Budgeting

Purposes of Budgeting Systems

Budget
a detailed plan, expressed in financial terms, that specifies how resources will be acquired and used during a specified period of time.
Planning Controlling Profit and Operations Evaluating Performance and Providing Incentives

Types of Budgets
Detail Budget
Detail Budget Detail Budget

Production

Master Budget
Covering all phases of a companys operations.

Sales of Services or Goods

Exh. 9-1

Ending Inventory Budget Raw Materials, Work in Process and Finished Goods

Production Budget

Materials purchase budget

Direct Labor Budget

Overhead Budget

Selling and Administrative Budget

Capital budget

Financing budget

Cash Budget

Budgeted Financial Statements

Sales Budget
Breakers, Inc. is preparing budgets for the quarter ending June 30, 2012. Budgeted sales for the next five months are:
April May June July August 20,000 units 50,000 units 30,000 units 25,000 units 15,000 units.

The selling price is $10 per unit.

Sales Budget
April Budgeted sales (units) 20,000 Selling price per unit $ 10 Total Revenue $200,000 May 50,000 $ 10 $ June 30,000 10 $ Quarter 100,000 10

$500,000

$300,000

$ 1,000,000

Production Budget
Sales Budget Production Budget

Production must be adequate to meet budgeted sales and provide for sufficient ending inventory.

Production Budget
The management of Breakers, Inc. wants ending finished goods inventory to be equal to 20% of the following months budgeted sales in units. On March 31, 4,000 units were on hand.

Lets prepare the production budget.

Production Budget
Sales in units Add: desired end. inventory Total needed Less: beg. inventory Units to be produced April 20,000 May June Quarter

From sales budget

Production Budget
Sales in units Add: desired end. inventory Total needed Less: beg. inventory Units to be started April 20,000 10,000 30,000 May June Quarter
50,000 units 20% 10,000 units May sales Desired percent Desired inventory

Production Budget
Sales in units Add: desired end. inventory Total needed Less: beg. inventory Units to be started April 20,000 10,000 30,000 4,000 26,000 May June Quarter

March 31 ending inventory

Production Budget
Sales in units Add: desired end. inventory Total needed Less: beg. inventory Units to be started April 20,000 10,000 30,000 4,000 26,000 May 50,000 6,000 56,000 10,000 46,000 June Quarter

Production Budget
Sales in units Add: desired end. inventory Total needed Less: beg. inventory Units to be started April 20,000 10,000 30,000 4,000 26,000 May 50,000 6,000 56,000 10,000 46,000 June 30,000 5,000 35,000 6,000 29,000 Quarter 100,000 5,000 105,000 4,000 101,000

Direct-Material Budget
At Breakers, five pounds of material are required per unit of product.

Management wants raw materials on hand at the end of each month equal to 10% of the following months production. On March 31, 13,000 pounds of material are on hand. Material cost $.40 per pound. Lets prepare the direct materials budget.

Direct-Material Budget
Production in units Materials per unit Production needs Add: desired ending inventory Total needed Less: beginning inventory Materials to be purchased April 26,000 May 46,000 June 29,000 Quarter 101,000

From our production budget

Direct-Material Budget
Production in units Materials per unit Production needs Add: desired ending inventory Total needed Less: beginning inventory Materials to be purchased April 26,000 5 130,000 23,000 153,000 May 46,000 5 230,000 June Quarter

10% of the following months production

Direct-Material Budget
Production in units Materials per unit Production needs Add: desired ending inventory Total needed Less: beginning inventory Materials to be purchased April 26,000 5 130,000 23,000 153,000 13,000 140,000 May 46,000 5 230,000 June 29,000 5 145,000 Quarter 101,000 5 505,000

March 31 inventory

Direct-Material Budget
Production in units Materials per unit Production needs Add: desired ending inventory Total needed Less: beginning inventory Materials to be purchased April 26,000 5 130,000 23,000 153,000 13,000 140,000 May 46,000 5 230,000 14,500 244,500 23,000 221,500 June 29,000 5 145,000 11,500 156,500 14,500 142,000 Quarter 101,000 5 505,000 11,500 516,500 13,000 503,500

Direct-Material Budget
July Production

April 25,000 May Sales in units Add: desired ending inventory Production in units 26,000 3,000 46,000 Total units needed unit Materials per 5 28,000 5 Less: beginning inventory 130,000 5,000 230,000 Production needs Production in units 23,000

June 29,000 5 145,000

Quarter 101,000 5 505,000 11,500 516,500 13,000 503,500

Add: desired ending inventory 23,000 14,500 11,500 Total needed 153,000 244,500 156,500 Less: beginning June Ending Inventory inventory 13,000 23,000 14,500 July be 23,000 Materials toproduction in units Materials per unit 5 purchased 140,000 221,500 142,000 Total units needed 115,000 Inventory percentage 10% June desired ending inventory 11,500

Direct-Labor Budget
At Breakers, each unit of product requires 0.1 hours of direct labor.

The Company has a no layoff policy so all employees will be paid for a minimum of 40 hours of work each week.
In exchange for the no layoff policy, workers agreed to a wage rate of $8 per hour regardless of the hours worked (No overtime pay). For the next three months, the direct labor workforce will be paid for a minimum of 3,000 hours per month. Lets prepare the direct labor budget.

Direct-Labor Budget
Production in units Direct labor hours Labor hours required Guaranteed labor hours Labor hours paid Wage rate Total direct labot cost April 26,000 May 46,000 June 29,000 Quarter 101,000

From our production budget

Direct-Labor Budget
Production in units Direct labor hours Labor hours required Guaranteed labor hours Labor hours paid Wage rate Total direct labot cost April 26,000 0.10 2,600 May 46,000 0.10 4,600 June 29,000 0.10 2,900 Quarter 101,000 0.10 10,100

Direct-Labor Budget
Production in units Direct labor hours Labor hours required Guaranteed labor hours Labor hours paid Wage rate Total direct labot cost April 26,000 0.10 2,600 3,000 3,000 May 46,000 0.10 4,600 3,000 4,600 June 29,000 0.10 2,900 3,000 3,000 Quarter 101,000 0.10 10,100

10,600

This is the greater of labor hours required or labor hours guaranteed.

Direct-Labor Budget
Production in units Direct labor hours Labor hours required Guaranteed labor hours 3,000 Labor hours paid 3,000 Wage rate $ 8 Total direct labot cost $ 24,000 April 26,000 0.10 2,600 May 46,000 0.10 4,600 3,000 4,600 $ 8 $ 36,800 June 29,000 0.10 2,900 3,000 3,000 $ 8 $ 24,000 Quarter 101,000 0.10 10,100

10,600 $ 8 $ 84,800

Overhead Budget
Here is Breakers Overhead Budget for the quarter.
April Indirect labor Indirect material Utilities Rent Insurance Maintenance $ 17,500 7,000 4,200 13,300 5,800 8,200 56,000 $ May 26,500 12,600 8,400 13,300 5,800 9,400 76,000 $ June 17,900 8,600 5,200 13,300 5,800 8,200 59,000 $ Quarter 61,900 28,200 17,800 39,900 17,400 25,800 $ 191,000

Selling and Administrative Expense Budget

At Breakers, variable selling and administrative expenses are $0.50 per unit sold. Fixed selling and administrative expenses are $70,000 per month. The $70,000 fixed expenses include $10,000 in depreciation expense that does not require a cash outflow for the month.

Selling and Administrative Expense Budget

Sales in units Variable S&A rate Variable expense Fixed S&A expense Total expense Less: noncash expenses Cash disbursements April 20,000 May 50,000 June 30,000 Quarter 100,000

From our Sales budget

Selling and Administrative Expense Budget

Sales in units Variable S&A rate Variable expense Fixed S&A expense Total expense Less: noncash expenses Cash disbursements April 20,000 $ 0.50 $ 10,000 70,000 80,000 May 50,000 $ 0.50 $ 25,000 70,000 95,000 June 30,000 $ 0.50 $ 15,000 70,000 85,000 Quarter 100,000 $ 0.50 $ 50,000 210,000 260,000

Selling and Administrative Expense Budget

Sales in units Variable S&A rate Variable expense Fixed S&A expense Total expense Less: noncash expenses Cash disbursements April 20,000 $ 0.50 $ 10,000 70,000 80,000 10,000 $ 70,000 May 50,000 $ 0.50 $ 25,000 70,000 95,000 10,000 $ 85,000 June 30,000 $ 0.50 $ 15,000 70,000 85,000 10,000 $ 75,000 Quarter 100,000 $ 0.50 $ 50,000 210,000 260,000 30,000 $ 230,000

Cash Receipts Budget

At Breakers, all sales are on account. The companys collection pattern is:
70% collected in the month of sale, 25% collected in the month following sale, 5% is uncollected.

The March 31 accounts receivable balance of $30,000 will be collected in full.

Cash Receipts Budget

Accounts rec. - 3/31 April sales 70% x $200,000 25% x $200,000 April $ 30,000 140,000 $ 50,000 May June Quarter $ 30,000 140,000 50,000

Total cash collections

$ 170,000

Cash Receipts Budget

Accounts rec. - 3/31 April sales 70% x $200,000 25% x $200,000 May sales 70% x $500,000 25% x $500,000 June sales 70% x $300,000 Total cash collections April $ 30,000 140,000 $ 50,000 350,000 $ 125,000 210,000 $ 335,000 May June Quarter $ 30,000 140,000 50,000 350,000 125,000 210,000 $ 905,000

$ 170,000

$ 400,000

Cash Disbursement Budget

Breakers pays $0.40 per pound for its materials.

One-half of a months purchases are paid for in the month of purchase; the other half is paid in the following month. No discounts are available.
The March 31 accounts payable balance is $12,000.

Cash Disbursement Budget

Accounts pay. 3/31 April purchases 50% x $56,000 50% x $56,000 April $ 12,000 28,000 $ 28,000 May June Quarter $ 12,000 28,000 28,000

Total cash payments for materials

$ 40,000

140,000 lbs. $.40/lb. = $56,000

Cash Disbursement Budget

Accounts pay. 3/31 April purchases 50% x $56,000 50% x $56,000 May purchases 50% x $88,600 50% x $88,600 June purchases 50% x $56,800 Total cash payments for materials April $ 12,000 28,000 $ 28,000 44,300 $ 44,300 28,400 $ 40,000 $ 72,300 $ 72,700 May June Quarter $ 12,000 28,000 28,000 44,300 44,300 28,400 $ 185,000

Cash Budget
Breakers:

Maintains a 12% open line of credit for $75,000.

Maintains a minimum cash balance of $30,000.

Borrows and repays loans on the last day of the month.

Pays a cash dividend of $25,000 in April.

Purchases $143,700 of equipment in May and $48,300 in June paid in cash. Has an April 1 cash balance of $40,000.

Cash Budget
Continued
April May June Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials Direct labor From our Cash Mfg. overhead Selling and admin. Receipts Budget Equipment purchase Dividends Total disbursements Excess (deficiency) of Cash available over disbursements Quarter

Cash Budget
Continued
April May June Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor Mfg. overhead Selling and admin. Equipment purchase Dividends From our Cash Total disbursements Excess (deficiency) of Disbursements Cash available over Budget disbursements Quarter

Cash Budget
Continued
April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead Selling and admin. Equipment purchase Dividends Total disbursements Excess (deficiency) of Cash available over disbursements May June Quarter

From our Direct Labor Budget

Cash Budget
Continued
April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. Equipment purchase Dividends Total disbursements Excess (deficiency) of Cash available over disbursements May June Quarter

From our Overhead Budget

Cash Budget
Continued
April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends Total disbursements Excess (deficiency) of Cash available over disbursements May June Quarter

From our Selling and Administrative Expense Budget

Cash Budget
Continued
April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends 25,000 Total disbursements 215,000 Excess (deficiency) of Cash available over disbursements $ (5,000) May June Quarter

To maintain a cash balance of $30,000, Breakers must borrow $35,000 on its line of credit.

Cash Budget
Financing and Repayment
April Excess (deficiency) of Cash available over disbursements Financing: Borrowing Repayments Interest Total financing Ending cash balance May June Quarter

$ (5,000) 35,000 35,000 $ 30,000

Ending cash balance for April is the beginning May balance.

April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends 25,000 Total disbursements 215,000 Excess (deficiency) of Cash available over of Excess (deficiency) disbursementsover $ (5,000) Cash available
disbursements Financing: Borrowing Repayments Interest Total financing Ending cash balance $ (5,000) 35,000 35,000 $ 30,000

May

June

Quarter

Cash Budget
Continued
April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends 25,000 Total disbursements 215,000 Excess (deficiency) of Cash available over disbursements $ (5,000) May $ 30,000 400,000 430,000 72,300 36,800 76,000 85,000 143,700 413,800 June Quarter

Breakers must borrow an addition $13,800 to maintain a cash balance of $30,000.

$ 16,200

Cash Budget
Financing and Repayment
April Excess (deficiency) of Cash available over disbursements Financing: Borrowing Repayments Interest Total financing Ending cash balance May June Quarter

$ (5,000) 35,000 35,000 $ 30,000

$ 16,200 13,800 13,800 $ 30,000

Cash Budget
Continued
April May Beginning cash balance $ 40,000 $ At the end of June, Breakers 30,000 Add: cash collections 170,000 has enough cash to repay 400,000 Total cash available 210,000 430,000 the $48,800 loan plus interest Less: disbursements at 12%. 40,000 Materials 72,300 Direct labor 24,000 36,800 Mfg. overhead 56,000 76,000 Selling and admin. 70,000 85,000 Equipment purchase 143,700 Dividends 25,000 Total disbursements 215,000 413,800 Excess (deficiency) of Cash available over disbursements $ (5,000) $ 16,200 June $ 30,000 335,000 365,000 72,700 24,000 59,000 75,000 48,300 279,000 Quarter

$ 86,000

Cash Budget
Financing and Repayment
April Excess (deficiency) of Cash available over disbursements Financing: Borrowing Repayments Interest Total financing Ending cash balance
Borrowing $ 35,000 13,800

May

June

Quarter

$ (5,000) 35,000 35,000 $ 30,000

$ 16,200 13,800 13,800 $ 30,000

$ 86,000

(48,800) (838) (49,638) $ 36,362

Annual Rate Interest 12% = $ 4,200 12% = 1,656

Months Interest Outstanding Expense 2 mths = $ 700 1 mth. = 138 $ 838

April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends 25,000 Total disbursements 215,000 April Excess (deficiency) of Excess (deficiency) Cash available over of Cash available disbursementsover $ (5,000) disbursements $ (5,000) Financing: Borrowing 35,000 Repayments Interest Total financing 35,000 Ending cash balance $ 30,000

May $ 30,000 400,000 430,000 72,300 36,800 76,000 85,000 143,700 413,800 May $ 16,200 $ 16,200
13,800 13,800 $ 30,000

June $ 30,000 335,000 365,000 72,700 24,000 59,000 75,000 48,300 279,000 June $ 86,000 $ 86,000

Quarter $ 40,000 905,000 945,000 185,000 84,800 191,000 230,000 192,000 25,000 907,800 Quarter $ 37,200 $ 37,200
48,800 (48,800) (838) (838) $ 36,362

(48,800) (838) (49,638) $ 36,362

Budgeted Income Statement

Cash Budget Budgeted Income Statement

After we complete the cash budget, we can prepare the budgeted income statement for Breakers.

Budgeted Ending Inventory

Manufacturing overhead is applied on the basis of direct labor hours.
Production costs per unit Direct materials Direct labor Manufacturing overhead Quantity Cost 5.00 lbs. $ 0.40 0.10 hrs. $ 8.00 0.10 hrs. $18.02 $ Total 2.00 0.80 1.80 4.60

$ Budgeted finished goods inventory Ending inventory in units Unit product cost Ending finished goods inventory

5,000 $ 4.60 $23,000

Total overhead $191,000 = $18.02 per hr.* Total labor hours 10,600 hrs.
*rounded

Budgeted Income Statement

Breakers, Inc. Budgeted Income Statement For the Three Months Ended June 30 Revenue (100,000 $10) Cost of goods sold (100,000 $4.60) Gross margin Operating expenses: Selling and admin. Expenses Interest expense Total operating expenses Net income $ 1,000,000 460,000 540,000 $ 260,000 838 $ 260,838 279,162

Budgeted Balance Sheet

Breakers reports the following account balances on June 30 prior to preparing its budgeted financial statements:

Land - $50,000 Building (net) - $148,000 Common stock - $200,000 Retained earnings (beginning of year) $46,400

Breakers, Inc. Budgeted Balance Sheet June 30

25%of June sales of $300,000 11,500 lbs. at $.40 per lb. 5,000 units at $4.60 per unit.

Current assets Cash Accounts receivable Raw materials inventory Finished goods inventory Total current assets Property and equipment Land Building Equipment Total property and equipment Total assets Accounts payable Common stock Retained earnings Total liabilities and equities

36,362 75,000 4,600 23,000 138,962

50,000 148,000 192,000 390,000 $ 528,962 $ 28,400 200,000 300,562 $ 528,962

Breakers, Inc. Budgeted Balance Sheet June 30 Current assets Cash Accounts receivable Raw materials inventory Finished goods inventory Total current assets Property and equipment Land Building Beginning balance $ 46,400 Equipment Add: net income 279,162 Total property and equipment Deduct: dividends Total assets (25,000) Ending balance $300,562 Accounts payable Common stock Retained earnings Total liabilities and equities

50% of June purchases of $56,800

36,362 75,000 4,600 23,000 138,962

50,000 148,000 192,000 390,000 $ 528,962 $ 28,400 200,000 300,562 $ 528,962

Flexible Budgets
Static budgets are prepared for a single, planned level of activity. Performance evaluation is difficult when actual activity differs from the planned level of activity.
Hmm! Comparing static budgets with actual costs is like comparing apples and oranges.

Static Budgets and Performance Reports

Static Budget Machine hours Variable costs Indirect labor Indirect materials Power Fixed costs Depreciation Insurance Total overhead costs 10,000 $ 40,000 30,000 5,000 12,000 2,000 $ 89,000 Actual Results 8,000 Variances 2,000 U

U = Unfavorable variance Cheese Company was unable to achieve the budgeted level of activity.

Static Budgets and Performance Reports

Static Budget Machine hours Variable costs Indirect labor Indirect materials Power Fixed costs Depreciation Insurance Total overhead costs 10,000 $ 40,000 30,000 5,000 12,000 2,000 $ 89,000 Actual Results 8,000 $ 34,000 25,500 3,800 12,000 2,000 $ 77,300 Variances 2,000 U $6,000 F 4,500 F 1,200 F 0 0 $11,700 F

Static Budgets and Performance Reports

Static Budget Machine hours Variable costs Indirect labor Indirect materials Power Fixed costs we done a good Depreciation Insurance 10,000 $ 40,000 30,000 5,000 Actual Results 8,000 $ 34,000 25,500 3,800 Variances 2,000 U $6,000 F 4,500 F 1,200 F 0 0 $11,700 F

Since cost variances are favorable, have job controlling costs? 12,000 12,000
2,000 $ 89,000 2,000 $ 77,300

Total overhead costs

Static Budgets and Performance Reports

I dont think I can answer this question using a static budget.

I do know that actual activity is below budgeted activity which is unfavorable.

But shouldnt variable costs be lower if actual activity is below budgeted activity?

Static Budgets and Performance Reports

The relevant question is . . .
How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?

To answer the question, we must the budget to the actual level of activity.

Preparing a Flexible Budget

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. Total fixed costs remain unchanged within the relevant range.
Fixed

Preparing a Flexible Budget

Variable Cost Per Hour Machine hours Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs 4.00 3.00 0.50 7.50 $12,000 2,000 Total Fixed Cost Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours 8,000 10,000 12,000

Note that the cost budgets are prepared using a cost behavior format, similar to variable costing.

Preparing a Flexible Budget

Variable Cost Per Hour Machine hours Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs 4.00 3.00 0.50 7.50 $12,000 2,000 Total Fixed Cost Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours 8,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000 10,000 12,000

Preparing a Flexible Budget

Variable Cost Per Hour Machine hours Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs 4.00 3.00 0.50 7.50 $12,000 2,000 Total Fixed Cost Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours 8,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000 10,000 $ 40,000 30,000 5,000 $ 75,000 $ 12,000 2,000 $ 14,000 $ 89,000 12,000 $ 48,000 36,000 6,000 $ 90,000 $ 12,000 2,000 $ 14,000 $ 104,000

Preparing a Flexible Budget

Variable Cost Per Hour Machine hours Variable costs Indirect labor Note: There is no Indirect material in the fixed costs. Power Total variable cost $ Fixed costs Depreciation Insurance Total fixed cost Total overhead costs 4.00 flex 3.00 0.50 7.50 $12,000 2,000 Total Fixed Cost Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours 8,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000 10,000 $ 40,000 30,000 5,000 $ 75,000 $ 12,000 2,000 $ 14,000 $ 89,000 12,000 $ 48,000 36,000 6,000 $ 90,000 $ 12,000 2,000 $ 14,000 $ 104,000

Flexible Budget Performance Report

Original actual results for Variable Total Cheese Company that Fixed Flexible we saw Cost Per Hour Costs Budget earlier.
Machine hours Variable costs Indirect labor $ Indirect material Power Total variable costs $ Fixed Expenses Depreciation Insurance Total fixed costs Total overhead costs 4.00 3.00 0.50 7.50 $12,000 2,000 Actual Results 8,000 $ 34,000 25,500 3,800 $ 63,300 $ 12,000 2,000 $ 14,000 $ 77,300 Variances 0

Flexible Budget Performance Report

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

Flexible Budget Performance Report

Indirect indirect material have Machine hours unfavorable variances Variable costs because costs Indirect labor actual4.00 $ are more Indirect material than the 3.00 Power flexible budget 0.50 costs.
Total variable costs $ Fixed Expenses Depreciation Insurance Total fixed costs Total overhead costs 7.50 $12,000 2,000 Variable Total Cost Fixed laborHour Costs Per and Flexible Budget 8,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000 Actual Results 8,000 $ 34,000 25,500 3,800 $ 63,300 $ 12,000 2,000 $ 14,000 $ 77,300 Variances 0 $ 2,000 U 1,500 U 200 F $ 3,300 U 0 0 0 $ 3,300 U

Flexible Budget Performance Report

Variable Cost Per Hour Machine hours Total Fixed Costs Flexible Budget 8,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000 Actual Results 8,000 $ 34,000 25,500 3,800 $ 63,300 $ 12,000 2,000 $ 14,000 $ 77,300 Variances 0 $ 2,000 U 1,500 U 200 F $ 3,300 U 0 0 0 $ 3,300 U

Power has a favorable Variable costs variance because the Indirect labor $ 4.00 actual cost is Indirect material less than 3.00 Power 0.50 the flexible budget cost.
Total variable costs $ Fixed Expenses Depreciation Insurance Total fixed costs Total overhead costs 7.50 $12,000 2,000

Handout 10 (a): Static and Flexible Budgetingd

Standard Costs, C-P-V, Flexible Budgets and Analysis of Standard Cost Variations
This example provides a comprehensive illustration of standard costing, flexible budgeting, and analysis of differences between budgeted and actual operating results.

Per Unit Standards, Product X:

Sales price Direct materials Direct labor Variable overhead Total variable cost Contribution margin Fixed overhead* Gross margin Quantity 1 lb. 2 hours 2 hours Price $ 10 $ 12 $ 15 $ 100 Total $ 10 $ 24 $ 30 $ 64 $ 36 $ 15 $ 21

2 hours

$ 7.50

* Budgeted annual fixed costs are $ 1,200,000. Budgeted production is 80,000 units. Budgeted direct labor hours are therefore 160,000 (2 x 80,000). Therefore, the fixed overhead rate per labor hour is $7.50 ($1,200,000 / 160,000 DLH).

Static budget and flexible budget

The static budget is prepared based on the companys budgeted output of 80,000 units, using standard sales prices and production costs. The flexible budget uses the same per-unit standards, at the companys actual output. In substance, the profit volume equation is an alternative way of expressing the firms flexible budget. Assume that the company has actual output of 100,000 units. The static and flexible budgets are as follows:

Item
Revenues Direct materials Direct labor Variable overhead Contribution Fixed overhead Operating profit

Static budget (80,000 units)

$100 x 80,000 u. $ 10 x 80,000 u. $ 24 x 80,000 u. $ 30 x 80,000 u. $ 36 x 80,000 u. $ 8,000,000 $ 800,000 $ 1,920,000 $ 2,400,000 $ 2,880,000 $ 1,200,000 $ 1,680,000

Flexible budget (100,000 units)

$100 x 100,000 u. $ 10,000,000 $ 10 x 100,000 $ 1,000,000 u. $ 24 x 100,000 u. $ 2,400,000 $ 30 x 100,000 u. $ 3,000,000 $ 36 x 100,000 u. $ 3,600,000 $ 1,200,000 $ 2,400,000

The next step is a comparison of the firms actual revenues and expenses to the amounts allowed in the flexible budget. Actual results Flexible budget Item (100,000 units) (100,000 units) Variance
Revenues Direct mat. Direct labor Variable overhead Contribution Fixed overhead Operating profit $100 x 100,000 u. $ 11 x 105,000 lbs. $ 10 x 210,000 dlh. $10,000,000 $ 1,155,000 $ 2,100,000 $ 3,400,000 $ 3,345,000 $ 1,400,000 $ 1,945,000 $100 x 100,000 u. $10 x 100,000 lbs. $12 x 200,000 dlh. $15 x 200,000 dlh. $36 x 100,000 u. $ 10,000,000 $ 1,000,000 $ 2,400,000 $ 3,000,000 $ 3,600,000 $ 1,200,000 $ 2,400,000 $ 0 $ 155,000 U $ 300,000 F $ 400,000 U $ 255,000 U $ 200,000 U $ 455,000 U

Note that the firms actual profit exceeds the profit in the firms original static budget by $ 265,000. The flexible budget, however, indicates that profits should have increased by $ 720,000 because of the increase in sales. For this reason, management requires as explanation for the shortfall of $ 455,000 ($ 720,000 - $ 265,000). The analysis of the source of this variation focuses on the variance column above. In a variable costing framework, the following seven variances are usually measured:

A. Prime cost variances: 1. Materials price variance. 2. Materials efficiency variance. 3. Labor rate variance. 4. Labor efficiency variance.

B. Overhead variances: 5. Variable overhead efficiency variance. 6. Variable overhead spending variance. 7. Fixed overhead spending variance. In an absorption costing framework, the following additional variance is measured: 8. Fixed overhead volume variance. (The economic interpretation of this variance is not the same as the interpretation of the other seven variances.)

A. Over-all reconciliation of budgeted and actual amounts: Static budget Actual results Total variance $ 1,680,000 $ 1,945,000 $ 265,000 Static budget profit Sales activity variance (fav) Flexible budget profit Actual profit Flexible budget variance (unfav) $ 1,680,000 $ 720,000 $ 2,400,000 $ 1,945,000 $ 455,000

B. Components of the flexible budget variance: Item Total Price* Quantity* Direct materials $ 155,000 UNF $ 105,000 UNF $ 50,000 UNF Direct labor $ 300,000 FAV $ 420,000 FAV $ 120,000 UNF Variable OH $ 400,000 UNF $ 250,000 UNF $ 150,000 UNF Fixed OH $ 200,000 UNF $ 200,000 UNF NA Total $ 455,000 UNF $ 135,000 UNF $ 320,000 UNF Fixed overhead volume variance $ 300,000 FAV Aggregate $ 155,000 UNF * For purposes of this table, the terms price, rate and spending variances are used as synonyms; also, the terms quantity, usage and efficiency are used as synonyms. C. Calculations of the variances shown in the previous table: Item Materials Labor VOH FOH FOH-Vol Price* Quantity* (11-10)*105,000=$ 105,000 U (105,000-100,000)*10=$ 50,000 (10-12)*210,000=$ 420,000 F (210,000-200,000)*12=$ 120,000 Plugged U (210,000-200,000)*15=$ 150,000 $ 200,000 over budget U 20,000u.*2DLH*$ 7.50=$300,000 F

U
U U

Handout 10(b) Industry and market share variances

Additional Variances In addition to the basic variances examined on the previous slides, many firms develop further disaggregations of sales activity variances. The total contribution margin variance is often disaggregated into three components: (1) contribution margin per unit, (2) industry and (3) market share variances. These variances are defined as follows:

Additional Variances Contribution margin per unit variance: The impact of the standard cost variances for materials, labor and variable overhead. Industry variance: The impact of the change in inventory sales, holding market share constant. Market share variance:The impact of the change in market share percentage, given the actual level of industry sales. Note: The sum of the industry and market share variances is equal to the sales activity variance.

Handout 10(b): Partition of the sales activity variance into industry and market share variances: The sales activity variance measures the change in the flexible budget total contribution margin that is due to the difference between the budgeted and actual level of sales. The sales activity variance may be partitioned into the portion due to changes in industry sales, and the portion due to changes in market share. Example: Consider the following information: Expected industry sales Expected market share Budgeted contribution margin Actual industry sales Actual market share Actual contribution margin 1,000,000 units 20% $ 10 per unit 1,100,000 units 15% $ 12 per unit

Expected industry sales Expected market share Budgeted contribution margin Actual industry sales Actual market share Actual contribution margin
Required: Determine the following amounts:

1,000,000 units 20% $ 10 per unit 1,100,000 units 15% $ 12 per unit

1. Variation between budgeted and actual total contribution margin. Budgeted contribution margin: ($10) (20% x 1,000,000u) = $2,000,000 Actual contribution margin: ($12) (15% x 1,100,000u) = $1,980,000 Variance: $ 20,000UNF

Expected industry sales Expected market share Budgeted contribution margin Actual industry sales Actual market share Actual contribution margin
Required: Determine the following amounts:

1,000,000 units 20% $ 10 per unit 1,100,000 units 15% $ 12 per unit

1. Variation between budgeted and actual total contribution margin. Budgeted contribution margin: ($10) (20% x 1,000,000u) = $2,000,000 Actual contribution margin: ($12) (15% x 1,100,000u) = $1,980,000 Variance: $ 20,000UNF
2. Portion of variation due to change in unit contribution margin. Total contribution margin variance = (ACM SCM) (AQ) = ($12 - $10) (165,000) = $ 330,000FAV

Expected industry sales Expected market share Budgeted contribution margin Actual industry sales Actual market share Actual contribution margin
Required: Determine the following amounts:

1,000,000 units 20% $ 10 per unit 1,100,000 units 15% $ 12 per unit

1. Variation between budgeted and actual total contribution margin. Budgeted contribution margin: ($10) (20% x 1,000,000u) = $2,000,000 Actual contribution margin: ($12) (15% x 1,100,000u) = $1,980,000 Variance: $ 20,000UNF
2. Portion of variation due to change in unit contribution margin. Total contribution margin variance = (ACM SCM) (AQ) = ($12 - $10) (165,000) = $ 330,000FAV

3. Portion of variation due to change in industry sales Change in industry sales: + 100,000u Impact on contribution margin: ($10) (20% x 100,000u) = $ 200,000FAV
4. Portion of variation due to change in market share

Impact of change in market share

= (SMS AMS) ($10 x 1,100,000u) = (.20 - .15) (11,000,000) = $ 550,000UNF