Static versus flexible budget variances
Dan Ludwig is the manufacturing production supervisor for Atlantic Lighting
Systems. Trying to explain why he did not get the year-end bonus that he had
expected, he told his wife, “This is the dumbest place I ever worked. Last year
the company set up this budget assuming it would sell 150,000 units. Well, it
sold only 140,000. The company lost money and gave me a bonus for not using as
much materials and labor as was called for in the budget. This year, the
company has the same 150,000 units goal and it sells 160,000. The company’s
making all kinds of money. You’d think I’d get this big fat bonus. Instead,
management tells me I used more materials and labor than was budgeted. They
said the company would have made a lot more money if I’d stayed within my
budget. I guess I gotta wait for another bad year before I get a bonus. Like I
said, this is the dumbest place I ever worked.”
Atlantic Lighting System’s master budget
and the actual results for the most recent year of operating activity follow.
Master Budget Actual Results Variances F or U
Number of Units 150,000 160,000 10,000 .
Sales revenue $33,000,000 $35,520,000 $2,520,000 F
Variable Manufacturing Costs
Materials (4,800,000) (5,300,000) (500,000) U
Labor (4,200,000) (4,400,000) (200,000) U
Overhead (2,100,000) (2,290,000) (190,000) U
Variable, selling general admin cost (5,250,000) (5,450,000) (200,000) U
Contribution
margin 16,650,000 18,080,000 1,430,000 F
Fixed Costs
Manufacturing overhead (7,830,000) (7,751,000) 79,000 F
Selling, general and admin (6,980,000) (7,015,000) (35,000) U
Net income $1,840,000 $3,314,000 $1,474,000 F
.:.
Required
a. Did Atlantic increase unit sales by
cutting prices or by using some other strategy?
b. Is Mr. Ludwig correct in his
conclusion that something is wrong with the company’s performance evaluation process?
If so, what do you suggest be done to improve the system?
c. Prepare a flexible budget and re-compute
the budget variances.
d. Explain what might have caused the
fixed costs to be different from the amount budgeted.
e. Assume that the company’s material
price variance was favorable and its material usage variance was unfavorable.
Explain why Mr. Ludwig may not be responsible for these variances. Now, explain
why he may have been responsible for the material usage variance.
f. Assume the labor price variance is
unfavorable. Was the labor usage variance favorable or unfavorable?
g. Is the fixed cost volume variance
favorable or unfavorable? Explain the effect of this variance on the cost of
each unit produced.
a. The increase in sales volume was not
achieved by lowering the sales price.
The budgeted sales price was $220 per unit (i.e., $33,000,000 ÷ 150,000
units). The actual sales price was $222
per unit (i.e., $35,520,000 ÷ 160,000 units).
Some other factor such as increased advertising or a general rise in
demand due to a robust economy caused the increase in sales.
b. There is a problem with the performance
evaluation system. Performance
evaluation should be based on flexible budget variances rather than the
activity variances.
c. To prepare a flexible budget, first
determine the budgeted sales price, and the standard cost per unit for
materials, labor, overhead, and S, G, and A.
These amounts are shown below:
|
|
Dollars
|
|
Units
|
|
Cost Per Unit
|
|
Sales Price
|
$33,000,000
|
÷
|
150,000
|
=
|
$220
|
|
Materials
|
(4,800,000)
|
÷
|
150,000
|
=
|
32
|
|
Labor
|
(4,200,000)
|
÷
|
150,000
|
=
|
28
|
|
Overhead
|
(2,100,000)
|
÷
|
150,000
|
=
|
14
|
|
S, G, and A
|
(5,250,000)
|
÷
|
150,000
|
=
|
35
|
The
flexible budget variances are shown below.
|
|
Flexible
|
Actual
|
|
|
|
|
Budget
|
Results
|
Variances
|
|
|
Number of Units
|
160,000
|
160,000
|
0
|
|
Sales
Revenue
|
$35,200,000
|
$35,520,000
|
$320,000
|
Favorable
|
|
Variable Manuf. Costs
|
|
|
|
|
|
Materials ($32/unit)
|
(5,120,000)
|
(5,300,000)
|
(180,000)
|
Unfavorable
|
|
Labor ($28/unit)
|
(4,480,000)
|
(4,400,000)
|
80,000
|
Favorable
|
|
Overhead ($14/unit)
|
(2,240,000)
|
(2,290,000)
|
(50,000)
|
Unfavorable
|
|
Variable G,S,&A ($35/unit)
|
(5,600,000)
|
(5,450,000)
|
150,000
|
Favorable
|
|
Contribution Margin ($111/unit)
|
17,760,000
|
18,080,000
|
320,000
|
Favorable
|
|
Fixed Costs
|
|
|
|
|
|
Manufacturing
|
(7,830,000)
|
(7,751,000)
|
79,000
|
Favorable
|
|
S, G, and A
|
(6,980,000)
|
(7,015,000)
|
(35,000)
|
Unfavorable
|
|
Net Income
|
$2,950,000
|
$3,314,000
|
$364,000
|
Favorable
|
|
|
|
|
|
|
d. A cost is defined as fixed if it does
not change simply because there is a change in activity, but there are other
things that can cause a “fixed” cost to change.
For example, the monthly rental rate charged by a landlord can be
increased, or the property tax rate charged by a municipality can be raised or
lowered.
e. Scenario 1: The favorable price variance may have been
attained by purchasing low quality materials.
This could have led to waste in the production process that was beyond
Mr. Ludwig’s control. Scenario 2: Mr. Ludwig could have failed to properly
supervise the workers under his control.
The workers could have developed poor work habits that led to
unnecessary waste of materials.
f. Recall that the total variance is
composed of price and usage variances.
Note that the total labor variance was favorable (see part c
above). Accordingly, if the labor price
variance was unfavorable, the usage variance had to be favorable; otherwise the
total could not have been favorable.
g. The fixed overhead volume variance was
favorable, because more units were produced than were budgeted (160,000 vs.
150,000).
