CHAPTER 7
FLEXIBLE BUDGETS, VARIANCES,
AND MANAGEMENT CONTROL: I
LEARNING OBJECTIVES
1. Distinguish a static budget from a flexible budget
2. Develop a flexible budget and compute flexible-budget variances and sales-volume variances
3. Explain why standard costs are often used in variance analysis
4. Compute price variances and efficiency variances for direct-cost categories
5. Explain why purchasing performance measures should focus on more factors than just price variances
6. Integrate continuous improvement into variance analysis
7. Perform variance analysis in activity-based costing systems
8. Describe benchmarking and how it can be used in cost management
CHAPTER OVERVIEW
Chapter 7 illustrates specific tools used by accountants for providing managers information for improved
decision making. The tool developed from the assumptions and use of cost behavior in relation to volume
found in cost-volume-profit analysis is that of the flexible budget. Having the ability to compare what
actually happened with what “should have” happened furnishes the accountant with another helpful tool,
variance analysis. As illustrated in the chapter, the calculation of a variance is the process of closely
examining the details of the static budget, that one point ideal or bull’s eye, with the point of actual
impact (dart thrown at the bull’s eye) by use of multiple flexible budgets acting as concentric rings
emanating from the ideal. By increasing the level of detail, more opportunity exists for comparison and
more levels of variance calculation.
In the previous chapter, the emphasis was on the planning aspect of budgeting. This chapter incorporates
the control aspect of the study of budgeting. Control, as defined in Chapter 1, “comprises (a) taking
actions that implement the planning decisions, and (b) deciding how to evaluate performance and what
feedback to provide that will help future decision making.” Thus the action taken with actual results are
compared to planned or budgeted amounts for control purposes. Of special interest is the use of flexible
budgets and variance analysis in performance measurement and evaluation as an aspect of control.
Caution is always necessary when evaluating the performance of individuals. In keeping with the key
management accounting guideline of behavior consideration, the authors highlight that the important task
is to understand why variances arise and to use that knowledge to promote learning and continuous
improvement.
88 Chapter 7
CHAPTER OUTLINE
I. Budgets—aiding managers in their control functions [Chapter 6 Budgets—assisting managers in
their planning function]
A. Variances: differences between amount based on actual result and amount supposed to be
according to budget amount
1. Management by exception: practice of concentrating on areas not operating as expected and
giving less attention to areas operating as expected
2. Performance evaluation use
3. Strategy changes possible
Learning Objective 1:
Distinguish a static budget from a flexible budget
B. Static budgets and flexible budgets
1. Static budget: budget for a single planned output level at the start of the budget period
2. Flexible budget: adjusted (flexed) to recognize actual output level of budget period and help
managers gain more insight into causes of variances than available from static budgets
C. Static budget variances: difference between actual result and corresponding amount in static
budget [Exhibits 7-1and 7-4]
1. Various levels of detail reported [Levels 0 – 3 in this chapter with 0 as least detail]
a. Level 0 – Static-budget variance: static budget to actual results–operating income only
b. Level 1 – Static-budget variance: static budget to actual results by line items
2. Variance designations in reference to operating income
a. Favorable variance: effect of increasing operating income relative to budgeted amount
b. Unfavorable variance: effect of decreasing operating income relative to budgeted
amount
Do multiple choice 1. Assign Exercise 7-16.
Learning Objective 2:
Develop a flexible budget and compute flexible-budget variances and sales-volume variances
II. Steps in developing a flexible budget
A. Assumption: all costs either variable with respect to output unit produced or fixed
Flexible Budgets, Variances, and Management Control: I 89
B. Three-step procedure [Exhibit 7-2]
1. Identify the actual quantity of output
2. Calculate the flexible budget for revenues based on budgeted selling price and actual
quantity of output
3. Calculate the flexible budget for costs based on budgeted variable costs per output unit,
actual quantity of output, and the budgeted fixed costs
C. Level 2—Variances [Exhibit 7-4]
1. Difference due to inaccurate forecasting of output units sold
a. Sales-volume variance: difference caused solely by difference in volume sold and
volume expected to be sold in static budget—hence the name
b. Variance calculated because budget developed based on volume sold—flexible budget
c. Response to variance influenced by presumed cause of variance
2. Difference due to company’s performance
a. Flexible-budget variance: difference between actual results and flexible-budget amounts
b. Selling-price variance: solely pertains to revenues (selling price—actual to budgeted)
c. Variance analysis: provides suggestions for further investigation not evidence of good or
bad performance
Do multiple choice 2 and 3. Assign Exercises 7-17, 7-23, and 7-24.
D. Level 3—Variances for direct cost inputs
1. Sources of information for budgeted input prices and quantities
a. Actual input data from past periods
b. Data from other companies that have similar processes
Learning Objective 3:
Explain why standard costs are often used in variance analysis
c. Standards developed by company [Surveys of Company Practice]
i. Standard: carefully predetermined price, cost, or quantity based on efficient
operations and usually expressed on a per unit basis
ii. Standard input: carefully predetermined quantity of inputs required for one unit of
output
iii. Standard price: carefully determined price expected to pay for a unit of input
iv. Standard cost: carefully predetermined cost of a unit of output
d. Standard can be used to obtain budgeted amounts but budget is broader term
e. Standards can be set as attainable through efficient operations or as ideal or theoretical
Do multiple choice 4. [See next section for assignment using standards.]
Learning Objective 4:
Compute price variances and efficiency variances for direct-cost categories
TEACHING TIP: See note at end of this Outline section before Chapter Quiz Solutions.
2. Price variance [Exhibits 7-3 and 7-4]
a. Difference between the actual price and the budgeted price multiplied by actual quantity
of input
b. Also known as input-price variance or rate variance
c. Response to variance influenced by presumed cause of variance [Concepts in Action]
2. Efficiency variance [Exhibits 7-3 and 7-4]
