The Portable MBA in Finance and Accounting, 3rd Edition

208 Understanding the Numbers

So, as you can see, the pieces fit together quite logically. The points underlying
these pieces can be summarized quite brief ly:

1. First, we saw the need to distinguish between basic, ideal, and currently
   attainable standards.


2. Second, we saw the wisdom of distinguishing f lexible from static budgets.


3. Third, we noted that our standards are the foundation stones on which
   these budgets are based.


4. We noted that all cost variances follow one simple formula: Actual Cost
   less Budgeted Cost equals Standard Cost Variance.


5. 
   


6. Flexible budgets adjust variable cost and their variances for volume.


7. Volume has no effect on fixed costs or the variances derived from fixed
   costs.

VARIABLE COST BUDGETS

“That’s fine, but what am I going to do with these variances?” Tom asked a lit-
tle impatiently. “Everything that I’ve seen so far may help top management, but
it’s not much help to me.”
“Good point, Tom. That’s why we need to examine productivity, which
is the relationship between inputs and outputs. We’ll enhance your produc-
tivity and your control over costs if we can focus on the elements that go into
your costs.”
With that Jane began to explain how in a typical cost accounting system
the variable cost of a product or service is a function of:

1. The hours of labor (both direct and indirect) that go into a product.


2. The units of material that are used.


3. The other components of overhead.


4. The unit cost of each of these items.

“Let’s call the amount of input that goes into one unit of output the pro-
ductivity rate. For instance, one might need 500 pages or sheets of paper and
16 minutes of labor to produce a ream of letterhead. The material productivity
rate is 500 pages per ream; the labor productivity rate is 18 minutes or 0.30
hour per ream. When the expected cost of the inputs is attached to the ex-
pected productivity rates, a standard cost is said to result. The productivity

Activity Variances Flexible Budget Static Budget

Price Variances Actual Results Flexible Budget

Activity Indices Flexible Budget

Static Budget

Price Indices Actual Results

Flexible Budget

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