EN.662.611 Chap.12 Master Budgets, Standard Costs and Variances
Master Budgets, Standard Costs and Variances
The master budget as a plan
The course's master budget exercise shows what a plan must assume: a price and cost per unit, an inventory policy tied to the next month's sales, a payment lag on purchases, a collection pattern for credit sales, a minimum cash balance and borrowing in fixed multiples at a stated interest rate.
The schedules build on each other and end in a cash budget and budgeted income statement, the documents a bank asks for before it extends a line of credit.
Standard costs
Week 12 defines standard costs as engineered costs, set so that expected and actual costs can be compared sensibly. They suit products made in repetitive runs.
Their advantages are that they identify variances, point to the responsible party, motivate, normalize costs in the financial statements and speed up bidding. Ideal standards assume peak effort with no waste and tend to demotivate; practical standards are tight but attainable.
Each standard is a quantity times a price, where material quantity includes normal waste and labor time includes rest, cleanup and downtime.
Master versus flexible budget
Week 13 explains why a master budget, prepared in advance at a static volume, is good for planning but poor for evaluation.
A flexible budget, prepared in arrears, recomputes revenue and variable costs at the actual volume and leaves fixed costs unchanged. Comparing master with flexible isolates the volume variance; comparing flexible with actual isolates revenue and spending variances.
Each variance is favorable or unfavorable according to its effect on net income.
Splitting spending variances and assigning them
Standard costs let a spending variance be split into a quantity variance, actual quantity minus standard quantity allowed times standard price, and a price variance, actual price minus standard price times actual quantity.
Managers investigate only significant deviations, set by a dollar amount or a percentage, which the lecture calls management by exception. Responsibility follows the cause: sales for volume, production for material usage, purchasing for material price.
The aim is the root cause, not blame.
Working the seven steps in order
The lecture lays out seven steps from budget to responsibility: compute the per-unit selling price and variable costs, recompute sales and variable costs at actual volume, hold fixed costs, compute the volume variance, compute the revenue and spending variances, break the spending variances into quantity and price, and finally evaluate the results and assign them to the responsible party.
Skipping the flexible budget step is the most common way to mislabel a volume effect as a spending problem.
What this chapter covers
- 01
The schedules of a master budget
- 02
Collections, payments and the cash budget
- 03
Engineered standard costs
- 04
Ideal and practical standards
- 05
Master versus flexible budget
- 06
Volume, revenue and spending variances
- 07
Quantity and price variances
- 08
Management by exception and responsibility
Worked example · free
Split a direct labor variance
- 1Standard hours allowed: 4,000 times 0.5 is 2,000; the actual rate is $43,050 divided by 2,100, or $20.50.
- 1Quantity: (2,100 minus 2,000) times $20 is $2,000 unfavorable.
- 1Rate: ($20.50 minus $20.00) times 2,100 is $1,050 unfavorable.
- 1Total: $3,050 unfavorable, equal to $43,050 less the $40,000 flexible budget.
Key terms
- Master Budget
- A comprehensive plan prepared in advance for a static level of activity.
- Flexible Budget
- A budget recomputed after the period for the actual level of activity, used to evaluate performance.
- Standard Cost
- An engineered cost per unit, a standard quantity times a standard price, used as a performance benchmark.
- Practical Standard
- A standard that is tight but attainable, allowing for normal waste, rest and machine downtime.
- Management by Exception
- Investigating only variances that exceed a set dollar amount or percentage.
Master Budgets, Standard Costs and Variances FAQ
Why is a master budget poor for judging performance?
It is set at a planned volume. If the company sells more, costs rise simply because more was made, so comparing actual cost with the master budget blames managers for volume they may have been right to deliver.
What is the difference between ideal and practical standards?
Ideal standards assume perfect conditions with no waste or breakdowns and are rarely met, which tends to discourage staff. Practical standards allow for normal inefficiencies, so meeting them is hard but possible.
Can a zero spending variance hide a problem?
Yes. A favorable quantity variance and an unfavorable price variance of the same size cancel out. Splitting the variance reveals both, and each may need its own explanation.
Exam move
Build a three-month collections schedule and cash budget for an invented company, then set a standard cost card and run one month of flexible budget variances, splitting each spending variance and naming who should explain it.
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