible budget variance: $5, 000 U Materials $3, 100 U Labour 200 F Marketing and admin. variance 800 U Flexible budget man. overhead variance 1, 300 U Total $5, 000 U Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 44

Total Variances Why was actual profit $5, 000 less than the flexible budget for 10 pools? l Variable costs exceeded the flexible budget by $3, 000 and actual fixed costs exceeded the static budget by $2, 000. l l See exhibit 23 -9 page 1005 textbook Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 45

Objective 6 Record transactions at standard cost. Horngren ♦ Harrison ♦ Bamber ♦ Best

Standard Costs in the Accounts What is the entry to record the purchase of 11, 969 cubic metres of materials (actual price paid was $1. 93 per cubic foot and the standard being $2. 00/cubic metre)? Materials Inventory 23, 938 Direct Materials Price Variance 838 Accounts Payable 23, 100 To record purchases of direct materials Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 47

Standard Costs in the Accounts What is the entry to record the transfer of 11, 969 actual cubic metres of materials to work in process inventory? (All at $2 SP) Work in Process Inventory 20, 000* Direct Materials Efficiency Variance 3, 938 Materials Inventory 23, 938 To record use of materials *10, 000 SQ × $2 SP Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 48

Standard Costs in the Accounts Notice that in these entries direct materials price variance is recorded at the time of purchase. l An unfavourable variance has a debit balance which increases the expense. l A favourable variance has a credit balance in the accounts and is a reduction in expenses. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 49

Standard Costs in the Accounts Manufacturing Overhead Accounts Payable, Accumulated Depreciation, and Other accounts 21, 300 To record actual overhead costs incurred See Exhibit 23 -14 page 1013 textbook Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 50

Standard Costs in the Accounts What is the entry to record allocated manufacturing overhead? Work in Process Inventory Manufacturing Overhead 23, 000 To allocate overhead Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 51

Other Entries Finished Goods Inventory 85, 000 Work in Process Inventory 85, 000 To record completion of 10 pools Cost of Goods Sold 85, 000 Finished Goods Inventory 85, 000 To record sale of 10 pools Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 52

Closing Variances Unfavourable Variances Materials efficiency $ Labour price Flexible budget Total $ 3, 938 1, 900 1, 300 7, 138 Favourable Variances Materials price $ 838 Labour efficiency 2, 100 Production volume 3, 000 Total $ 5, 938 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 53

Closing Variances $7, 138 unfavourable – $5, 938 favourable = $1, 200 unfavourable Profit and Loss Summary Net Variance To close various variances 1, 200 This entry decreases profits. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 54

Objective 7 Prepare a standard cost statement of financial performance for management. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 55

Standard Cost Statement of Financial Performance for Management Standard Costing Revenues $120, 000 COGS 85, 000 Unadjusted gross profit $ 35, 000 Actual Costing Revenues $120, 000 Cost of goods sold 86, 200 Unadjusted income $ 33, 800 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 56

Standard Cost Statement of Financial Performance for Management Closing the $1, 200 net unfavourable variance to profit and loss summary reduces the gross profits by $1, 200. l This produces the $33, 800 gross profit figure. l Remember standard costs are different to flexible budgets. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 23 - 57