THE MASTER BUDGET AND

FLEXIBLE BUDGETING

Lecture # 17
SUMMARY OF THE BUDGETING PROCESS
1 A Sales Forecast in units, considering the
2 Inventory Policy, minimum-maximum and stable or fluctuating, helps in developing the
3 Production Plan in units and by periods.
This information aids in developing the
4(a) Requirements for Direct 4(b) Requirements for Direct 4(c) Requirements for Indirect
Materials Labor Costs, Facilities, and Supplies
(quantities and prices) (hours and rates) (fixed and variable costs)
From this information is developed the
5(a) Direct Materials Budget 5(b) Direct Labor Budget 5(c) Factory Overhead Budget

From these budgets are developed the

6(a) Standard Unit Cost for 6(b) Standard Unit Cost for 6(c) Standard Unit Cost for
Direct Materials Direct Labor Factory Overhead
(These combined figures determine the Standard Unit Cost for the Product.)
FLEXIBLE BUDGETING

Hmm! Comparing
costs at different
Consider
Consider the
the following
following levels of activity
condensed
condensed example
example is like comparing
from
from Barton,
Barton, Inc.
Inc. .. .. .. apples with oranges.

Performance evaluation
is difficult when actual
activity differs from the
activity originally
budgeted.
FLEXIBLE BUDGETING
 A plan of what will happen to a company under varying
sets of conditions.
 The company plans in advance what the effect will be on
revenue, expense, and profit if sales or production differ
from the budget.
 Standard production is determined and the initial
calculation of variable and fixed costs is based on this
level of production.
PREPARING THE FLEXIBLE BUDGET

28,000 units 30,000 units 32,000 units

Sales ($150/unit $4,200,000 $4,500,000 $4,800,000
Direct materials:
Lumber ($20/unit) 560,000 600,000 640,000
Paint ($4/unit) 112,000 120,000 128,000
Direct labor:
Cutting ($3.75/unit) 105,000 112,500 120,000
Assembly ($2.40/unit) 67,200 72,000 76,800
Variable FOH ($6.93/unit) 194,040 207,900 221,760
Contribution Margin $3,161,760 $3,387,600 $3,613,440
Fixed FOH and S & A expense 773,825 773,825 773,825
Operating income $2,387,935 $2,613,775 $2,839,615
PERFORMANCE REPORT BASED ON FLEXIBLE BUDGETING

Budget Actual Variance

(28,000 units) (28,000 units)
Sales ($150/unit) $4,200,000 $4,250,000 $50,000 F
Direct materials:
Lumber ($20/unit) 560,000 585,000 25,000 U
Paint ($4/unit) 112,000 108,000 4,000 F
Direct labor:
Cutting ($3.75/unit) 105,000 120,000 15,000 U
Assembly ($2.40/unit) 67,200 72,000 4,800 U
Variable FOH ($6.93/unit) 194,040 206,823 12,763 U
Contribution Margin $3,161,760 $3,158,177 $3,583 U
Fixed FOH and S & A expense 773,825 770,550 3,275 F
Operating income $2,387,935 $2,387,627 $308 U
FLEXIBLE BUDGETING

Original Actual
Budget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs
Indirect labor $ 40,000 $ 34,000 $6,000 F
Indirect materials 30,000 25,500 4,500 F
Power 5,000 3,800 1,200 F
Since cost variances are favorable, have
Fixed costs
we done a good job controlling costs?
Depreciation 12,000 12,000 0
Insurance 2,000 2,000 0
Total overhead costs $ 89,000 $ 77,300 $11,700 F
FLEXIBLE BUDGETING

How much of
I don’t think I can the favorable cost
answer the question variance is due to lower
using the original activity, and how much is due
budget. to good cost control?
FLEXIBLE BUDGETING

How much of
I don’t think I can the favorable cost
answer the question variance is due to lower
using the original activity, and how much is due
budget. to good cost control?

To answer the question, we must

the budget to the actual level of activity.
FLEXIBLE BUDGETING

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.
FLEXIBLE BUDGETING
Show expenses that should have
occurred at the actual level of
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.

FLEXIBLE BUDGETING

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. le
ab
ri
 Total fixed costs remain Va
unchanged within the Fixed
relevant range.
PREPARING THE FLEXIBLE BUDGET FOR FACTORY OVERHEAD

 The standard production level must first be

determined.
 The manufacturing capacity must be
determined.
1. Theoretical capacity
2. Practical capacity
3. Normal capacity
SEMIFIXED COSTS

 Semifixed costs are

those that generally
remain the same in
dollar amount through
a wide range of
activity, but increase
when production
exceeds certain limits.
SEMIVARIABLE COSTS

 Semivariable costs are

those that may change
with production but not
necessarily in direct
proportion.
FLEXIBLE BUDGETING

Let’s prepare
budgets for
Barton, Inc.
FLEXIBLE BUDGETING
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Units of Activity Variable 8,000 10,000 12,000
Variable costs
costs are
are expressed
expressed as
as aa constant
constant
Variable costs amount
amount per
per hour.
hour.
Indirect labor 4.00 In
In the
the $original
32,000 budget,
original budget, indirect
indirect labor
labor waswas
Indirect material 3.00 $40,000
$40,000 for
for 10,000
10,000 hours
24,000 hours resulting
resulting in
in aa rate
rate
Power 0.50 of
of $4.00
4,000 $4.00 per
per hour.
hour.
Total variable cost $ 7.50 $ 60,000
Fixed costs
Depreciation $12,000
Insurance 2,000
Total fixed cost
Total overhead costs
FLEXIBLE BUDGETING
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 $ 32,000 $ 40,000 $ 48,000
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost $ 7.50 $ 60,000 $ 75,000 $ 90,000
Fixed costs
Depreciation $12,000 $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000 2,000
Total fixed cost $ 14,000 $ 14,000 $ 14,000
Total overhead costs $ 74,000 $ 89,000 $ 104,000
FLEXIBLE BUDGETING
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 $ 32,000 $ 40,000 $ 48,000
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost $ 7.50 $ 60,000 $ 75,000 $ 90,000
Fixed costs
Depreciation $12,000 $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000 2,000
Total fixed cost $ 14,000 $ 14,000 $ 14,000
Total
Total variable
Total variable cost
overhead cost == $7.50
costs $7.50 per
per unit
unit ×× budget
budget level
level in
$ 74,000 in units
units
$ 89,000 $ 104,000
FLEXIBLE BUDGETING
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs Fixed costs are expressed as a total
Indirect labor 4.00 amount$that does not
32,000 change within
$ 40,000 the
$ 48,000
Indirect material 3.00 relevant
24,000 range 30,000
of activity. 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost $ 7.50 $ 60,000 $ 75,000 $ 90,000
Fixed costs
Depreciation $12,000 $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000 2,000
Total fixed cost $ 14,000 $ 14,000 $ 14,000
Total overhead costs $ 74,000 $ 89,000 $ 104,000
FLEXIBLE BUDGETING
PERFORMANCE REPORT

Cost Total
Formula Fixed Flexible Actual
Per Hour Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Variable costs
Indirect labor $ 4.00 $ 32,000 $ 34,000 $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable costs $ 7.50 $ 60,000 $ 63,300 $ 3,300 U
Fixed Costs
Depreciation $12,000 $ 12,000 $ 12,000 0
Insurance 2,000 2,000 2,000 0
Total fixed costs $ 14,000 $ 14,000 0
Total overhead costs $ 74,000 $ 77,300 $ 3,300 U
FLEXIBLE BUDGETING
PERFORMANCE REPORT

Cost Total
Formula Fixed Flexible Actual
Indirect labor and
Per indirect
Hour Costs Budget Results Variances
material have unfavorable
Units variances
of Activitybecause actual costs 8,000 8,000 0
are more than the flexible
Variable costs
budget costs.
Indirect labor $ 4.00 $ 32,000 $ 34,000 $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable costs $ 7.50 $ 60,000 $ 63,300 $ 3,300 U
Fixed Costs
Depreciation $12,000 $ 12,000 $ 12,000 0
Insurance 2,000 2,000 2,000 0
Total fixed costs $ 14,000 $ 14,000 0
Total overhead costs $ 74,000 $ 77,300 $ 3,300 U
FLEXIBLE BUDGETING
PERFORMANCE REPORT

Cost Total
Formula Fixed Flexible Actual
Per Hour Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Power
Power has
has aa favorable
favorable variance
variance
Variable costs
because
because the
the actual
actual cost
cost is
is less
less
Indirect
than labor
than the
the flexible $ 4.00
flexible budget
budget cost.
cost. $ 32,000 $ 34,000 $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable costs $ 7.50 $ 60,000 $ 63,300 $ 3,300 U
Fixed Costs
Depreciation $12,000 $ 12,000 $ 12,000 0
Insurance 2,000 2,000 2,000 0
Total fixed costs $ 14,000 $ 14,000 0
Total overhead costs $ 74,000 $ 77,300 $ 3,300 U
SERVICE DEPARTMENT BUDGETS AND VARIANCES

 Expenses are estimated at different levels of production, a

standard rate for application of service department
expenses to production departments is determined based
on the type of service and usage by the production
departments.
 Production departments are charged with service
department expenses at a standard rate, using their actual
activity base.