So, if the flexible budget predicts that the total cost to produce 10,000 units is $50,000, then the cost to produce 12,000 units should be $60,000. A flexible budget model, which is used to create a flexible budget, consists of formulas that generate expected costs based on assumptions used to create the master budget. Any difference between the flexible budget and actual costs and revenue is referred to as a flexible budget variance.
These reports are distributed to the managers, planners or schedulers, and plant accountants, which permits people to ask questions while the job is still fresh in everyone’s mind. Hold supervisors responsible for only those costs over which they have control by using a contribution approach. The $330 variance for clinic supplies is only 3.48% of the budgeted amount ($330 ÷ $9,480) and favorable. Similarly, the lab-test variance, while unfavorable, is only 3.23% of the budget ($9,954 ÷ $308,100). Answers will vary widely, depending on the governmental unit selected and the budget items selected by the student. An unfavorable variable-overhead spending variance does not imply that the company paid more than the anticipated rate per kilowatt-hour for electricity.
The less input used to produce a given output, the more efficient the operation. In the next Chapter, direct material, direct labor and variable and fixed overhead flexible-budget variances will be discussed in detail. This type of budget shows the business what the static budget should have been by using actual output figures from the budget period. For example, if the static budget covered the production of 1,000 units, but only 600 units were made, the flexible budget takes only 600 units into account. The flexible budget shows the budgeted items from the static budget — such as cost and expected sales — and the actual results. Flexible budget variances may be used to determine any shortcomings in actual performance during a given period.
Accountants enter actual activity measures into the flexible budget at the end of the accounting period. It subsequently generates a budget that ties in specifically with the inputs. To do this, take your monthly overhead costs and divide it by your company’s monthly sales. For example, if your company has $100,000 in monthly manufacturing overhead and $600,000 in monthly sales, the overhead accounting percentage would be about 17%. This revised analysis shows that in fact the profit was $7,610 higher than would have been expected from a sales volume of 1,000 units. This type of budget takes into account the variation and ranges of expenses based on each category of a company’s budget. An advanced flexible budget will also change based on the actual expenses for each category.
The sales quantity variance represents what the sales volume variance would have been if the budgeted sales mix and actual sales mix were the same. It is easy to see this because the sum of the sales mix variance and sales quantity variance has to equal the sales volume variance. Notice also that if the budgeted sales mix and actual sales mix are the same, then actual units and actual units adjusted would be the same quantity.
A favorable variance works to the business’s advantage by increasing overall income, while an unfavorable variance represents unexpected costs or cost increases that negatively affected profit levels. Unfavorable variances represent areas the business must work on to improve profits and reduce overhead. Flexible budget is budget typically in the form of an income statement QuickBooks that is adjustable to any level of activity such as units produced or units sold. In a simple flexible budget, fixed costs stay constant whereas variable and semi-variable costs change according to a standard predetermined at the beginning of an accounting period. Variable costs may be represented as percentages of some base figure such as number of units or revenue.
Assume that a firm produces a product line that includes three products, Economy, Regular and Deluxe. Budgeted and actual data are presented in Exhibit 13-6 and 13-7. The following example includes three products so that all the variances can be illustrated, including the sale mix variances. To start with a less involved problem, see theExample in the Chapter 13 Summary for a simple single product illustration. The combined flexible budget approach presented in Exhibit 13-3 illustrates these relationships. Every finance department knows how tedious building a budget and forecast can be.
The flexible-budget variances shown in column of Exhibit 2.3 total Br. The total flexible-budget variance arises from sales prices received and the variable and fixed costs incurred. Since revenues and variable costs vary directly with number of units, we need to calculate budgeted price and variable costs per unit by dividing static budget amounts by 30,000 budgeted units. This yields price per unit of $6.00, material cost per unit of $2.00, labor cost per unit of $1.50 per unit and variable factory overhead of $0.80 per unit. These figures are then multiplied by actual units sold i.e. 40,000 units to obtain flexible budget revenue and variable costs. The ($5,000) negative volume variance is a means of reconciling the control purpose and the product costing purpose of the cost accounting system. The negative sign of the volume variance results from the fact that the company’s actual production activity in February exceeded planned activity.
If there is an actual amount in the cell referenced, it will divide it by the same forecasted amount in the “forecast” worksheet and subtract 1 to derive a percentage variance. In this tab, you will pull in the actual values for the time periods that you have them for and the forecasted amounts for the time periods that have yet to occur. To conclude, a flexible budget is more useful, elastic and practical. Flexible budget recognises concept of variability and provides logical comparison of expenditure with actual expenditure as a means of control.
Static budgeting is constrained by the ability of an organization to accurately forecast its needed expenses, how much to allocate to those costs and its operating revenue for the upcoming period. A static budget incorporates expected values about inputs and outputs that are conceived retained earnings prior to the start of a period. A flexible budget performance report will scale your initial budget to allow for a meaningful comparison. Standard costs for manufactured goods are created at the beginning of the year and can differ from actual costs, resulting in variances.
The variation happens due to the change in the volume or level of activity. The fixed costs are constant and remain same in both static and flexed budgets. The next step is to subtract flexible budget amounts from actual figures to obtain the required variances. If, however, the cost was identified as a fixed cost, no changes are made in the budgeted amount when the flexible budget is prepared. Differences may occur in fixed expenses, but they are not related to changes in activity within the relevant range. Although the answer to this question is not available from this information, without a flexed budget comparison it was not possible to tell that a different selling price had been charged. This is an example of variances which may be interrelated – a favorable variance on sales price may have caused an adverse variance on sales volume.
This means there is an unfavorable flexible budget variance related to the cost of goods sold of $4,000 (calculated as 800 units x $5 per unit). In aggregate, this works out to an unfavorable variance of $2,400. A flexible budget variance is any difference between the results generated by a flexible budget model and actual results.
More to the point, different amounts of variable-overhead costs would be expected. Flexible overhead budgets are based on an input activity measure, such as process time, in order to provide a meaningful measure of production activity. An output measure, such as the number of units produced, could be used effectively only in a single-product enterprise. If multiple, heterogeneous products are produced, it would not be meaningful to base the flexible budget on an output measure aggregated across highly different types of products. Whatever the cause of this unfavorable variance, Jerry’s Ice Cream will likely take action to improve the cost problem identified in the materials price variance analysis.
To create a meaningful performance report, actual revenues and costs and expected revenues and costs must be compared at the same level of activity. Since actual activity level often differs from planned activity level, some method is needed to compare what the planned revenues and costs should have been for the actual activity level. A flexible budget variance is the difference between a line on the flexible budget and the corresponding information from actual business statements. When a flexible budget is adjusted to actual activity level, we call it a flexed budget.
In addition, the separation of costs into controllable and noncontrollable categories allows Clark to devote full effort to those costs which he can influence. Clark will probably exhibit a positive attitude and will continue looking for ways to improve his operation. The interpretation of the variable-overhead efficiency variance is related to the efficiency in using the activity upon which variable overhead is budgeted. Thus, the variableoverhead efficiency variance will disclose no information about the efficiency with which variable-overhead items are used. Rather, it results from inefficiency or efficiency, relative to the standards, in the usage of the cost driver . Before moving on to the next section, observe from Exhibit 13-9 that fixed costs can also be included in the analysis. Note, that the fixed costs that appear in column 4 are the same amounts that appear in column 1 since fixed costs are not affected by sales volume.
It also emphasizes the total variance in costs and the separate unit cost and volume effects (i.e., unit cost variance and cost part of sales volume variance). The sales price and unit cost effects are emphasized in column 5, while the volume effects on revenue and cost are emphasized in column 6.
Also, a vivid classification of the expenses to different categories of a fixed cost, semi-variable cost, and variable cost is necessary before preparing a budget. The original budget for selling expenses included variable and fixed expenses. To determine the flexible budget amount, the two variable costs need to be updated. The new budget for sales commissions is $10,500 ($262,500 sales times 4%), and the new budget for delivery expense is $1,750 (17,500 units times 10%).
Profit analysis refers to the techniques used to generate an overall performance evaluation from the financial perspective. It is a broader level of analysis than the standard cost variance analysis for manufacturing costs and includes those variances as well as several others. Carol’s Cookies expected to use 1.5 pounds of direct materials to produce 1 unit of product at a cost of $2 per pound. Actual results are in for last year, which indicates 390,000 batches of cookies were sold. The company purchased 640,000 pounds of materials at $1.80 per pound and used 624,000 pounds in production. These thin margins are the reason auto suppliers examine direct materials variances so carefully. Any unexpected increase in steel prices will likely cause significant unfavorable materials price variances, which will lead to lower profits.
If, however, the manager is the Chief Executive Officer, the entire income statement should be used in evaluating performance. Subsequently, the budget varies, depending on activity levels that the company experiences. Compute the overhead allocation rate by dividing total overhead by the number of direct labor hours. Apply overhead by multiplying the overhead allocation rate by the number of direct labor hours needed to make each product.
In this example there is a larger proportion of the less profitable products in the actual mix. A flexible budget allows a business to see more variances than a static budget. The information from the flexible budget is based on actual results, allowing the business to adjust the static budget for accuracy and compare results. The business compares actual line-by-line costs and profits from the flexible budget with the estimations made in the static budget. Variance flexible budget formula information, such as the difference between estimated and actual sales and estimated and actual operating costs, helps the business improve efficiency and identify problem areas. For example, if a static budget has a material cost of $45 each piece, but the flexible budget shows $65 each piece, the variance may indicate an issue with the material ordering or selection. For example, a flexible budget model is designed where the price per unit is expected to be $100.
Create your budget with set fixed costs that will not change and variable costs depicted as percentages that can be adjusted based on actual revenue. An intermediate flexible budget takes into account expenses that go beyond a company’s revenue. Typically, this budget includes costs that are related to activity in addition to or rather than revenue. For example, a business’s insurance policy costs may vary based on how many employees the company has and may increase if the company hires new employees. ISSUE “USING ENHANCED COST MODELS IN VARIANCE ANALYSIS FOR BETTER CONTROL AND DECISION MAKING,” MANAGEMENT ACCOUNTING QUARTERLY, WINTER 2000, KENNARD T. WING. Student answers will vary. The instructor should point out that variance analysis is based on overly simplistic cost models in which every cost has to be treated as either fixed or variable.