Chapter 15 - Flexible budgets. variances and management control I Flashcards
1 Describe the difference between a static budget and a flexible budget
A static budget is a budget that is based on one level of output; when variances are calculated at the end of the accounting period, no adjustments are made to the amounts in the static budget. A static budget is developed at the start of the period based on the planned output level for the period.
A flexible budget is a budget that is developed using budgeted revenue or cost amounts; when variances are calculated, the budgeted amounts are adjusted (flexed) to recognise the actual level of output (not the actual level of the cost driver). A flexible budget is calculated at the end of the period when the actual output is known. Flexible budgets help managers gain more insight into the causes of variances than do static budgets.
What is a favourable and an unfavourable variance?
Favourable variance - F- is a variance that increases operating income relative to the budgeted amount
Unfavourable variance - U - is a variance that decreases operating income relative to the budgeted amount
2 Illustrate how a flexible budget can be developed
A five-step procedure can be used to develop a flexible budget.
Step 1: Determine the budgeted selling price per unit, the budgeted variable costs per unit, and the budgeted fixed costs
Step 2: Determine the actual quantity of the revenue driver
Step 3: Determine the flexible budget for revenue based on the budgeted unit revenue and the actual quantity of the revenue driver (budgeted selling price multiplied by actual quantity of revenue driver)
Step 4: Determine the actual quantity of the cost driver(s)
Step 5: Determine the flexible budget for costs based on the budgeted unit variable costs and fixed costs and the actual quantity of the cost driver(s)
2 What are flexible-budget and sales-volume variances? And why is the flexible-budget variance for revenues sometimes called the selling-price variance?
The static-budget variance can be broken into a flexible-budget variance and a sales-volume variance
The sales-volume variance is the difference between the flexible-budget amount and the static-budget amount. It arises because the actual output units differ from the budgeted output units.
The flexible-budget variance is the difference between the actual result and the flexible-budget amount. It arises because the actual selling price, unit variable costs, and fixed costs differ from the budgeted amounts
The flexible-budget variance pertaining to revenues is often called a selling-price variance because it arises solely from differences between the actual selling price and the budgeted selling price
How can we obtain budgeted input prices and quantities, and what are the advantages and disadvantages of the methods?
Budgeted input prices and input quantities can be developed from past data (with or without adjustments) or by developing standards based on time and motion studies, engineering studies, and so on (usually expressed on a per unit basis).
The limitations of past data are (a) past data include past inefficiencies and (b) past data do not incorporate any expected changes planned to occur in the budget period
The advantages of using standard amounts are that (a) they can exclude past inefficiencies and (b) they can take into account expected changes in the budget period.
What are standard input and standard cost and what do we use them for?
Standard input - a carefully predetermined quantity of input required for one unit of output
Standard cost - a carefully predetermined costs. Can relate to units of inputs or units of outputs
Budgeted cost per unit = standard input allowed*standard cost per input unit
3 How do we interpret the price and efficiency variances for direct-cost input categories?
The computation of price variances and efficiency variances helps managers gain insight into two different (but not independent) aspects of performance.
Price variances focus on the difference between actual and budgeted input prices.
Efficiency variances focus on the difference between actual inputs used and the budgeted inputs allowed for the actual output achieved.
The breakdown of the flexible-budget variance into its price and efficiency components is important when evaluating individual managers.
This separate computation of the price variance enables the efficiency variance to be calculated using budgeted input process - thus judgements about efficiency are not affected by whether the actual input prices differ from budgeted input prices
A word of caution, however, is appropriate as the causes of price and efficiency variances can be interrelated. For this reason, do not interpret these variances in isolation from each other.
How do we compute price variances and efficiency variances (and what is the sum of the two)?
Price variance = (actual price of input - budgeted price of input) * actual quantity of input
Efficiency variance = (actual quantity of input used - budgeted quantity of input allowed for actual output units achieved) * budgeted price of input
The sum of the price variance and the efficiency variance equals the flexible-budget variance
4 Explain why purchasing performance measures should focus on more factors than just price variances for inputs and describe two attributes of performance that are commonly measured
Effectiveness - the degree to which a predetermined objective or target is met
Efficiency - the relative amount of inputs used to achieve a given level of output
Price variances capture only one aspect of a manager’s performance. Other aspects include the quality of the inputs the manager purchases and his or her ability to get suppliers to deliver on time.
If any single performance measure (for example, a labour efficiency cost variance or a consumer rating report) receives excessive emphasis, managers tend to make decisions that maximise their own reported performance in terms of that single performance measure. Such actions may conflict with the organisation’s overall goals. This faulty perspective on performance arises because top management has designed a performance measurement and reward system that does not adequately emphasise total organisational objectives.
5 Describe how the continuous improvement theme can be integrated into variance analysis
Managers can use continuous improvement budgeted costs in their accounting system to highlight to all employees the importance of continuously seeking ways to reduce total costs and learning from variance investigations to improve organisational performance.
Continuous improvement budgeted cost is a budgeted cost that is successively reduced over succeeding time periods
Improvement opportunities can be much easier to identify when products have just started in produc
When should variances be investigated?
Can be based on subjective judgements or rules of thumb
For some items a small variance may prompt a swift follow-up
For other items, a minimum euro variance or a certain percentage of variance from budget may be necessary to prompt an in-depth investigation.
Therefore, rules such as ‘investigate all variances exceeding €5000 or 25% of budgeted cost, whichever is lower’ are common.
Variance analysis is subject to the same cost–benefit context test as all other phases of a management control system.
Practically, managers realise that the budget is a band or range of possible acceptable outcomes and they consequently expect variances to fluctuate randomly within certain normal limits.
6 How can we perform variance analysis in activity-based costing systems?
The Level 1, 2 and 3 framework can be applied to variance analysis of activity costs (such as set-up costs) to gain insight into why actual activity costs differ from those in the static budget or flexible budget.
Interpreting cost variances for different activities requires an understanding of whether the costs are output-unit driven or are of a batch-level, product-sustaining or facility-sustaining kind.
If we are dealing with a batch-level cost, the flexible-budget quantity calculations should be focused at the batch level
If a cost had been a product-sustaining cost, the flexible-budget quantity computations would focus at the product-sustaining level.
How can we dispose of price and efficiency variances?
The methods described in chapter 3 to recognise under- or overallocated manufacturing overhead at the end of a period:
The adjusted allocation-rate approach, which adjusts every job cost record for the difference between the allocated and actual indirect cost amounts;
The proration approach, which makes adjustments to one or more of the following end-of period account balances: materials, work in progress, finished goods and cost of goods sold.
7 Describe benchmarking and how it can be used by managers in variance analysis
The budgeted amounts in variances formulas discussed in this chapter are benchmarks (points of reference from which comparisons may be made)
Benchmarking is the continuous process of measuring products, services and activities against the best levels of performance. Benchmarking enables companies to use the best levels of performance within their organisation or by competitors or other external companies to gauge the performance of their own managers.
Cost benchmark reports are attention directing in nature
What is the static-budget variance?
Actual results - Static budget = Static-budget variance
