Management Accounting- Gurgaon

Campus

Profit Planning and Control :Flexible Budgets and Variance

Management by exception is the practice of concentrating on areas not operating as expected and
giving less attention to areas operating as expected. Variance analysis helps managers identify areas
not operating as expected. The larger the variance, the more likely an area is not operating as
expected.

Two sources of information about budgeted amounts are (a) past amounts and (b) detailed
engineering studies.

A favorable variance––denoted F––is a variance that has the effect of increasing operating income
relative to the budgeted amount. An unfavorable variance––denoted U––is a variance that has the
effect of decreasing operating income relative to the budgeted amount.

The key difference is the output level used to set the budget. A static budget is based on the level
of output planned at the start of the budget period. A flexible budget is developed using budgeted
revenues or cost amounts based on the actual output level in the budget period. The actual level of
output is not known until the end of the budget period.

A flexible-budget analysis enables a manager to distinguish how much of the difference between an
actual result and a budgeted amount is due to (a) the difference between actual and budgeted
output levels, and (b) the difference between actual and budgeted selling prices, variable costs, and
fixed costs.

The steps in developing a flexible budget are:

Step 1: Identify the actual quantity of output.
Step 2: Calculate the flexible budget for revenues based on budgeted selling price and
actual quantity of output.
Step 3: Calculate the flexible budget for costs based on budgeted variable cost per output
unit, actual quantity of output, and budgeted fixed costs.

Four reasons for using standard costs are:

(i) cost management,
(ii) pricing decisions,
(iii) budgetary planning and control, and
(iv) financial statement preparation.

A manager should subdivide the flexible-budget variance for direct materials into a price variance
(that reflects the difference between actual and budgeted prices of direct materials) and an
efficiency variance (that reflects the difference between the actual and budgeted quantities of direct
materials used to produce actual output). The individual causes of these variances can then be

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investigated, recognizing possible interdependencies across these individual causes.

Possible causes of a favorable direct materials price variance are:

 purchasing officer negotiated more skillfully than was planned in the budget,
 purchasing manager bought in larger lot sizes than budgeted, thus obtaining quantity
discounts,
 materials prices decreased unexpectedly due to, say, industry oversupply,
 budgeted purchase prices were set without careful analysis of the market, and
 purchasing manager received unfavorable terms on non purchase price factors (such as lower
quality materials).

Some possible reasons for an unfavorable direct manufacturing labor efficiency variance are the
hiring and use of under skilled workers; inefficient scheduling of work so that the workforce was
not optimally occupied; poor maintenance of machines resulting in a high proportion of non-value-
added labor; unrealistic time standards. Each of these factors would result in actual direct
manufacturing labor-hours being higher than indicated by the standard work rate.

Variance analysis, by providing information about actual performance relative to standards, can
form the basis of continuous operational improvement. The underlying causes of unfavorable
variances are identified, and corrective action taken where possible. Favorable variances can also
provide information if the organization can identify why a favorable variance occurred. Steps can
often be taken to replicate those conditions more often. As the easier changes are made, and
perhaps some standards tightened, the harder issues will be revealed for the organization to act
on—this is continuous improvement.

An individual business function, such as production, is interdependent with other business

functions. Factors outside of production can explain why variances arise in the production area.
For example:
 poor design of products or processes can lead to a sizable number of defects,
 marketing personnel making promises for delivery times that require a large number of rush
orders can create production-scheduling difficulties, and
 purchase of poor-quality materials by the purchasing manager can result in defects and waste.

The plant supervisor likely has good grounds for complaint if the plant accountant puts excessive
emphasis on using variances to pin blame. The key value of variances is to help understand why
actual results differ from budgeted amounts and then to use that knowledge to promote learning
and continuous improvement.

Variances can be calculated at the activity level as well as at the company level. For example, a
price variance and an efficiency variance can be computed for an activity area.

Evidence on the costs of other companies is one input managers can use in setting the
performance measure for next year. However, caution should be taken before choosing such an
amount as next year's performance measure. It is important to understand why cost differences
across companies exist and whether these differences can be eliminated. It is also important to
examine when planned changes (in, say, technology) next year make even the current low-cost

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producer not a demanding enough hurdle

Problem -1: You have been hired as Consultant by Sona Steering an auto manufacturing company
that makes automobile parts. The company was struggling by working with inadequate cost data.
Your mandate is to install Flexible Budgeting and standard costs.The company has asked you to
consider the following May 2012 data and recommend how variances might be computed and
presented in performance reports.

Static Budget in Output Units 20,000

Actual Output Units produced and sold. 23,000
Budgeted Selling Price per unit of Output Rs 40
Budgeted Variable Costs per unit of Output Rs 25
Budgeted Fixed Costs Per Month Rs 2,00,000
Actual Revenue Rs 8,74,000
Actual Variable Costs Rs 6,30,000
Favourable Variance in Fixed Costs Rs 5,000

Although output units sold exceeded expectations , operating income did not. Assume that there
was no beginning or ending inventory .You thought to analyse the situation and communicate to
higher management..Use F for Favourable and U for Unfavourable.

Problem -2: Haldiram Company sells sweets. Its budgeted operating income for the year ended
December 31, 2006, was Rs 31,50,000. As a result of continued explosive growth in its sales, actual
operating income totaled Rs 65,56,000.

You are required to :

1. Calculate the total static-budget variances.
2. Flexible-budget operating income was Rs 69,30,000. Calculate the total flexible-budget and total
sales-volume variances.
3. Comment on the total flexible-budget variance in the light of the explosive growth in its sales.

Problem -3: Consider the following data collected (for March) for Alps Industries Limited:
Direct Direct Manufacturing
Materials Labour
Costs Incurred :Actual Inputs X Actual Prices 2,00,000 90,000
Actual Inputs X Budgeted Prices 2,14,000 86,000
Budgeted Input X Budgeted Prices 2,25,000 80,000

You are required to : Compute the price, efficiency, and flexible-budget variances for direct
materials and direct manufacturing labor.

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 Example -4: Below presented budgeted and actual data of productions of 2000 dessert cakes.
The data contains variable costs comprises of material and labour.
Standard Qty and Rate (Per Unit) Actual Quantity and Price Used
Production 2000 Production 2000
Material Qty 2.5 kg Actual Material Qty 5200
Material Price Rs 14 Material Price 72500
Labour Hours 0.5 hours Labour Hours 1100
Labour Rate Per Hour Rs 20 Labour Charges 20900
Material Cost 70000
Labour Charges 20000
Total 90000 Total Cost 93400
Your are to find out the price variance and usage variance to explain the deviation of actual
performance from the planned performance.

Problem -5

Standard Qty and Rate (Per Unit) Actual Quantity and Price Used
Production 4000 Production 4200
Material Qty 1.0 kg Actual Material Qty 4200
Material Price Rs 20 Material l Price 84000
Labour Hours 1.0 Labour Hours 3800
Labour Rate Per Hour Rs 20 Labour Charges 76000
Material Cost 80000
Labour Charges 80000
Total 160000 Total Cost 160000

When Material and Labour costs go up people responsible for these expenses should be asked ,
where things have gone wrong :

 Production- VP:Purchase and Operation Supervisor

 Personnel – VP:Recruitment;Training;Time and Motion Study

Material Labour
Price Usage Rate Efficiency
 Source  Machine Salary Technical Skill
Set
 Rate Negotiation  Scrap/Rejection Overtime Training

 Cheap  Quality ; Rework Fringe Benefit Technology

 Costly  Availability Bonus Absorption of

Input
 Escalation Clause  Utilisation

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Problem -6: Consider the following selected data regarding the manufacture of a line of
upholstered chairs:

Standards Per Chair

Direct Material 2 Squire yards of input at Rs 100 per square
yard
Direct Manufacturing Labour 0.5 hour of input at 40 per hour

The following data were compiled regarding actual performance: actual output units (chairs)
produced, 20,000; square yards of input purchased and used, 37,000; price per square yard, Rs
102; direct manufacturing labor costs, Rs 3,52,800; actual hours of input 9,000; labor price per
hour, Rs 39.20.
Required Show computations of price and efficiency variances for direct materials and direct
manufacturing labor. Give a plausible explanation of why the variances occurred.

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Problem -7 : Suppose the static budget was for 24,000 units of output. The general manager is
thrilled about the following report:

Actual Results Static Budget Variance

Direct materials Rs 37,74,000 Rs 48,00,000 Rs 10,26,000 F
Direct manufacturing labor Rs 3,52,800 Rs 4,80,000 Rs 1,27,200 F

Required Is the manager’s glee warranted? Prepare a report that provides a more detailed
explanation of why the static budget was not achieved. Actual output was 20,000 units.

Problem -8 : TNT manufactures bust statues of famous historical figures. All statues are the same
size. Each unit requires the same amount of resources. The following information is from the static
budget for 2006:

Expected production and sales 5,000 units

Direct materials 50,000 kgs
Direct manufacturing labor 20,000 hours
Total fixed costs Rs 10,00,000

Standard quantities, standard prices, and standard unit costs follow for direct materials and
direct manufacturing labor.

Standard Standard Price Standard Unit

Quantity Cost
Direct material 10 kgs Rs 100 per kg Rs 1,000
Direct manufacturing labor 4 hours Rs 40 per hour Rs 160

During 2006, actual number of units produced and sold was 6,000. Actual cost of direct materials
used was Rs 59,40,000, based on 54,000 kgs purchased at Rs 110 per kg. Direct manufacturing
labor-hours actually used were 25,000, at the rate of Rs 38 per hour. This resulted in actual direct
manufacturing labor cost of Rs 9,50,000. Actual fixed costs were Rs 10,05,000. There were no
beginning or ending inventories.

Required: 1. Calculate sales volume variance and flexible-budget variance. 2. Compute price and
efficiency variances for direct materials and direct manufacturing labor.

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 Cash

Budget

Cash Budget
The following accrual accounting information was available from the Arihant Company’s books:
2016 Purchases Sales
(before Discounts)
January Rs42,000 Rs72,000
February 48,000 66,000
March 36,000 60,000
April 54,000 78,000
Collections from customers are normally 70% in the month of sale, 20% in the month following
the same, and 9% in the second month following the sale. The balance is expected to be
uncollectible. Arihant takes full advantage of the 2% discount allowed on purchases paid for by
the tenth of the following month. Purchases for May are budgeted at Rs 60,000 (before discounts),
while sales for May are forecasted at Rs 66,000. Cash disbursements for costs are expected to be
Rs14,000 for the month of May. Arihant’s cash balance at May-1 was Rs 20,000. You are
required to prepare the following schedules:

1. Expected cash collections during May

2. Expected cash disbursements during May
3. Expected cash balance at May 31