Chapter Three

Flexible Budgets
and
Standards
•A budget is a formal plan of action expressed in
monetary terms. A budget that is based on a
single estimate of expected sales and production
is called a static budget.
•A static budget shows the expected results for only
one activity level.
•Once the budget has been determined, it is not
changed, even if the activity changes. All static
budgets have the following common points:-
 They are focused only one level of activity
 They are static/fixed/ in nature.
• Static budget variances
A variance is the difference between
actual price and quantity and
standard budgeted price and
quantity.
When we come to static budget
variance, it is simply the difference
between the actual result and the
corresponding budgeted amount in
the static budget.
 A fixed budget is a budget which is
designed to remain unchanged
irrespective of the level of activity.
actually attained.
 a Budget prepared based on fixed
level of activity is known as a fixed
budget. It does not change with the
change in the level of activity.
 A Flexible budget is a budget designed
to change in accordance with the level
of activity actually reached.
 Flexible budgets show expected
Generally, Flexible Budgets
 are budgets that change with
changing levels of activity.
 It a performance evaluation
tool.
 It cannot be prepared before
the end of the period.
 Also known as variable or
sliding sale budget.
• Static budget variance=Actual
result - Static budget amount
• Variance we compute at last favorable
or unfavorable variance.
• Favorable variance (denoted by
F):- has the effect of increasing
operating income relative to the
budgeted amount.
For revenue items, favorable means
actual revenues exceed budgeted
revenues and the reverse is true for
unfavorable variance.
• An unfavorable variances
(denoted by u):-
has the effect of decreasing operating
income relative to the budgeted
amount. we can identify each static
budget variance favorable (F) or
unfavorable (U) based on their effect
on operating income.
The difference between an actual
result and the corresponding flexible
budget amount is called flexible
budget variance,
Example: ABC Company manufactures and sells
jackets. The jackets require tailoring and many hand
operations. The company incurred only manufacturing
costs. ABC Company has three variable cost
categories. The budgeted variable cost per jacket for
each category is:-
Cost category Variable cost per jacket
•Direct material costs $ 60
•Direct manufactory labor costs $16
•Variable manufacturing overhead costs 12
•Total variable costs $88
•The number of units manufactured is the cost driver for direct materials,
direct manufacturing labor, and variable manufacturing overhead. The
relevant range for the cost driver is from 0 to 12,000 jackets. Budgeted
and Actual data for April 2008 follow:-
• Budgeted fixed cost under the relevant range……………....$276,000
• Budgeted selling price ………………………………………………….…$120 per
jackets
•Budgeted production and sales …………………………………12,000 jackets
•Actual fixed cost under the relevant rage…………………...$285,000
•Actual selling price ……………………………………………….………$125 per
jackets
•Actual production and sales ………………………………………..10,000 jackets
Cost category Variable cost per jacket
• Direct material costs…………………………………………………$62.16
• Direct manufacturing labor costs ………………….............$19.8
• Variable manufacturing over head costs ………………..$13.05
• Total variable cost …………………………………………….……..$95.01
• Required
 Compute Actual operating income, static budget operating income and
static budget variance for operating income.
 Solution
(1) (2)=(1)-(3) (3)
Level 1 analysis Actual Static budget Static budge
Result Variances
Unit sold 10,000 2000U 12,000
Revenues $1,250,000 $190,000U $1,440,000
Variable costs
Direct material 621,600 984,000F 720,000
Directmanufacturinglabor 198,000 6,000U 192,000
Variable manufactory overhead 130,500 13,500F 144,000
Total variable costs 950,100 105,900F 1,056,000
Contribution margin 299,900 84,100 U 384,000
Fixed costs 285,000 9,000 u 276,000
Operating income $14,900 $93,100U $108, 000
Static budget
Variance for = actual result – static
budget
Operating income $14,900 - $ 108,000 = $93,100 U
 Standards for Materials and Labor
• The pre-set standards require managers to
plan in advance the amount and price of
each resource that will be used in providing a
service or manufacturing a product. These
pre-set standards, for selling prices and sales
volumes as well as for costs, provide a basis
for planning,
• If resource price or usage is below standard
  Developing flexible budget

•The only difference between static budget and flexible budget is that :-
 static budget is prepared for the planned output; whereas flexible
budget is based on the actual output.
 using example above ABC produced and sold 10,000 jackets
then:-
A. develop flexible budget revenue
B. flexible budgets for cost
Solution:
In April 2003 ABC produced and sold 10,000 jackets
Flexible budget revenue= budgeted selling price x actual quantity of
output.
$120 per jacket x 10,000 jackets.
= $1,200,000
 B. flexible budgets for cost
• Flexible budget variable costs = TVC+TFC
D.M $60 per jacket x 10,000 jackets …..$600,000
DL $16 per jacket x10, 000 jackets……….160,000
MOH $12 per jacket x10, 000 jak............120,000
Total flexible-budget variable costs………880,000
Flexible budget fixed costs………………276,000
Flexible budget total cost…….………$1,156,000
 Direct Material Price Variance:

•Direct Material Price Variance is the difference

between the actual cost of direct material and the
standard cost of quantity purchased or consumed.
• Actual Quantity is the quantity purchased during a
period if the variance is calculated at the time of
material purchase
 Actual Quantity is the quantity consumed during a
period if the variance is calculated at the time of
material consumption.
•Example
Cement PLC manufactured 10,000 bags of cement during the
month of January. Following raw materials were purchased and
consumed by Cement PLC during the period:
Material Actual Actual Standard
Quantity Price Price
Limestone 100 tons $75/ton $70/ton
Clay 150 tons $20/ton $24/ton
Sand 250 tons $10/ton $12/ton

A. Calculet actual cost

B. Find the Standard Cost of Actual Quantity
C. Calculate the Variance
A. Actual cost = actual quantity X actual price
limestone………….100tone X $75=$7,500
Clay……………….150tone X $20 = $3,000
sand……………….250tone X $10= $2,500
Total actual cost = $13,000.00
B. Standard Cost = Actual Quantity x Standard Price
limestone………....100tone X $70=$ 7,000
Clay……………….150tone X $24 =$3,600
sand……………….250tone X $12= $ 3,000
Total standard cost = $13,600.00
C. Material Price Variance = Actual Cost (A) - Standard Cost (B)
limestone………….$7,500 – 7,000 = $500 U
Clay……………….$3,000 – 3,600 = $ 600 F
sand……………….$2,500 – 3,000 = $ 500 F
Total price variance…………………………..$ 600 F
 A favorable material price variance suggests cost
effective procurement by the company.

• An overall decrease in the market

Reasons price level
for a • Purchase of materials of lower
favorable price
material • Better price negotiation by the
price procurement staff
variance • Implementation of better
may procurement practices
include: •
Purchase discounts on larger orders
Unfavorable material price variance indicates
higher purchase costs incurred during the
period compared with the standard.

• An overall hike in the market price

of materials
Reasons for • Purchase of materials of higher
unfavorable quality than the standard
• Increase in bargaining power of
material suppliers
price • Loss of purchase trade discounts due
variance to smaller order sizes
• Inefficient buying by the
include: procurement staff
Direct Material Usage Variance is the measure of
difference between the actual quantity of
material utilized during a period and the standard
consumption of material for the level of output
achieved.
Direct Labor Efficiency Variance is the measure
of difference between the standard cost of actual
number of direct labor hours utilized during a
period and the standard hours of direct labor for
the level of output achieved.