Chapter 4

Standard Costing,
Flexible Budgeting
and Variance Analysis
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Budgetary Control and Reporting
Budgets are an important cost control tool. Actual
results are compared with budgets and differences
are investigated and analyzed.
 Develop the budget
from planned objectives.

 Revise  Compare
Management uses
objectives actual to
budgets to monitor
and prepare budget and
and control
a new analyze any
operations.
budget. differences.

 Take corrective and

strategic actions.

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 Fixed Budget Performance Report
A fixed budget, also called a static budget, is based on a single
predicted amount of sales or other activity measure.

If unit sales are higher, should U = Unfavorable

we expect
Optel costs to be variance
higher?
Fixed Budget Performance Actual cost is greater
Report
How much of the higher costs are because of higher unit sales?
For the than31,budgeted
Month Ended January 2015 cost.
Fixed Actual
Budget Results Variances
Sales: In units 10,000 12,000
In dollars $ 100,000 $ 125,000 $ 25,000 F
Cost of goods F = Favorable
sold variance$ 58,100
$ 49,000 $ 9,100 U
Actual
Selling revenue and income
expenses 13,000 are greater
15,100 2,100 U
Gen. &than budgeted
admin. revenue
expenses and income.
26,000 26,400 400 U
Total expenses $ 88,000 $ 99,600 $ 11,600 U
Income from operations $ 12,000 $ 25,400 $ 13,400 F

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Purpose of Flexible Budgets
Show revenues and 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.

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 Preparation of Flexible Budgets
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. b le
ri a
– Total fixed costs remain Va
Fixed
unchanged within the
relevant range.

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 Preparation of Flexible Budgets
Variable costs are a constant amount per unit.
Optel
Flexible Budgets
For the Month Ended January 31, 2015
Flexible Budget
Variable Total
Amount Fixed Flexible Budget for Unit Sales of
per Unit Cost 10,000 12,000 14,000
Sales: $ 10.00 $ 100,000 $ 120,000 $ 140,000
Total variable costs 4.80 48,000 57,600 67,200
Contribution margin $ 5.20 $ 52,000 $ 62,400 $ 72,800
Total fixed costs $ 40,000 40,000 40,000 40,000
Income from operations $ 12,000 $ 22,400 $ 32,800

Total variable cost = $4.80 per unit × budget level in units

P1 Total Fixed costs do not change within the relevant range. 6

 Flexible Budget Performance Report
A flexible budget performance report compares actual performance and budgeted
performance based on actual sales. In Optel’s case, January’s sales are 12,000 units.

Optel
Favorable sales variance indicates that the average
Flexible Budget Performance Report
selling price
For the was
Month greater
Ended than
January $10.00 per unit.
31, 2015
Budget Actual
Variable Total for for
Amount Fixed 12,000 12,000
per Unit Cost Units Units Variances
Sales (12,000 units) $ 10.00 $ 120,000 $ 125,000 $ 5,000 F
Total variable costs 4.80 57,600 59,400 1,800 U
Contribution margin $ 5.20 $ 62,400 $ 65,600 $ 3,200 F
Total fixed costs $ 40,000 40,000 40,200 200 U
Income from operations $ 22,400 $ 25,400 $ 3,000 F

Favorable Unfavorable
variance because favorable indicate
cost variances sales variance
costs is
P1 greater than unfavorable
are greater costfor
than expected variances.
12,000 units.
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 Standard Costs
Standard costs can be used in a flexible budgeting system to enable
management to better understand the reasons for variances

Based on carefully
predetermined amounts.

Used for planning materials,

labor, and overhead
Standard
requirements.
costs are
The expected level of
performance.

Benchmarks for measuring

C1 performance.
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 Identifying Standard Costs
Managerial accountants, engineers, personnel administrators, and other
managers combine their efforts to set standard costs.

Practical standards should be set at levels that are

currently attainable with reasonable and efficient effort.

Managerial
Engineer Accountant

Human
Production Resources
Manager Manager

Ideal standards, that are based on perfection, are

unattainable and discouraging to most employees.
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 Setting Standard Costs
Price Direct Quantity
Standard Materials Standards
s

Rate Direct Time

Standards Labor Standards

Rate Variable Activity

Standards Overhead Standards
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 Setting Standard Costs
The standard costs of direct materials, direct labor, and
overhead for one bat, manufactured by ProBat, are
shown below.
This is called a standard cost card.

These standard cost amounts are then used to

prepare manufacturing budgets for a budgeted level
C1 of production.
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 Cost Variances
This variance is
This variance is unfavorable A standard cost variance
favorable (F)
(U) because the actual cost is the amount by which
because
exceeds the standard cost. an actual the
cost differs from
actual cost
the standard cost.
is less than the
standard cost.
Standard cost
$ Amount

Direct
Materials Direct
Labor Manufacturing
Overhead

C2 Type of Product Cost 12

 Cost Variance Analysis

• Variance analysis involves preparing a standard cost performance

report and comparing actual costs with standard costs.
• We then investigate variances by asking for explanations and
possible causes for the variances.
• We should correct problems that caused unfavorable variances
and possibly adopt and reward the practices that resulted in
favorable variances.
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 Cost Variance Computation
Management needs information about the factors causing a cost
variance, but first it must properly compute the variance. In its
most simple form, a cost variance (CV) is computed as:

Cost Variance (CV) = Actual Cost (AC) - Standard Cost (SC)

where:
Actual Cost (AC) = Actual Quantity (AQ) x Actual Price (AP)
Standard Cost (SC) = Standard Quantity (SQ) x Standard Price (SP)

• Actual quantity (AQ) is the input • Actual price (AP) is the actual
(material or labor) used to manufacture amount paid to acquire the input
the quantity of output. (material or labor).
• Standard quantity (SQ) is the • Standard price (SP) is the
standard input for the quantity of standard price.
C2
output.
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 Cost Variance Computation
Two main factors cause a cost variance:

Cost Variance

Price Variance Quantity Variance

The difference between The difference between

the actual price and the the actual quantity and
standard price. the standard quantity.

To assess the impacts of these two factors in a cost

C2 variance, let’s look at the model on the next slide.
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 Cost Variance Computation
Standard quantity is the quantity that should
have been used for the actual good output.

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Standard price is the amount that should
C2 have been paid for the resources acquired.16
 Cost Variance Computation
Actual Cost Standard Cost
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

(AP - SP) x AQ (AQ - SQ) x SP

AQ = Actual Quantity SP = Standard Price
AP = Actual Price SQ = Standard Quantity

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 Computing Materials
and Labor Variances
G-Max Company makes golf club heads with
the following standard cost information:

Direct materials (0.5 lb. per unit at $20 per lb.) $ 10.00
Direct labor (1.0 hrs. per unit at $8 per hr.) 8.00
Total standard direct cost per unit $ 18.00

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 Materials Cost Variances
During May, G-Max produced 3,500 club heads using
1,800 pounds of material. G-Max paid $21.00 per
pound for the material.
Compute the material price and quantity variances.

Direct materials (0.5 lb. per unit at $20 per lb.) $ 10.00
Direct labor (1.0 hrs. per unit at $8 per hr.) 8.00
Total standard direct cost per unit $ 18.00

Use this information to compute the

material price and quantity variances
before you go to the next slide.
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 Materials Cost Variances
SQ = 3,500 units × 0.5 lb. per unit = 1,750 lbs.
Actual Cost Standard Cost
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price
1,800 lbs. 1,800 lbs. 1,750 lbs.
× × ×
$21.00 per lb. $20.00 per lb. $20.00 per lb.
$37,800 $36,000 $35,000

Price Variance Quantity Variance

$1,800 Unfavorable
+ $1,000 Unfavorable
P2 $2,800 Total Cost Variance (U)
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 Materials Cost Variances
Who is responsible for material cost variances??

I am not responsible for You used too much material because of

this unfavorable material poorly trained workers and poorly
quantity variance. maintained equipment.
You purchased cheap Also, your poor scheduling requires me
material, so my people to rush order material at a higher price,
had to use more of it. causing unfavorable price variances.

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 Labor Cost Variances
Instead of price and quantity, for direct labor we use
the terms rate and hours.
Actual Cost Standard Cost

Actual Hours Actual Hours Standard Hours

× × ×
Actual Rate Standard Rate Standard Rate

*NEW *Rate Variance *Efficiency Variance

AH(AR - SR) SR(AH - SH)
AH = Actual Hours SR = Standard Rate
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AR = Actual Rate SH = Standard Hours
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 Labor Cost Variances
During May, G-Max produced 3,500 club heads working
3,400 hours. G-Max paid an average of $8.30 per
hour for the hours worked.
Compute the labor rate and efficiency variances.

Direct materials (0.5 lb. per unit at $20 per lb.) $ 10.00
Direct labor (1.0 hrs. per unit at $8 per hr.) 8.00
Total standard direct cost per unit $ 18.00

Use this information to compute the

labor rate and efficiency variances
before you go to the next slide.
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 Labor Cost Variances
SQ = 3,500 units × 1.0 hour per unit = 3,500 hours.
Actual Cost Standard Cost
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
3,400 hours. 3,400 hours 3,500 hours
× × ×
$8.30 per hour. $8.00 per hour. $8.00 per hour.
$28,220 $27,200 $28,000

Rate Variance Efficiency Variance

$1,020 Unfavorable
+ $800 Favorable
P2 $220 Total Cost Variance (U)
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 Labor Cost Variances
Evaluating Labor Cost Variances
One possible explanation of G-Max’s labor rate and efficiency
variances is the use of workers with different skill levels.

Using highly paid skilled workers

to
perform unskilled tasks results in
an unfavorable rate variance.
High skill, However, fewer labor hours Low skill,
high rate might be required for the work low rate
resulting in a favorable
efficiency variance.

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 Labor Cost Variances
Who is responsible for material cost variances??
Production managers who make work assignments
are generally responsible for labor cost variances.

I am not responsible for the You used too much time

unfavorable labor efficiency
because of poorly
variance.
trained workers and
You purchased cheap material, poor supervision.
so it took more time to process it.

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 Overhead Standards
and Variances
Recall that overhead costs are assigned to
products and services using a
predetermined overhead rate (POHR):
Estimated total overhead costs
POHR =
Estimated activity

Assigned Overhead = POHR × Standard Activity

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 Setting Overhead Standards
Standard overhead costs are the overhead amounts expected to
occur at a certain activity level.
To allocate overhead costs to products or services, management
needs to establish the standard overhead cost rate.

Contains a fixed Contains a variable

overhead rate which Standard unit rate which stays
declines as activity Overhead constant at all levels
level increases. Rate of activity.
Function of activity level
chosen to determine rate.

Flexible budgets, showing budgeted amount of overhead for

various levels of activity, are used to analyze overhead costs.
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 Flexible Overhead Budgets
(Flexible budgets for overhead prepared at several levels of activity)

G-Max predicted an 80 percent activity level.

This standard G-Max
overhead rate will Flexible Overhead Budgets
be used in For the Month Ended May 31, 2015
computing overhead
cost variances. Variable Total Flexible Budget at Different
Amount Fixed Percentages of Monthly Capacity
per Unit Cost 70% 80% 90% 100%
Production in units 3,500 4,000 4,500 5,000
Total variable costs $ 1.00 $3,500 $4,000 $4,500 $5,000
Total fixed costs $4,000 4,000 4,000 4,000 4,000
Total factory overhead $7,500 $8,000 $8,500 $9,000
Standard direct labor hours 3,500 4,000 4,500 5,000
Predetermined OH rate per
standard direct labor hour $ 2.14 $ 2.00 $ 1.89 $ 1.80

P3
Standard overhead rate is: $8,000 ÷ 4,000 DL hours = $2.00 per DL hour
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Computing Overhead Cost Variances
When standard costs are used, a company applies
overhead to the units produced using the predetermined
standard overhead rate.
The difference between the total overhead cost applied to products and
the total overhead cost actually incurred is called an
overhead cost variance. It’s defined as:
Overhead cost Actual overhead Standard overhead
variance = incurred – applied
(OCV) (AOI) (SOA)

Ex: During May, G-Max produced 3,500 club heads working 3,400 hours.
G-Max budgeted for 4,000 units (80%).
Actual variable overhead was $3,650 and actual fixed overhead was $4,000.
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 Total Overhead Cost Variance
Ex: During May, G-Max produced 3,500 club heads working 3,400 hours.
G-Max budgeted for 4,000 units (80%).
Actual variable overhead was $3,650 and actual fixed overhead was $4,000.

Overhead cost Actual overhead Standard overhead

variance = incurred – applied
(OCV) (AOI) (SOA)

(OCV) = $3,650 + $4,000 – 3,500 DLH × $2.00 per DLH

(OCV) = $7,650 – $7,000
(OCV) = (unfavorable ) $650

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End of Chapter 4

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