As you study the exhibits in this chapter, note that “level” followed by a number denotes the amount of detail shown by a variance analysis. Level 1 reports the least detail, level 2 offers more information, and so on.
Consider Webb Company, a firm that manufactures and sells jackets. The jackets require tailoring and many other hand operations. Webb sells exclusively to distributors, who in turn sell to independent clothing stores and retail chains. For simplicity, we assume the following:
Webb has three variable-cost categories. The budgeted variable cost per jacket is as follows:
The table depicts the budgeted variable cost per jacket for Webb. The details of the table are as follows:
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 2020 are shown below:
The table depicts the budgeted and actual data for April 2020 for Webb. The details of the table are as follows:
The static budget, or master budget, is based on the level of output planned at the start of the budget period. The master budget is called a static budget because the budget for the period is developed around a single (static) planned output level. Exhibit 7-1, column 3, presents the static budget for Webb Company for April 2020 that was prepared at the end of 2019. For each line item in the income statement, Exhibit 7-1, column 1, displays data for the actual April results. The following table presents more details for some of the differences between actual and budgeted outcomes:
The table depicts actual revenues and costs, actual jackets produced and sold, actual price/cost per jacket (actual revenues and costs divided by actual jackets produced and sold), and budgeted price/cost per jacket for revenues and direct material costs. The details of the table are as follows:
1. Revenues
Actual revenues and costs: 1,250,000 dollars
Actual jackets produced and sold: 10,000
Actual price/cost per jacket (actual revenues and costs divided by actual jackets produced and sold): 125 dollars
Budgeted price/cost per jacket: 120 dollars
2. Direct material costs
Actual revenues and costs: 621,600 dollars
Actual jackets produced and sold: 10,000
Actual price/cost per jacket (actual revenues and costs divided by actual jackets produced and sold): 62.16 dollars
Budgeted price/cost per jacket: 60 dollars
The static budget variances, which are the difference of actual results and static budget, are classified as favorable or unfavorable effect on operation system denoted by “F” and “U” respectively. The details of the level 1 analysis are as follows.
Actual results:
Units sold: 10,000
Revenues: dollar 1,250,000
Variable costs
Direct materials: 621,600
Direct manufacturing labor: 198,000
Variable manufacturing overhead: 130,500
Total variable costs: 950,100
Contribution margin: 299,900
Fixed costs: 285,000
Operating income: dollar 14,900
Static budget variances
Units sold: 2,000 U
Revenues: dollar 190,000 U
Variable costs
Direct materials: 98,400 F
Direct manufacturing labor: 6,000 U
Variable manufacturing overhead: 13,500 F
Total variable costs: 105,900 F
Contribution margin: 84,100 U
Fixed costs: 9,000 U
Operating income: dollar 93,100 U
Static budget
Units sold: 12,000
Revenues: dollar 1,440,000
Variable costs
Direct materials: 720,000
Direct manufacturing labor: 192,000
Variable manufacturing overhead: 144,000
Total variable costs: 1,056,000
Contribution margin: 384,000
Fixed costs: 276,000
Operating income: dollar 108,000
We describe potential reasons and explanations for these differences as we discuss different variances throughout the chapter.
The static-budget variance (see Exhibit 7-1, column 2) is the difference between the actual result and the corresponding budgeted amount in the static budget.
A favorable variance—denoted F in this text—has the effect, when considered in isolation, of increasing operating income relative to the budgeted amount. For revenue items, F means actual revenues exceed budgeted revenues. For cost items, F means actual costs are less than budgeted costs. An unfavorable variance—denoted U in this text—has the effect, when viewed in isolation, of decreasing operating income relative to the budgeted amount. Unfavorable variances are also called adverse variances in some countries, such as the United Kingdom.
The unfavorable static-budget variance for operating income of $93,100 in Exhibit 7-1 is calculated by subtracting static-budget operating income of $108,000 from actual operating income of $14,900:
The analysis in Exhibit 7-1 provides managers with additional information on the static-budget variance for operating income of $93,100 U. The more detailed breakdown indicates how the line items that comprise operating income—revenues, individual variable costs, and fixed costs—add up to the static-budget variance of $93,100.
Recall that Webb produced and sold only 10,000 jackets, although managers anticipated an output of 12,000 jackets in the static budget. Managers want to know how much of the static-budget variance is due to Webb inaccurately forecasting what it expected to produce and sell and how much is due to how it actually performed manufacturing and selling 10,000 jackets. Managers, therefore, create a flexible budget, which enables a more in-depth understanding of deviations from the static budget.