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CHAPTER 7

Flexible Budgets,
Direct-Cost Variances,
and Management Control

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Why conduct variance analysis?


Part of the control function
Promotes organizational learning
Makes responsibility accounting possible

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Terms
Variance difference between actual and budgeted amount
Management by exception focusing attention on areas not
operating as expected (budgeted)
Static (Master) Budget a point estimate based on output
planned at the start of the budget period

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Terms, continued
Static budget variance (Level 0) difference between actual
results and the static budget amount
Favorable variance (F) increases operating income compared
to the budgeted amount
Unfavorable variance (U) decreases operating income
compared to the budgeted amount

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Variances
Level 0 variance analysis the total variance from budget
Level 1 variance analysis disaggregates total variance into line
item variances
Levels 2 and 3 variance analysis - Progressively finer
disaggregation of the total variance

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Level 1 Analysis, Illustrated

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Flexible Budget
Flexible Budget shows budgeted revenues and costs adjusted
for actual volume
Flexible budget variance (level 2) Actual results compared to
flexible budget amounts
Sales volume variance (level 2) Flexible budget amounts
compared to static budget amounts

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Level 2 Analysis, Illustrated

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Price and Efficiency Variances (level 3)


A disaggregation of the flexible budget (level 2) variance
Can be calculated for direct materials, direct labor, fixed
MOH, variable MOH

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Level 3 Analysis, Illustrated

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Variance Summary

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Level 3 Variances
Price Variance formula:

Efficiency Variance formula:

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Journal Entries
Variances may be journalized, but will not be tested on exam
Each variance has a separate account
Favorable variances are credits; Unfavorable variances are
debits
Variance accounts are generally closed to Cost of Goods Sold at
the end of the period, if immaterial

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Standard Costing
Budgeted amounts and rates are actually booked
Differences between budgeted and actual amounts give rise to
variance accounts.
Standard costing is used because:
Improved software systems allow it
Variance information is extremely useful

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Uses of Variances
Helps explain underlying causes of departures from budget
Performance measurement Helps evaluate effectiveness and
efficiency of employees
Promotes organizational learning
Makes continuous improvement initiatives possible
Variances are interrelated and have multiple causes

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Activity-Based Costing and Variances


Budgeting and variance analysis can be used with ABC
In such cases, budgeting is not conducted on the
departmental-wide basis (or other macro approaches)
Instead, budgets are built from the bottom-up with activities
serving as the building blocks of the process

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Benchmarking
Benchmarking process of comparing performance
against best performance in competing companies
Variances can be extended to include comparison to other
entities

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Benchmarking Example: Airlines

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