Chapter 7:

Flexible Budgets, Variances, and

Management Control: I
Learning objectives:

 Concept of Static budget and flexible budget

 Level 2 Flexible budget variances
 Level 3 variances
 Level 4 variances
 Use of variance by the managers as a control tool
Budget

Budget is the numerical expression of future courses of actions.

Example:
Tim Hortons has a plan to produce 50,000 units of donuts for the month of July
2020 and they prepared the following production costs budget:
Material costs $10,000
Labor costs $12,000
Factory OH costs $ 2,000
Total budgeted production costs $24,000

Any plan that cannot be expressed in terms of number is not a budget.

Static budget and Flexible budget:

When a budget is prepared for a specific activity level and remains same no matter what the actual
activity is, then it is called a STATIC BUDGET.
Comparison between budgeted activity and actual activity becomes irrational as bases are not equal.
Example: Budgeted material costs for 50,000 (static budget) units cannot be compared with actual material
costs for 52,000 units.

Budget: Production 50,000 units, Costs $50,000 Static budget

Budget: Production 49,000 units, Costs $52,000 Flexible budget M+L+OH

Actual Production 49,000 units Costs $51,500, savings of $500

over spent 1,500
On the other hand, When a budget is prepared for a specific activity level and that activity level
changes with the changes in actual activity level, then it is called a FLEXIBLE BUDGET.
Example: In case of a flexible budget, budgeted material costs for 52,000 units will be available to make the
comparison justified. Flexible budget always follow the actual activity level.
Limitation of static budget
Before production data:
Mr X is allowed to use 5000Kg of material @ $5 per kg (total $25,000) to produce
10,000 units of finished goods.

After production data:

Mr X produces 12,000 units of finished goods and spent $26,000 for materials.
Budget for 12000 units = $30,000
Comment on the performance of Mr X
Variance analysis
BUDGET is an important tool in cost accounting that is used to control the costs
and VARIANCE is difference between actual and budgeted results.

If there is a budgetary control system, performance of each and every segment /

manager of the business is measured in terms of budget.

The difference between the actual performance and budgeted performance is

called the variance.

This variance is then broken down to smallest possible components to trace the
reasons for variances or good/bad performance of a segment. This analysis helps
to identify the weaknesses and strength, as a result management can take the
corrective measures for the next period.
Types of variances
Favourable variance:
A favourable variance (F) results in operating income that exceeds the budgeted
amount

Unfavourable variance:
An unfavourable variance (U) results in operating income that is less than the
budgeted amount

There is nothing to be happy with a favourable variance and sad with an

unfavourable variance. Rather, lower the variances, better is the control over
expenditure, no matter it is F or U
Levels of variance analysis
Level 0 variance:
This is overall variance, it could be income, revenue or costs depending on the
analysis an organization is doing.

Level 1 variance:
Further breakdown of level 0 variance

Level 2 Variance
Further breakdown of level 1 variance

Level 3 variance
Further breakdown of level 2 variance, and so on.
Example: Level 0 and 1 variances
Monthly budget and variances

Jan-20
Budget Actual Variances
Level - 0 Overall exenditure $ 2,000.00 $ 2,300.00 $ 300.00 U

Food $ 500.00 $ 700.00 $ 200.00 U

Housing $ 600.00 $ 600.00 $ -
Level - 1 Transport $ 400.00 $ 600.00 $ 200.00 U
Education $ 500.00 $ 400.00 $ 100.00 F
$ 2,000.00 $ 2,300.00 $ 300.00 U
Static budget variance analysis
Static budget variance analysis
Flexible budget variance analysis
Flexible budget variance analysis, cont..
Flexible budget variance analysis, cont..
Flexible budget variance analysis, cont..
Element wise costs variance

 Mat costs V = price , quantity (2kg per unit, 2.2kg per unit), mix var
A: b: c = [Link] =6
= [Link] =6
 Lab costs V = rate, hours

 OH costs V = rate, hrs, activity

Material costs variances
Acronyms

For single material :

SP: Standard price per unit of materials
AP: Actual price per unit of materials
SQ: Standard quantity allowed for actual output (60,800) of finished goods
5kg is allowed to produce 1 unit. If production is 12,000 units, what is SQ?

AQ: Actual quantity used for actual output(10000/110000)of finished goods

In case of more than one materials, these may be required in addition to the above :
SMAQ: Standard mix/ratio of actual quantity of materials
AMAQ: Actual mix/ratio of actual quantity of materials
SWAP: Standard weighted average price
Material costs variances, cont.…

 Flexible budget variance for material or material cost variance:

SQ x SP = Standard material costs

Less: AQ x AP = Actual material costs
Material costs variance = _____XXXXX___

Or
Material costs variance = (SQ x SP) – (AQ x AP)
Material costs variances, cont.…

 Material quantity variance, Or, Material usage variance

Or
Material efficiency variance = (SQ – AQ) SP
(AQ - SQ)SP
SQXSP
- AQXSP
Qty Var
 Material price variance or
Material usage price variance = (SP – AP) AQ used
(AP – SP) AQ used

Material purchase price variance = (SP – AP) AQ purchased

Purchase = 10000, used 8000, Clsing Mat 2000units

Mat costs v = Mat qty v + mat price v

Labour costs variances

Acronyms:

SR = Standard rate per labour hour

AR = Actual rate per labour hour
SH = Standard hours allowed for actual output (?)
AH = Actual hours used for actual output
Labour costs variances, cont.…

Labour costs variance or Flexible budget variance for labour costs:

= (SH x SR) – (AH x AR)

Labour rate variance:

= (SR – AR) AH

Labour efficiency variance:

= (SH – AH) SR
Exercise: 7-19
RATE AND EFFICIENCY VARIANCES:

Doux Dulce manufactures kale salads. For January 2018, it budgeted to purchase
and use 16,000 kilograms of kale at $1.11 per kilogram; budgeted output was
60,000 salads. Actual purchases and use for January 2018 were 17,000 kilograms
at 0.99 per kilogram; actual output was 60,800 salads.

Required
1. Calculate the flexible-budget variance. Mat costs variance
2. Calculate the price and efficiency/quantity variances.
3. Comment on the results in requirements 1 and 2.
Solution:
Required information
SP: 1.11 given
AP: 0.99 given
SQ: (16,000/60000)*60,800 = 16,213.33Kg for 60,800
AQ: 17,000 for 60800

Mat costs v = (SQ x SP) – (AQ x AP)

= (16213.33 x 1.11) – (17,000 x 0.99) = 17,996.80 ( for 60800units) – 16,830 (60800 units)=
1,166.8 (F)
Material usage price variance = (SP – AP) AQ = (1.11-0.99)x17,000 = 2040 (F)
Material efficiency variance = (SQ – AQ) SP = (16,213.33-17,000)1.11 = 873.20 (U)
Mat costs v = Mat qty v + mat price v
1166.8(F) = 2040 (F) + 873.2 (U)
Problem 7-36
 DIRECT MATERIALS AND MANUFACTURING LABOUR VARIANCES, SOLVING
UNKNOWNS. (CPA, adapted) On May 1, 2017, Bovar Company began the
manufacture of a new paging machine known as Dandy. The company
installed a standard costing system to account for manufacturing costs. The
standard costs for a unit of Dandy follow:

Dire ct ma te ria ls (3 kg a t $4 pe r kg) $ 12.00

Dire ct ma nufa cturing la bour (1/2 hour a t $20 pe r hour) $ 10.00
Ma nufa cturing ove rhe a d (75% of dire ct ma nufa cturing la bour cos ts ) $ 7.50
Cos ts pe r unit $ 29.50
Problem 7:36, cont. ..
The following data were obtained from Bovar’s records for the month of May:
Debit Credit
Revenues $125,000
Accounts payable control (for May’s purchases of direct materials) 55,000
Direct materials price variance $3,500
Direct materials efficiency variance 2,400
Direct manufacturing labour price variance 1,890
Direct manufacturing labour efficiency variance 2,200

Actual production in May was 4,000 units of Dandy, and actual sales in
May were 2,500 units.
The amount shown for direct materials price variance applies to materials
purchased during May.
There was no beginning inventory of materials on May 1, 2017.
Compute each of the following items for Bovar for the month of May.
Show your computations.
Problem 7:36, cont. ..

Re quire d
1. Sta nda rd dire ct ma nufa cturing la bour-hours a llowe d for a ctua l output produce d
2. Actual dire ct ma nufa cturing la bour-hours worked
3. Actual dire ct ma nufa cturing la bour wa ge rate
4. Sta nda rd quantity of dire ct ma te rials a llowe d (in kilograms )
5. Actual quantity of dire ct ma te ria ls us e d (in kilogra ms )
6. Actual quantity of dire ct ma te ria ls purcha s ed (in kilograms )
7. Actual dire ct ma teria ls price pe r kilogra m
Solution

R-1:
SH = 4000 x ½ hr = 2000 Direct Lab Hr

R-2:
AH = ?

Lab eff V = (SH – AH)SR

2200 = (2000 – AH) 20
AH = 1890
Solution

R- 3:
AR = ?
Labour rate variance = (SR - AR ?) AH / Rate var = (AR-SR)AH
-1890 = (20 – AR) 1890 1890 = (AR – 20) 1890
AR = 21 AR = 21

R-4:
SQ = 4000 x 3kg = 12,000kg
Solution

R–5
AQ = AQ used for actual output (4000)
Mat Qty variance =( SQ – AQ ) SP
-2400 = (12,000 – AQ) 4
AQ = 12,600
R–6
Actual qty of mat purchased

Standard price of mat Dr 51,500 (balancing figure)

Price Variance Dr 3500
AP Cr 55,000

AQ purchased = 51,500/4 = 12,875

R- 7
AP
55,000/12875 = 4.27
Level 4 Variances
Further analysis of Material Quantity/efficiency Variance

Material Quantity variance = Material Mix Variance + Material Yield

Variance

Calculation:
Material Quantity Variance = (SQ – AQ)SP

Material Mix Variance = (St. Mix of actual qty – A. Mix of actual qty) SP

Material Yield Variance = (SQ – AQ) St. weighted average price

Material Mix and Yield variance
A further analysis of material quantity variance can results material mix variance
and material yield variance.

Material Mix Variance: Material mix variance happens when more than one
material is used in a standard ratio to produce a product. If we isolate material
price variance and material quantity variance ( or material efficiency variance)
or assuming there is no price and quantity variance, still there might be a
variance because of changes in the ratio of material.

Material Yield Variance: This is the difference between standard quantity of

material and actual quantity of material multiplied by the standard weighted
average price. The reason is, when prices are same for all materials, mix
variance becomes zero. Thus yield variance is isolated from mix variance.
Example: Material Mix Variance
St Costs of Materials
Materials St. Ratio measure SP/unit Total costs
A 2 kg $ 5.00 $ 10.00
B 3 kg $ 6.00 $ 18.00
C 1 kg $ 7.00 $ 7.00
Total 6 kg $ 5.83 $ 35.00
A. Costs of Materials
Materials St. Ratio measure SP/unit Total costs
A 1.5 kg $ 5.00 $ 7.50
B 2.5 kg $ 6.00 $ 15.00
C 2 kg $ 7.00 $ 14.00
Total 6 kg $ 6.08 $ 36.50

Material Mix Variance $ 1.50 (U)

5+6+7 = 18, Simple Ave = 18/3=6, Weighted Ave 5.83

Material Mix variance: exception

If the price per unit of all material is similar, then any changes in ratio will not
trigger any material mix variances.
St Costs of Materials
Materials St. Ratio measure SP/unit Total costs
A 2 kg $ 5.00 $ 10.00
B 3 kg $ 5.00 $ 15.00
C 1 kg $ 5.00 $ 5.00
Total 6 kg $ 5.00 $ 30.00
A. Costs of Materials
Materials St. Ratio measure SP/unit Total costs
A 1.5 kg $ 5.00 $ 7.50
B 2.5 kg $ 5.00 $ 12.50
C 2 kg $ 5.00 $ 10.00
Total 6 kg $ 5.00 $ 30.00

Material Mix Variance $ - (U)

Illustration: Mix & Yield variance
Illustration: Mix & Yield variance, Cont..
Material quantity variance
Material Quantity variance

SQ 4000 X 1.6/1 = 6400

SQ SP Total value
Latmos 50% 3,200 $ 70.00 $ 224,000
Caltoms 30% 1,920 $ 80.00 $ 153,600
Flotoms 20% 1,280 $ 90.00 $ 115,200
6,400 $ 77.00 $ 492,800

AQ
AQ SP Total Value
Latmos 3,250.00 $ 70.00 $ 227,500.00
Caltoms 2,275.00 $ 80.00 $ 182,000.00
Flotoms 975.00 $ 90.00 $ 87,750.00
6,500.00 $ 497,250.00

$ 4,450.00 (U)
Material yield variance

Material Yield Variance

(SQ - AQ) X SWAP
(6,400 - 6,500) x 77
$ 7,700.00 (U)

OR
Mat SQ AQ SWAP Variance
Latmos 3,200 3,250 $ 77.00 $ 3,850.00 (U)
Caltoms 1,920 2,275 $ 77.00 $ 27,335.00 (U)
Flotoms 1,280 975 $ 77.00 $ 23,485.00 (F)
$ 7,700.00 (U)
 Price variance = (SP – AP)AQ used
L = (70 – 70) 3250 = 0
C = (80 – 82) 2275 = 4550 (U)
F = (90 – 96) 975 = 5850 (U)
Price variance =10,400 (U)

Mat cost variance = 14,850 (U) = Mat price Var + Mat Yield V + Mat Mix
14,850 (U) = 10,400 (U) + 7700(U)+3250(F)
14,850 (U) = 14,850 (U)
Material mix variance

Material Mix Variance

(St Mix of actual Qty - A mix of actual qty) SP

Latmos $ 3,250.00 $ 3,250.00 $ 70.00 $ -

Caltoms $ 1,950.00 $ 2,275.00 $ 80.00 $ 26,000.00 (U)
Flotoms $ 1,300.00 $ 975.00 $ 90.00 $ 29,250.00 (F)
$ 6,500.00 $ 6,500.00 $ 3,250.00 (F)
Proof:
Material Quantity variance = Material Mix Variance + Material Yield Variance

$ 4,450.00 (U) = 3,250 (F) + 7,700 (U)

Further analysis of Labour Efficiency Variance

Labour efficiency variance = Labour Mix Variance + Labour Yield Variance

Calculation:
Labour Efficiency Variance = (SH – AH)SR

Labour Mix Variance = (St. Mix of actual Hrs – A. Mix of actual Hrs) SR
Material Mix Variance = (St. Mix of actual qty – A. Mix of actual qty) SP

Labour Yield Variance = (SH – AH) St. weighted average rate

Material Yield Variance = (SQ – AQ) St. weighted average price
7-39 VARIANCES IN THE SERVICE SECTOR. 

Derek Wilson operates Clean Ride Enterprises, an auto detailing company with 20
employees. Jamal Jackson has recently been hired by Wilson as a controller. Clean
Ride’s previous accountant had done very little in the area of variance analysis, but
Jackson believes that the company could benefit from a greater understanding of his
business processes. Because of the labour-intensive nature of the business, he
decides to focus on calculating labour variances.

Jackson examines past accounting records and establishes some standards for the
price and quantity of labour. While Clean Ride’s employees earn a range of hourly
wages, they fall into two general categories: skilled labour, with an average wage of
$20 per hour, and unskilled labour, with an average wage of $10 per hour. One
standard 5-hour detailing job typically requires a combination of 3 skilled hours and 2
unskilled hours.
Prob. 7-39 …
Actual data from last month, when 600 detailing jobs were completed, are as
follows:

Skilled (2,006 hours) $ 39,117

Unskilled (944 hours) 9,292
Total actual direct labour cost $ 48,409

Looking over last month’s data, Jackson determines that Clean Ride’s labour
price variance was $1,151 favourable, but the labour efficiency variance was
$1,560 unfavourable. When Jackson presents his findings to Wilson, the latter is
furious. “Do you mean to tell me that my employees wasted $1,560 worth of
time last month? I have had enough. They had better shape up, or else!” Jackson
tries to calm him down, saying that in this case the efficiency variance does not
necessarily mean that employees were wasting time. Jackson tells him that he is
going to perform a more detailed analysis and will get back to him with more
information soon.
Required:

1. What is the budgeted cost of direct labour for 600 detailing jobs?
2. How were the $1,151 favourable price/rate variance and the $1,560
unfavourable labour efficiency variance calculated? What was the company’s
flexible-budget variance?
3. What do you think Jackson meant when said that “in this case the efficiency
variance doesn’t necessarily mean that employees were wasting time”?
4. For the 600 detailing jobs performed last month, what is the actual direct
labour input mix percentage? What was the standard mix for labour?
5. Calculate the total direct labour mix and yield variances.
6. How could these variances be interpreted? Did the employees waste time?
Upon further investigation, you discover that there were some unfilled
vacancies last month in the unskilled labour positions that have recently been
filled. How will this new information likely impact the variances going
forward?
Solution:
Standard rates
Skilled 20 per hr
Unskilled 10 per hr

Actual rates
Skilled $ 39,117.00 2006 $ 19.50 per hr
Unskilled $ 9,292.00 944 $ 9.84 per hr
$ 48,409.00

Standard Mix
Skilled 3 Hrs
Unskilled 2 Hrs
5

Standard Hours
600 x 5 3,000 Hrs

Skilled 1,800 Hrs

Unskilled 1,200 Hrs
3,000

Actual Hours
Skilled 2,006 Hrs
Unskilled 944 Hrs
2,950
R-1

R#1 Standard costs for 600 units (detailing jobs)

Standard costs = SH x SR

SH SR St Costs
Skilled 1800 $ 20.00 $ 36,000.00
Unskilled 1200 $ 10.00 $ 12,000.00
$ 48,000.00
R-2
R - 2: Labour rate variance

Rate variance = (SR - AR) AH

SR AR AH
Skilled $ 20.00 $ 19.50 2,006 $ 1,003.00 F
Unskilled $ 10.00 $ 9.84 944 $ 148.00 F
$ 1,151.00 F

R - 2: Labour efficiency variance

Effi ciency variance = (SH - AH) SR

SH AH SR
Skilled 1,800 2,006 $ 20.00 $ 4,120.00 U
Unskilled 1,200 944 $ 10.00 $ 2,560.00 F
$ 1,560.00 U
R–2…
Flexible Budget variance: (Lab costs variance)
SH x SR = St Costs
Less: AH x AR - A. Costs

SH SR St Costs
Skilled 1,800 $ 20.00 $36,000.00
Unskilled 1,200 $ 10.00 $12,000.00
3,000 $ 16.00 $48,000.00

AH AR A. Costs
Skilled 2,006 $ 19.50 $39,117.00
Unskilled 944 $ 9.84 $ 9,292.00
$48,409.00

Fllexible budget variance $ 409.00 U

Proof:
Labour effi ciency variance $ 1,560.00 U
Labour rate variance $ 1,151.00 F
$ 409.00 U
R-3

In a company where there is a mixture of workers, some at higher wages and others
at lower, all working on the same projects, an unfavourable efficiency variance can
be the result of which employees worked on the project, not just how many hours
were spent. If higher paid workers worked more than their standard percentage of
the time, an unfavourable efficiency variance will result.

Mix and match is offered only when the prices are same. Higher priced and lower
priced product can never be offered ‘mix and match’.
R–4
Total hrs = 2006 + 944 = 2950
Skilled % = 2006/2950 = 68%.
Unskilled = 944/2950 = 32%

Standard Hours
600 x 5 3,000 Hrs

Skilled 1,800 Hrs

Unskilled 1,200 Hrs
3,000
 St mix of actual Hrs:
 Actual Hrs = 2950
 Skilled = (2950/5)*3 = 1770
 Unskilled = (2950/5)*2 = 1180

 St W. Ave rate:
 Skilled = 3X20 = 60
 Unskilled = 2X10 = 20
 Total = $80, total hrs 5, SWAR = 80/5 = 16
R-5
Labour Mix Variance = (St. Mix of actual Hrs – A. Mix of actual Hrs) SR

Skilled 1,770 2,006 $ 20.00 $ 4,720.00 U

Unskilled 1,180 944 $ 10.00 $ 2,360.00 F
2,950 2,950 $ 2,360.00 U

Labour Yield Variance = (SH – AH) St. weighted average rate

3,000 2,950 $ 16.00 800 F

Proof:
Labour efficiency variance = Labour Mix Variance + Labour Yield Variance

$ 1,560.00 U = $ 2,360.00 U + 800 F

R-6

While the efficiency variance was unfavourable, it was due to the mix of labour,
not the total hours used. The unfavourable mix variance is the result of a higher
than standard percentage of skilled labour (68% vs. 60%) used. The yield variance,
which is a more accurate measure of hours used, is favorable because total hours
(2,950) were actually lower than the standard for 600 detail jobs (3,000). The
skilled labour workers were probably able to work more quickly than the unskilled.
Case study: Electronic Process Equipment
Case summary:
Early 80s, Tom Simon was an employee of Pulp & Paper Mill in Vancouver Island. He
developed integrated process control system in the mill and promoted as a Chief
Engineer.
At some point in 1987, he left the job and formed Electronic Process Equipment (EPE)
with two other young engineer. EPE designs, assembles and implements process control
system, do ongoing maintenance for different Pulp & Paper Mills. The company was very
successful and by 1994, it becomes a world leading process control engineering
consulting firm. At the same time they developed process control system for petroleum
and chemical industries as well. Annual revenue is half a billion dollar.
Case study: Electronic Process Equipment ….
They realised some issues with cost accounting system and hired a chartered
accountant in 1999 as VP Finance.
Assignment of VP Finance was:
• Understand the existing system
• Problems with the existing system
• Assess the need for a cost accounting system
• Recommend a costs accounting system

Existing system was good for inventory valuation and periodic financial reporting
according to the then GAAP.
Case study: Electronic Process Equipment ….
• But it was inadequate to determine the costs of activities and business
process as well as profitability of products, services and customers. Also it
was inadequate to provide feedback for further improvement.
• Product designers and developers did not have accurate information about
their costs.
• Example: Response to customer requests involves people from seven
departments, what is the cost of customer response? Difficult to determine
competitive price for customers because of lack of costs data, hence hard to
determine profit by customers.
• Problems with allocation off-the-factory (admn + Selling OH) costs were not
allocated by products, services, customers.
Case study: Solution format
 Root Issues
• study and recommend a cost accounting system
• inaccurate costing
• lack of useful feedback on activities and processes
 Analyses
• current system adequate for GAAP
• valuating inventory
• financial reporting
• inappropriate internal responsibility center reporting
• inappropriate product and service costing
• inappropriate operational feedback
 Recommendations/conclusion
• integrated, activity-based system
• comprehensive ABC
• comprehensive operational feedback
• ERP, PeopleSoft, SAP