Chapter 7

Cost Accounting
Chapter 7:
Flexible Budgets, Direct-Cost Variances,
and Management Control
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Learning Objectives
1. Understand static budgets and static-budget variances
2. Examine the concept of a flexible budget and learn how to
develop it
3. Calculate flexible-budget variances and sales-volume
variances
4. Explain why standard costs are often used in variance analysis
5. Compute price variances and efficiency variances for direct
cost categories
6. Understand how managers use variances
7. Describe benchmarking and explain its role in cost
management
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Learning Objective
1. Understand static budgets and static-budget

variances
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Terms
• Variance: A variance is the difference between actual results
and expected performance. The expected performance is also
called budgeted performance, which is a point of reference for
making comparisons.
• Management by exception: This is the practice of focusing

management attention on areas that are not operating as
expected (such as a large shortfall in sales of a product) and
devoting less time to areas operating as expected.
• The static budget, or master budget, is based on the level of

output planned at the start of the budget period
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Cont..
• A flexible budget calculates budgeted revenues
and budgeted costs based on the actual output in
the budget period.
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Learning Objective 2
Examine the concept of a flexible budget and
learn how to develop it
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Steps of Developing a flexible budget
• Step 1: Identify the Actual Quantity of Output
• Step 2: Calculate the Flexible Budget for
Revenues Based on Budgeted Selling Price and
Actual Quantity of Output.
• Step 3: Calculate the Flexible Budget for Costs
Based on Budgeted Variable Cost per Output
Unit, Actual Quantity of Output, and Budgeted
Fixed Costs.
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3. Calculate flexible-budget variances and sales-

volume variances
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Flexible-Budget Variances and Sales-Volume
Variances
• The sales-volume variance is the difference

between a flexible-budget amount and the
corresponding static-budget amount.
• The flexible-budget variance is the difference

between an actual result and the
corresponding flexible-budget amount.
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Reason for unfavorable sales-volume
variance
Unfavorable sales-volume variance in operating income could be because of one
or more of the following reasons:
1. The overall demand for jackets is not growing at the rate that was
anticipated.
2. Competitors are taking away market share
3. The company did not adapt quickly to changes in customer preferences and
tastes.
4. Budgeted sales targets were set without careful analysis of market conditions.
5. Quality problems developed that led to customer dissatisfaction

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4. Explain why standard costs are often used in

variance analysis

Obtaining Budgeted Input Prices and Budgeted Input
Quantities
To calculate price and efficiency variances, the company

needs to obtain budgeted input prices and budgeted
input quantities. The three main sources for this
information are past data, data from similar companies,
and standards.
1. Actual input data from past periods

2. Data from other companies that have similar
processes.
3. Standards developed by the company
5. Compute price variances and efficiency

variances for direct cost categories

Price variance
• A price variance is the difference between
actual price and budgeted price, multiplied
by actual input quantity, such as direct
materials purchased or used. A price variance
is sometimes called an input-price variance or
rate variance, especially when referring to a
price variance for direct manufacturing labor.

Efficiency variance
• An efficiency variance is the difference
between actual input quantity used—such as
square yards of cloth of direct materials—and
budgeted input quantity allowed for actual
output, multiplied by budgeted price. An
efficiency variance is sometimes called a
usage variance.

6. Understand how managers use variances

Uses of variance
Managers and management accountants use variances
• to evaluate performance after decisions are implemented,
• to trigger organization learning, and
• to make continuous improvements.
• Variances serve as an early warning system to alert managers to existing

problems or to prospective opportunities.
• Variance analysis enables managers to evaluate the effectiveness of the

actions and performance of personnel in the current period
Multiple Causes of Variances
1. Poor design of products or processes
2. Poor work on the production line because of
under skilled workers or faulty machines
3. Inappropriate assignment of labor or machines
to specific jobs
4. Congestion due to scheduling a large number
of rush orders
5. Suppliers not manufacturing raw materials of
uniformly high quality
Performance Measurement Using Variances
• Managers often use variance analysis when evaluating the performance

of their subordinates. Two attributes of performance are commonly
evaluated:
1. Effectiveness: the degree to which a predetermined objective or

target is met—for example, sales, market share and customer
satisfaction ratings of Starbucks’ new VIAR Ready Brew line of instant
coffees.
2. Efficiency: the relative amount of inputs used to achieve a given output

level—the smaller the quantity of Arabica beans used to make a given
number of VIA packets or the greater the number of VIA packets made
from a given quantity of beans, the greater the efficiency.

7. Describe benchmarking and explain its role in

cost management

Benchmarking
• Benchmarking is the continuous process of
comparing the levels of performance in
producing products and services and
executing activities against the best levels of
performance in competing companies or in
companies having similar processes

Thanks to all

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Cost Accounting

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1. Understand static budgets and static-budget

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• Management by exception: This is the practice of focusing

• The static budget, or master budget, is based on the level of

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3. Calculate flexible-budget variances and sales-

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• The sales-volume variance is the difference

• The flexible-budget variance is the difference

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2. Competitors are taking away market share

5. Quality problems developed that led to customer dissatisfaction

4. Explain why standard costs are often used in

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To calculate price and efficiency variances, the company

1. Actual input data from past periods

5. Compute price variances and efficiency

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6. Understand how managers use variances

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• to evaluate performance after decisions are implemented,

• to trigger organization learning, and

• to make continuous improvements.

• Variances serve as an early warning system to alert managers to existing

• Variance analysis enables managers to evaluate the effectiveness of the

• Managers often use variance analysis when evaluating the performance

1. Effectiveness: the degree to which a predetermined objective or

2. Efficiency: the relative amount of inputs used to achieve a given output

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7. Describe benchmarking and explain its role in

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