Chapter 08 Flexible Budgets, Standard Costs, and Variance Analysis
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Chapter 8
Lecture Notes
Chapter theme: This chapter explains how to prepare
flexible budgets and how to compare them to actual results
I. The variance analysis cycle
A. The steps of the cycle
i. The cycle begins with the preparation of
performance reports in the accounting
department.
ii. These reports highlight variances which are
iii. The variances raise questions such as:
1. Why did this variance occur?
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II. Flexible budgets
A. Characteristics of a flexible budget
i. A planning budget is prepared before the period
begins and is valid for only the planned level of
activity.
1. If the actual level of activity differs from
ii. A flexible budget is an estimate of what revenues
and costs should have been, given the actual level
of activity for the period. Flexible budgets:
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Chapter 08 Flexible Budgets, Standard Costs, and Variance Analysis
B. Larry’s Lawn Service: Illustrating the deficiencies
of the static planning budget
i. Assume the following facts with respect to Larry’s
ii. Assume that Larry prepared the planning budget
for June as shown. Notice that the budget includes:
1. Two variable costs—gasoline and supplies
iii. Assume that Larry’s actual results for the month
of June are as shown. Notice:
1. Larry actually mowed 550 lawns.
iv. If Larry wanted to, he could compare his actual
results to the planning budget as shown on this
slide. Notice:
1. A variance is computed for revenue and
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3. A favorable (unfavorable) revenue variance
occurs when actual revenue is greater than
(less than) the planning budget.
6. At this point, we cannot answer this question
because the actual level of activity is
greater than the planned level of activity.
C. How a flexible budget works
i. Keys to understanding a flexible budget
1. Variable costs change in direct proportion to
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ii. Larry’s Lawn Service: preparing a flexible
budget
1. Larry’s flexible budget for an activity level
of 550 lawns mowed is as shown on this
slide. Notice, the “Q” in all revenue and
2. The fixed costs in Larry’s flexible budget
are not sensitive to changes in the activity
level.
Learning Objective 8-2: Prepare a report showing
revenue and spending variances.
D. Computing revenue and spending variances
i. A revenue variance is the difference between what
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E. Larry’s Lawn Service: Computing revenue and
spending variances
i. The revenue and spending variances for Larry’s
Lawn Service would be computed as shown on this
slide. Notice:
1. The apple icons on the slide indicate that the
actual results and flexible budget columns
III. Flexible budgets with multiple cost drivers
Learning Objective 8-3: Prepare a flexible budget with
more than one cost driver.
A. Key concepts
i. More than one cost driver may be needed to
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I. Larry’s Lawn Service: Multiple cost drivers
i. Let’s assume that Larry determined that wages
ii. Larry’s flexible budget could easily be adjusted to
accommodate the second cost driver. Notice:
1. The number of hours (H) is designated as
the second cost driver.
IV. Standard costs – setting the stage
A. Basic definitions/concepts
1. A standard is a benchmark for measuring
performance. In managerial accounting, two types
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a. Auto service centers like Firestone
b. Price standards specify how much should
be paid for each unit of the input. For
example:
a. Hospitals have standard costs for
food, laundry, and other items.
b. Home construction companies have
B. Setting direct materials standards
i. The standard quantity per unit for direct
materials should reflect the amount of material
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C. Setting direct labor standards
i. The standard hours per unit reflects the labor
hours required to complete one unit of product.
1. Standards can be determined by using
ii. The standard rate per hour for direct labor
includes not only wages earned but also fringe
benefits and other labor costs.
1. Many companies prepare a single rate for
all employees within a department that
reflects the “mix” of wage rates earned.
D. Setting variable manufacturing overhead standards
i. The quantity standard for variable manufacturing
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E. The standard cost card
i. The standard cost card is a detailed listing of the
V. Using standards in flexible budgets
A. Breaking down spending variances
i. Standard costs per unit for direct materials, direct
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VI. A general model for standard cost variance analysis
A. Price and quantity variances
i. A price variance is the difference between the
B. Price and quantity standards
i. Price and quantity standards are determined
separately because price and quantity variances
usually have different causes. In addition:
1. Different managers are usually
responsible for buying and for using
inputs. For example:
2. The buying and using activities occur at
different points in time. For example:
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C. The general model—an overview
i. Price and quantity variances can be computed for
all three variable cost elements – direct materials,
1. The actual quantity represents the actual
amount of direct materials, direct labor, and
variable manufacturing overhead used.
Helpful Hint: Emphasize that the quantities in this
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2. The standard quantity represents the
standard quantity allowed for the actual
output of the period.
Helpful Hint: Mention that the “SQ” portion of the
3. The actual price represents the actual
VII. Using standard costs—direct materials variances
Learning Objective 8-4: Compute the direct materials
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A. Glacier Peak Outfitters – an example
i. The materials price variance, defined as the
difference between what is paid for a quantity of
ii. The materials quantity variance, defined as the
difference between the quantity of materials used in
production and the quantity that should have been
used according to the standard, is $50 unfavorable.
Helpful Hint: Remind students that a favorable price
variance might not always be a good thing. If it arose
iii. Supporting/additional computations
1. The standard quantity of 200 kilograms was
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B. Direct materials variances—points of clarification:
i. The purchasing manager and production
manager are usually held responsible for the
ii. The materials variances are not always entirely
controllable by one person or department. For
example:
1. The production manager may schedule
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VIII. Using standard costs—direct labor variances
Learning Objective 8-5: Compute the direct labor rate
and efficiency variances and explain their significance.
A. Glacier Peak Outfitters – continued (assume the
information as shown)
i. The labor rate variance, defined as the difference
between the actual average hourly wage paid and
ii. The labor efficiency variance, defined as the
difference between the actual quantity of labor
hours and the quantity allowed according to the
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iii. Supporting/additional computations
1. The standard quantity of 2,400 hours was
B. Direct labor variances—points of clarification:
i. Labor variances are partially controllable by
employees within the Production Department. For
example, production managers/supervisors can
influence:
1. The deployment of highly skilled workers
ii. However, labor variances are not entirely
controllable by one person or department. For
example:
1. The Maintenance Department may do a
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2. The purchasing manager may purchase
Quick Check – direct labor variance calculations
IX. Using standard costs—variable manufacturing
overhead variances
Learning Objective 8-6: Compute the variable
A. Glacier Peak Outfitters – continued
i. The variable overhead rate variance, defined as
the difference between the actual variable overhead
ii. The variable overhead efficiency variance,
defined as the difference between the actual activity
of a period and the standard activity allowed,
multiplied by the variable part of the predetermined
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iii. Supporting/additional computations
1. The standard quantity of 2,400 hours was
Quick Check – variable overhead variance calculations
X. Materials variances—an important subtlety
A. When the quantity of materials purchased differs
B. Glacier Peak Outfitters—revisited
i. The materials quantity variance is computed
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