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Chapter 23 - Flexible Budgets and Standard Costs
CHAPTER 23
FLEXIBLE BUDGETS AND STANDARD COSTS
Related Assignment Materials
Student Learning Objectives Discussion
Questions
Quick
Studies*
Exercises* Problems* Beyond the
Numbers
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Chapter 23 - Flexible Budgets and Standard Costs
Conceptual objectives:
C1. Define standard costs and
explain how standard cost
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C2. Describe variances and what
they reveal about performance.
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Analytical objectives:
A1. Analyze changes in sales from
expected amounts.
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Procedural objectives:
P1. Prepare a flexible budget and
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P2. Compute materials and labor
variances.
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P3. Compute overhead controllable
and volume variances.
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P4 Compute overhead spending and
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P5. Prepare journal entries for
standard costs and account for
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Chapter 23 - Flexible Budgets and Standard Costs
Additional Information on Related Assignment Material
Connect (Available on the instructor’s course-specific website) repeats all numerical Quick Studies, all
Systems starts in this chapter and continues throughout many chapters of the text.
Synopsis of Chapter Revision
Niner Bikes—New opener and entrepreneurial assignment.
Added learning objective for overhead spending and efficiency variances
Revised discussion of fixed budget performance report
Revised discussion of flexible budget performance report
Reorganized section on flexible budgeting
Revised several flexible budget exhibits
Revised discussion of standard cost systems
Revised discussion of setting standard costs
Revised discussion of computing and analyzing cost variances
Revised exhibits on computing direct materials and direct labor variances
Revised sections on analyzing materials, labor, and overhead variances
Simplified discussion of setting overhead standards
Revised discussion of computing the predetermined overhead rate
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Chapter 23 - Flexible Budgets and Standard Costs
Chapter Outline
Section 1 Flexible Budgets
I. Budgetary Process
A. Budgetary Control and Reporting
1. Budgetary controlmanagement’s use of budgets to see that planned
objectives are met.
2. Budget reports
a. Contain relevant information that compares actual results to
3. Budgetary control process involves at least four steps.
a. Develop budget from planned objectives.
b. Compare actual results to budgeted amounts and analyze
differences.
c. Take corrective and strategic actions.
d. Establish new planned objectives and prepare new budget.
4. Two alternative approaches: fixed budgeting and flexible budgeting.
a. Fixed budgeting: a fixed budget (also called a static budget) is
based on a single product amount of sales or other activity
measure.
b. Flexible budgeting: a flexible budget (also called a variable
budget) is based on several different amounts of sales or activity
levels.
c. A flexible budget is more useful when actual results are different
from predicted.
A. Fixed Budget Performance Report
1. A fixed budget performance report compares actual results with results
expected under the fixed budget (that predicted a certain sales volume
or other activity level). (Exhibit 23.2)
2. Differences between budgeted and actual results are designated as
variances.
a. Favorable variance (F)actual revenue is greater than budgeted
revenue, or actual cost is lower than budgeted cost.
b. Unfavorable variance (U)Actual revenue is lower than budgeted
revenue, or actual cost is greater than budgeted cost.
B. Budget Reports for Evaluation
1. Primary use of budget reports is to help management monitor and
control operations.
2. Fixed budget reports show variances from budget, but manager
3. Major limitation of fixed budget performance report is inability of
fixed budget reports to adjust for changes in activity levels.
Notes
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Chapter 23 - Flexible Budgets and Standard Costs
Chapter Outline
II. Flexible Budget Reports –Superior alternative to fixed budget reports.
A. Purpose of Flexible Budgets
1. Flexible budget (also called variable budget) is based on predicted
amounts of revenues and expenses corresponding to actual level of
output.
2. Useful both before and after the period’s activities are complete
3. Flexible budgets prepared before the period are based on several levels
of activities. Include both best case and worst case scenarios
4. Flexible budgets prepared after the period help managers evaluate past
performance.
5. Especially useful because it reflects the different levels of activities in
different amounts of revenues and costs.
1. Designed to reveal effects of volume of activity on revenue and costs.
2. Must classify costs as variable and fixed within a relevant range.
a. Variable cost per unit of activity remains constant; total amount of
variable cost changes in direct proportion to a change in level of
activity.
b. Total amount of fixed cost remains unchanged regardless of
changes in level of activity within relevant (normal) operating
range.
3. When numbers making up a flexible budget are created:
a. Each variable cost is expressed as either a constant amount per
4. Layout follows a contribution margin format (Exhibit 23.3)
a. Sales are followed by variable costs, and then by fixed
costsdifference between sales and variable costs equals
Notes
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Chapter 23 - Flexible Budgets and Standard Costs
Chapter Outline
C. Flexible Budget Performance Report
1. Lists differences between actual performance and budgeted
performance based on actual sales volume (or other level of activity).
2. Helps direct management’s attention to those costs or revenues that
differ substantially from budgeted amounts; areas where corrective
actions may help management control operations.
3. Used for variance analysis.
a. Actual and budgeted sales volumes are the same; as such, any
variance in total dollar sales must have resulted from a selling
price that was different than expected.
1. Used by management to assess the reasonableness of actual costs
incurred for producing the product or service.
2. When actual costs vary from standard costs, management follows up
to identify potential problems and take corrective action.
3. Management by exception: managers focus attention on most
significant differences and give less attention where performance is
reasonably close to standard.
4. Often used in preparing budgets because they are the anticipated costs
incurred under normal conditions.
5. Can also help control nonmanufacturing costs.
II. Materials and Labor Standards
A. Identifying Standard Costs
1. Managerial accountants, engineers, personnel administrators, and
other managers help set standard costs.
Notes
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Chapter 23 - Flexible Budgets and Standard Costs
Chapter Outline
2. Regardless, actual costs frequently differ from standard costs;
differences often due to more than one factor.
a. Actual quantity used (of direct labor hours or direct materials) may
differ from standard.
b. Actual price paid per unit (of direct labor or direct materials) may
differ from standard.
B. Setting Standard Costs
1. Due to inefficiencies and waste, materials may be lost as part of
was 100% efficient without any loss or waste.
b. A practical standard is the quantity of material required under
normal application of process; allowance for loss included in
standard.
c. Most companies use practical standards.
2. A standard cost card shows the standard costs of direct materials,
direct labor, and overhead for one unit of product or service.
.
1. Variances are commonly identified in performance reports.
2. Management examines circumstances to determine factors causing the
variance; analysis, evaluation, and explanation involved.
3. Results of efforts should allow assignment of responsibility for the
variance; actions can then be taken to correct problems.
4. Four steps involved in proper management of variance analysis.
a. Preparation of standard cost performance report.
1. Actual quantity (AQ ) Standard quantity (SQ)
2. Actual quantity is input (material or labor) used in manufacturing the
3. Actual Price is amount paid for acquiring the input (material or labor),
Notes
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Chapter 23 - Flexible Budgets and Standard Costs
Chapter Outline
4. Two main factors cause a cost variance
a. Price variance caused by difference between actual price paid and
standard price.
b. Quantity (or usage or efficiency) variance caused by difference
between the actual quantities of materials or hours used and the
standard quantity.
5. Price variance and quantity variance can be determined by formulas.
Actual Cost Standard
AQ x AP AQ x SP SQ x SP
Price variance Quantity variance
(AQ x AP) – (AQ x SP) (AQ x AP) – (AQ x SP)
Cost variance
2. Alternative price variance and quantity variance formulas can also be
used.
a. Price variance = (Actual price – Standard price) x Actual quantity.
PV = (AP – SP) x AQ.
b. Quantity variance = (Actual quantity - Standard quantity) x
Standard price.
QV = (AQ – SQ) x SP.
C. Computing Materials and Labor Variances
1. Material cost variances may be due to price and/or quantity factors.
a. A materials price variance results when company pays different
amount per unit than standard price; purchasing department
usually responsible.
b. A material quantity or usage variance results when company uses a
quantity that differs from the standard quantity allowed to produce
the actual amount of output; production department usually
responsible. Can also be fault of purchasing department if the
purchase of inferior materials caused excess use of materials.
2. Labor cost variances may be due to rate (price) and/or efficiency
(quantity) factors.
a. Labor rate (price) variance results when wage rate paid to
Notes
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Chapter 23 - Flexible Budgets and Standard Costs
Chapter Outline
IV. Overhead Standards and VariancesA predetermined overhead rate is used
to assign standard overhead costs to products or services produced;
predetermined rate is often based on relation between standard overhead and
standard labor cost, standard labor hours, standard machine hours, or another
measure of production.
A. Setting Overhead Standards
1. Standard overhead costs are amounts expected to occur at a certain
level of activity.
2. Overhead includes both variable and fixed costs; as such, average
overhead cost per unit changes as the predicted volume changes.
3. Standard overhead costs are average per unit costs based on predicted
level of activity.
4. To establish standard overhead cost rate, use same cost structure as
that used to construct flexible budget at end of a period.
a. Management selects a level of activity (volume) and predicts total
1. Cost accounting system applies overhead using predetermined
overhead rate when standard costs are used.
2. At end of period, the difference between total overhead cost applied to
3. Actual overhead costs incurred (AOI)
4. The standard overhead applied is based on the predetermined overhead
rate and the standard number of hours that should have been used,
based on the actual production output.
Total Overhead Variance
Actual total Overhead – Standard total overhead applied
Actual Overhead Incurred Budgeted Fixed Overhead
- Budgeted total Overhead - Applied Fixed Overhead
Controllable Variance Volume Variance
Notes
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Chapter 23 - Flexible Budgets and Standard Costs
Chapter Outline
5. To help identify factors causing the overhead cost variance managers
will analyze the variance separately for controllable and volume
variances.
a. The controllable variance is the difference between the actual
overhead costs incurred and the budgeted overhead costs based on
a flexible budget; named because it refers to activities usually
under management control.
b. The volume variance is the difference between the budged fixed
overhead (at predicted capacity) and the applied fixed overhead).
i. Occurs when there is a difference between the actual volume
of production and the standard volume of production
ii. The budgeted fixed overhead is the same value regardless of
the volume of production.
iii. The applied overhead is based on the standard direct labor
hours allowed for the actual volume of production.
iv. When a company operates at a capacity different from what is
expected, the volume variance will differ from zero
6. Analyzing controllable and volume variances
a. An unfavorable volume means the company did not reach its
expected operating level – a favorable variance means the
7. Overhead Variance Reports
a. Help managers isolate the reasons for a controllable variance.
1. Used to plan future actions to avoid unfavorable variances
2. Question why sales were higher/lower than expected.
3. Evaluate and reward salespeople.
C. When multiple products sold:
1. Sales mix variance is difference between actual and budgeted sales
mix of products.
2. Sales quantity variance is difference between total actual and total
budgeted quantity of units sold.
Notes
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Chapter 23 - Flexible Budgets and Standard Costs
Chapter Outline
Appendix 23A
I. Expanded Overhead Variances
A. Computing Overhead Cost Variancesassume predetermined rate is based
on relation between standard overhead and standard labor hours.
1. Framework uses classifications of overhead costs as either variable or
fixed
2. Exhibit 23A.1 shows that the variable overhead spending and
efficiency variances and the fixed overhead spending variance are
combined to get the controllable variance.
3. A spending variance results when amount paid to acquire overhead
items differs from standard price
4. An efficiency variance results when standard direct labor hours (the
assumed allocation base) expected for actual production are different
from actual direct labor hours used; reflects on the cost-effectiveness
in using the overhead allocation base such as direct labor hours.
Fixed overhead variance
SH = standard hours, and SFR = standard fixed overhead rate
1. Fixed overhead volume variance results when actual volume of
production differs from standard volume of production.
2. Budgeted fixed overhead amount remains same regardless of expected
volume, and is computed based on standard direct labor hours allowed
for the expected production volume.
Notes
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1. Simplifies recordkeeping
2. Helpful in report preparation.
3. Record standard materials costs incurred:
Work in Process Inventory SQ x SP
Direct Materials Price Variance
Direct Materials Quantity Variance
Raw Materials Inventory AQ x AP
(the variances are debited if unfavorable or credited if favorable)
4. Record standard labor cost of goods manufactured:
Work in Process Inventory SQ x SP
5. Assign standard predetermined overhead to Work in Process:
Work in Process Inventory SQ x SPR
Volume Variance
Variable Overhead Spending Variance
Variable Overhead Efficiency Variance
Fixed Spending Variance
Factory Overhead actual
(the variances are debited if unfavorable or credited if favorable)
6. An alternative is to combine the spending and efficiency variances into
one account called “Controllable Variances”.
7. Accumulate balances in the different variance accounts until end of
accounting period; to close, add to or subtract from the manufacturing
costs recorded in the period.
a. If variance is considered immaterial, add to, or subtract from
balance of Cost of Goods Sold.
b. Recorded costs will equal actual costs in the period;
8. Can use a standard costing income statement to summarize a
company’s performance. The Income Statement reports sales and cost
of goods sold at stand amounts and then lists the individual sales and
cost variances (favorable are subtracted and unfavorable are added) to
compute gross profit at actual cost.
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