p



 
 

  

 




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Main Topics:

‡ Feedback and feed forward control

systems
‡ Fixed budget vs flexible budget
‡ Standard cost
‡ Variance analysis (i.e. sales price
variance, total overhead variance,
material cost and labour cost
variances)
‡ Profit reconciliation statement
=
 ˜ontrol Systems
è FEEDBA˜ SYSTEMS ±
Where actual performance is measured
against budget and corrective action is
taken after the event ± like a gas central
heating system or air conditioning.


 ˜ontrol Systems
è FEEDBA˜ SYSTEMS ±

r
 ˜ontrol Systems

è FEEDFORWARD SYSTEMS ±
Where predictions are made of expected
outcomes and compared to budget ±
µrolling forecast¶ . Action can be taken
BEFORE the event occurs

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 Performance Reporting System
For a performance reporting system to be effective,
it must:
è Measure actual results with reasonable accuracy
è Speed of issue and total accuracy
è Identify variances (against plan) and the reasons for them
è Provide non-financial information (?

??? ?

as well as traditional accounting information
è Distinguish between µcontrollable¶ and µnon-controllable¶
items (µ 



??
 
¶)
è Be prepared in such a way that there is no bias
è Issued to everyone who needs to know.

O
Fixed Budget
A fixed budget is prepared at the
beginning of the budgeting period and is
valid for only the planned level of activity.

*
Fixed Budget þ

onits sold 12,000
Revenues @$120 $1,440,000
Variable costs
Direct materials @$60 x 12,000 720,000
Direct Labor @$16 x 12,000 192,000
Production overhead * 144,000
Total variable costs 1,056,000
˜ontribution margin 384,000
Fixed costs 276,000
Profit $108,000
*overhead absorption rate @ $12 x 12,000
A
Fixed-Budget Variance
- For planning and control, and for performance
evaluation, we are interested to study the
variances between the actual results and the
budgeted results.
- A 

 ? - denoted F ± has the
effect of increasing profit relative to the
budgeted amount. An  

 ? -
denoted o ± has the effect of decreasing profit
relative to the budgeted amount.

Ë
 þ

p 
 þ


     
   
onits sold 10,000 2,000 o 12,000
Revenues $1,250,000 $190,000 o $1,440,000
Variable costs
Direct materials 621,600 98,400 F 720,000
Direct Labor 198,000 6,000 o 192,000
Production overhead 130,500 13,500 F 144,000
Total variable costs 950,100 105,900 F 1,056,000
˜ontribution margin 299,900 84,100 o 384,000
Fixed costs 285,000 9,000 o 276,000
Profit $14,900 $93,100 o $108,000

$93,100 o
Fixed-budget variance |
á     

‡ A fixed budget is suitable for planning purposes,
but it is inadequate for evaluating how costs are
controlled.
‡ If the actual activity during a period differs from
what was planned, it would be misleading to
simply compare actual costs to the fixed budget,
as the actual costs are based on one level of
activity while the fixed budget costs are based
on a different level of activity.
‡ If activity is higher than expected, variable costs
should be higher than expected; Otherwise, the
variable costs should be lower than expected. ||
á     


How much of
the favorable cost I don¶t think I can
variance is due to lower answer the question
activity, and how much is using a fixed budget.
due to better cost control?

|=
þ



‡ A 
 calculates budgets revenues
and budgeted costs based on ?




.
‡ The flexible budget is prepared at the end of a
period after the actual output level is known.

|
þ



In preparing the flexible budget:
1. The budgeted selling price per unit is the same
one used in preparing the fixed budget.
2. The budgeted variable costs are the same per
unit costs used in the fixed budget.
3. The budgeted fixed costs are the same fixed
budget amount (assuming the company is still
producing within the relevant range).
The only difference between the fixed budget and the
flexible budget is that the fixed budget is prepared for
the planned output, whereas the flexible budget is
based on the actual output. |r
þ


 þ




onits sold 10,000
Revenues @120 x 10,000 $1,200,000
Variable costs
Direct materials @60 x 10,000 600,000
Direct labor @$16 x 10,000 160,000
Production overhead @12 x 10,000 120,000
Total variable costs 880,000
˜ontribution margin 320,000
Fixed costs ( within the relevant range) 276,000
Profit $44,000
|R
Fixed versus Flexible Budgets
Fixed Budgets Flexible Budgets
Ú osed for planning Ú osed for control
purposes. purposes.
Ú Prepared at the Ú Prepared at the
beginning of the end of the period.
period.
Ú ³Flexed´ to
Ú Based upon accommodate
projected level of actual level of
activity. activity.

|O
 þ


 þ


 

p 
  
 þ


         
 
      
onits sold 10,000 0 10,000 2,000 o 12,000
Revenues $1,250,000 $50,000 F $1,200,000 $240,000 o $1,440,000
Variable costs
Direct materials 621,600 21,600 o 600,000 120,000 F 720,000
Direct Labor 198,000 38,000 o 160,000 32,000 F 192,000
Production
overhead 130,500 10,500 o 120,000 24,000 F 144,000
Total variable
costs 950,100 70,100 o 880,000 176,000 F 1,056,000
˜ontribution
margin 299,900 20,100 o 320,000 64,000 o 384,000
Fixed costs 285,000 9,000 o 276,000 0 276,000
Profit $14,900 $29,100 o $44,000 $64,000 o $108,000
$29,100 o
Flexible-budget variance
$93,100 o
Fixed-budget variance |*
 Flexible-Budget Variance
þ



p 
 þ




     
   
onits sold 10,000 0 10,000
Revenues $1,250,000 $50,000 F $1,200,000
Variable costs
Direct materials 621,600 21,600 o 600,000
Direct labor 198,000 38,000 o 160,000
Production overhead 130,500 10,500 o 120,000
Total variable costs 950,100 70,100 o 880,000
˜ontribution margin 299,900 20,100 o 320,000
Fixed costs 285,000 9,000 o 276,000
Profit $14,900 $29,100 o $44,000

|A
 Flexible-Budget Variance
þ



p 
 þ




     
   
onits sold 10,000 0 10,000
Revenues $1,250,000 $50,000 F $1,200,000
Variable costs
Direct materials 621,600 21,600 o 600,000
Direct labor 198,000 38,000 o 160,000
p

Production !"p!p"
overhead 130,500 10,500 o 120,000
Total variable costs 950,100 70,100 o 880,000
    
#

˜ontribution margin 299,900 $ 
21,100 o 320,000
%  


Fixed costs $   9,000

285,000 
o 276,000
Profit
 

$ $14,900
 $29,100 o $44,000

|Ë
 Flexible-Budget Variance
þ



p 

p
&pp!p"  þ





     

  $  #   

      
 
onits sold
#  
$ ' 10,000

 #    0  10,000
(# $ #
Revenues $1,250,000  $50,000
$ '
F $1,200,000
Variable costs
Direct materials 621,600 21,600 o 600,000
Direct labor 198,000 38,000 o 160,000
Production overhead 130,500 10,500 o 120,000
Total variable costs 950,100 70,100 o 880,000
˜ontribution margin 299,900 20,100 o 320,000
Fixed costs 285,000 9,000 o 276,000
Profit $14,900 $29,100 o $44,000

=
Flexible-Budget Variance
Actual total units of the Total production
Absorption
absorption base  overheads
rate incurred during the absorbed
period

The unfavourable total overhead variance could due

to one or more of the following:

‡ onder estimation of the absorption rate (either by under

estimation of total production overhead or over
estimation of the absorption base)
‡ Less actual total units of the absorption base were used
than the estimated.

=|
 Flexible-Budget Variance
þ



p 
 þ



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 )




    




 #      
)
  
 
onits sold
 10,000 0 10,000
Revenues $1,250,000 $50,000 F $1,200,000
Variable costs
Direct materials 621,600 21,600 o 600,000
Direct labor 198,000 38,000 o 160,000
Production overhead 130,500 10,500 o 120,000
Total variable costs 950,100 70,100 o 880,000
˜ontribution margin 299,900 20,100 o 320,000
Fixed costs 285,000 9,000 o 276,000
Profit $14,900 $29,100 o $44,000

==
Flexible-Budget Variance

What is wrong with the flexible-budget variance for

direct materials and direct labor?

þ



p 
 þ




     
   
Variable costs
Direct materials 621,600 21,600 o 600,000
Direct labor 198,000 38,000 o 160,000
Production overhead 130,500 10,500 o 120,000
Total variable costs 950,100 70,100 o 880,000

=
Flexible-Budget Variance

What is wrong with the flexible-budget variance for

direct materials and direct labor?

We have no way to tell if the unfavorable variance is

due to:

1. Inputs are purchased at prices that are too high,

or
2. More input is used than is really necessary.

=r
What is wrong with the flexible-budget variance for direct
materials and direct labor?

How much of
the unfavorable variance is I don¶t think I can
due to higher input price, answer the question!
and how much is due to
more input us used?

=R
Standard ˜ost
The answer to the above problem lies largely in
Standard ˜ost.
Managers - often assisted by engineers and
accountants ± set quantity and price standards for
each major input such as raw materials and labor
time.
Managers focus on quantities and prices that
exceed standards.

=O
Standard ˜ost
X 
   specify how much of an input
should be used to make a product or provide a
service.


?   specify how much should be paid

for each unit of input.

=*
Standard ˜ost
Standard cost card for one unit of product:
    
 
        
*  %   "
!$ $+  !$+  $+ 
   
 '-,  .-$
, %  %  , %  ./-
  
 .-$

  -'0
 
  ./
  #   .-$
   -'      .

     .00

=A
Setting Standard ˜ost
è The future period of time covered by the standard should
be determined
è Relate to prescribed working conditions and practices
and defined levels of activity and operating efficiency
è The standard quantities of both direct material and labour
should be determined by scientific methods
è The standard prices for materials and rates of pay for
labour should be based on those anticipated in the
standard cost period
è The psychological effect of setting standards should not
be µtoo tough¶ - they should be attainable, but with hard
work!

=Ë
Setting Direct Material Standards
Price Quantity/
Standards (³osage´) Standards
($30 / sq. yard) ( 2 sq. yards)

Should reflect the

Should reflect the amount of material
final, delivered cost required for each unit
of the materials, net of finished product, as
of any discounts well as an allowance
taken. for unavoidable waste,
spoilage, and other
normal inefficiencies.

Setting Direct Labour Standards
Price Quantity
(³Rate´) (³Efficiency´)
Standards Standards
($20 / labor hr) ( 0.8 labor hr)

Should include not Should include

only wages earned allowances for breaks,
but also fringe personal needs of
benefits and other employees, cleanup,
labour costs and machine
downtime.

|
Standard Quantity Allowed for Actual Output
What is the standard quantity allowed for each
variable input for producing the actual output of
10,000 units?
    
 
  
*  %


   p 
 
!$ *  % $ 
$

   
 '-,'%  -)--- -)---,'% 

  
 -'0
  -)--- 0)---
 

=
Flexible-Budget ˜osts
The flexible-budget costs for each variable input can
also be computed by multiplying the standard price by
the standard quantity allowed for actual output.
    
 
  
*  %

 þ



    
!$ 
$   "

   
 -)---,'%  .-(,'%  ./--)---

  
 0)---
  .-(
 ' ./-)---


 Actual ˜osts
At the end of the month, the company obtained the
following actual costs information for their variable
inputs:
    
 
p 
p 
p 

!$ *  %   "

   
 )--,'%  .0(,'%  ./)/--

  
 1)---
  .(
 ' .10)---

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A General Model for Variance Analysis
˜ost Variance

Quantity Variance
Price Variance
(³osage Variance´)
(³Rate Variance´)
(³Efficiency Variance´)

The difference between The difference between

the actual price and the the actual quantity and
standard price the standard quantity
allowed for actual output
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The component parts of the direct material and direct labour
variances:

O
A General Model for Variance Analysis
p 
*  %p 
*  %   *  %
p


p 
$
2 2 2
p 
          
- -

     *  %   
p*p     p* *
+

þ


    
*
Material ˜ost Variances
p 
*  %p 
*  %   *  %
p


p 
$
2 2 2
p 
          
)--,'% )--,'% -)---,'%




.0(,'%' .-(,'%' .-(,'%'

./)/-- .///)--- ./--)---

.)--þ .//)---+
 #     #   
.)/--+
3 
 #    A
Material ˜ost Variances
The favourable  
$ #    represents the
company actually paid a lower price than what should
have been paid according to the standard that has been
set. This could due to one or more of the following:

‡ Better negotiation skill of the purchasing manager.

‡ Adopted a lower-price supplier.
‡ Purchased Lower-quality materials.
‡ Oversupply of the industry.
‡ Ordered large quantity.
‡ Standard price was set too low without careful analysis.

Ë
Direct Materials Quantity Variance
The unfavourable  
 #    represents
the company actually used more quantity of direct
materials than what should have been used according to
the standard that has been set. This could due to one or
more of the following:
‡ Personnel manager hired unskilled workers.
‡ Works were scheduled inefficiently.
‡ Poorly maintained machines.
‡ Inferior quality of materials.
‡ Poor supervision
‡ Standard quantity was set too tight without careful analysis.

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Labour ˜ost Variance
p 
*  %p 
*  %   *  %
p


p 
$
2 2 2
p 
          
1)---
 ' 1)---
  0)---
 




.(  .-(  .-( 

.10)--- .0-)--- ./-)---

.0)---+ .-)---+
 #      %#   
.0)---+

 #    r|
Labor Rate Variance
The unfavorable direct
 #    represents
the company actually paid a higher average hourly labour
rate than what should have been paid according to the
standard that has been set. This could due to one or
more of the following:
‡ Poor negotiation skill with labour union.
‡ Employed more skilled workers.
‡ More overtime work at premium rates.
‡ Tight labour market
‡ Standard rate was set too low without careful analysis.

r=
Labor Efficiency Variance
The unfavorable direct
  %#   
represents the company actually used more direct labour
time than what should have been used according to the
standard that has been set. This could due to one or
more of the following:
‡ Poorly trained or motivated workers.
‡ Poor quality materials, requiring more labour time in
processing.
‡ Faulty equipment, causing breakdowns and work
interruptions.
‡ Poor supervision of workers.
‡ Standard quantity was set too low without careful
analysis.
r
 Profit Reconciliation Statement
BoDGETED ˜ONTRIBoTION MARGIN $320,000

VARIAN˜ES:
è Sales price variance 50,000
è Material price variance 44,400
è Material usage variance (66,000)
è Labour rate variance (18,000)
è Labour efficiency variance (20,000)
è Total overhead variance (10,500)

TOTAL VARIAN˜ES $20,100

A˜ToAL ˜ONTRIBoTION MARGIN $299,900

rr
Quick ˜heck 1
Glacier Peak Outfitters has the following
direct material standard for the fiberfill in its
mountain jacket.
-'4' 

$5 4 .'--$4'

Last month 210 kgs of fiberfill were

purchased and used to make 2,000 jackets.
The material cost a total of $1,029.

rR
 Quick ˜heck 1
è What is Glacier Peak Outfitters actual price
of fiberfill per kg?
è What is the standard quantity of fiberfill that
should have been used to produce 2,000
jackets?
è What is the materials price variance and
usage variance?

rO
Quick ˜heck 2 6 $$%

Hanson Inc. has the following direct labor

standard to manufacture one Zippy:
'   $6 $$% ./'--$
  
 

Last week 1,550 direct labor hours were

worked at a total labor cost of $9,610 to
make 1,000 Zippies.

r*
 Quick ˜heck 2 6 $$%

è What is Hanson¶s actual rate for labour for

the week?
è What is the standard hours of labour that
should have been worked to produce 1,000
Zippies?
è What is the labour rate variance and
efficiency variance?

rA
SEMINAR 6

EXAMPLE

rË
The standard cost card for producing one ˜rusader Mountain Bike
shows the following information:
Materials £ £

|

 !
"  #$


|

"
 |
 |


iabour

% 
"

  "  |


p&
"
|
  |"  |
 #


Total Overheads 


'

 !


Profit margin 


Sales price 


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During the month of May, 4,000 cycles were sold and the actual results
were as follows:

£ £

Sales #( &  |(| (

Costs

#(
 |$(

#(
"
  (

$(% )" 
  #(#

#(p&)" 
  #( 

*+ ) !(  #(

Profit $(#

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| ,))"

#( & 

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x £58 = £232

 "  +  

))"  -#(. -š1,160,000

|(| (/ |(|(-£32


favourable

R=
  
0  1

p 2& p 2& PRICE )2& USAGE

3 3 VARIANCE 3 VARIANCE
p "   )"   )"  

' #( #(.|


3 3
!
 !


£175 

£ 20 00 £ 700 F £10 000 £1 00 U


"
 #( #.|

3 3
| |

£620 000 £608 000 £1 000 U £608 000 š


R
 
 
0  1

p 2& p 2& Rate )2& Efficiency

3 3 VARIANCE 3 VARIANCE
p "   )"   )"  

%  $( #(.
3 3
 

£4 400 £ 4 600 £3 00 U £4 000 £ 400 F

p& #( #.|


3 3
| |

£4 00 £48 000 £1 00 U £0 000 š  

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$'

+ )+  
*+ )
) 
+ ) ! (
#(. 
p 
+ ) !(
*+ )+   |(
OVER ABSORPTION (FAVOURABiE)

RR
PROFIT RE˜ON˜ILIATION STATEMENT
(š)
+ þ! 232,000

Sales price variance +32,000 F

Material price variance
Tubing 29,700 (F)
˜omponents 12,000(o) +17,700 F

Material usage variance

Tubing 15,200(o) -15,200 o
˜omponents -
Labour rate variance
Framing dept 3,800(o)
Assembly dept 1,200(o) -5,000 o

Labour efficiency variance

Framing dept 2,400(F)
Assembly dept 2,000(F) +4,400 F
Total overhead variance +1,500 F

p"+p
 þ! 267,400

RO
9) Whose Responsibility? Likely ˜auses?
SALES PRI˜E (F)



ð
?




 

?
 

? 

 ?


MATERIAL PRI˜E    !

 





 ?
  "
Tubing (F), 

 #
?!
 #
?
 " ?
 #
˜omponents (o) $
!
 $

?"

MATERIAL oSAGE  

   
  
 

 "
Tubing (o) %
 ?

?
 "



?


?"

LABOoR RATE 


  

 






 

"&


Framing (o) 

 "'

 

 
 ?"
Assembly (o)
 



    




 "  
LABOoR EFFI˜IEN˜Y $

 $


 


?
"
Framing (F) $
 ?
 
  

 


Assembly (F) ?"

OVERHEADS (F) 

  (??


?


 ?


  
" ?$ 





 
  
") 







 ?"
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˜ONNE˜TIONS?

Did the saving on the price of tubing (š29,700) have any effect on
other costs?

  ð*+,-.// 






 $
"

Extra was paid for labour with adverse rate variances totalling
š5,000. Were there any benefits from this?

  ð+00//
 


?
 ?





1 



RA
  * 
As the ˜hief Executive of a manufacturing company,
you are asked to make decisions on the following
matters:

1. Your company uses a key material to make its

product. Each unit that you make uses 6 kilograms
of the material and you are currently paying 50p per
kilo. You have the opportunity to purchase a
cheaper quality of this material and save 10% of the
price. However, wastage will increase so it will now
need 6.5 kilograms to make each unit. What should
you do? What effect would the decision have on
profits if you made and sold 120,000 units every
month?
RË
  * 

2. The product you make uses 2 hours of labour for

each unit and that costs š6 per hour. You could
recruit better trained labour at š8 per hour and it
would only take 1½ hours to make each unit. What
should you do? What effect would the decision
have on profits if you made and sold 120,000 units
every month?

O
 Tutorial Exercise


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Quick ˜heck 1
p 
*  %p 
*  %   *  %
2 2 2
p 
          
210 kgs. 210 kgs. 200 kgs.
× × ×
$4.90 per kg. $5.00 per kg. $5.00 per kg.
= $1,029 = $1,050 = $1,000

Price variance osage variance

$21 favorable $50 unfavorable
O
Quick ˜heck 2 6 $$%

p 
&p 
&   &
2 2 2
p 
       
1,550 hours 1,550 hours 1,500 hours
× × ×
$6.20 per hour $6.00 per hour $6.00 per hour
= $9,610 = $9,300 = $9,000

Rate variance Efficiency variance

$310 unfavorable $300 unfavorable
Or