Source: Final Exam Review, Cost Accounting, The Ohio State University
Tags: flexible budget, static budget, sales-volume variance, flexible-budget variance, direct material variance, direct labour variance, price variance, efficiency variance, rate variance, usage variance, favourable, unfavourable
Difficulty: Intermediate | Prerequisites: Understanding of variable vs. fixed costs, basic budgeting concepts.
Budgets are only useful if you can explain why actual results differed from the plan. A static budget is set at one activity level; a flexible budget adjusts that plan to the activity level that actually occurred. The difference between the static budget and the flexible budget isolates the effect of volume changes (the sales-volume variance). The difference between the flexible budget and actual results isolates the effect of price and efficiency changes (the flexible-budget variance). For direct materials and direct labour, those flexible-budget variances break down further into a price (rate) variance and an efficiency (usage) variance.
This is the framework your exam questions test over and over. Master the three-column layout (actual, flexible budget, static budget) and you can answer most variance questions mechanically.
The static budget reflects what you planned. The flexible budget shows what costs should have been at the volume you actually achieved. Comparing actual to the flexible budget reveals operational variances (price and efficiency). Comparing the flexible budget to the static budget reveals the volume variance. For direct costs, price variance = (actual price - budgeted price) x actual quantity, and efficiency variance = (actual quantity - budgeted quantity for actual output) x budgeted price.
Static budget
A budget based on one planned level of output. It does not adjust for actual volume. Think of it as your original game plan, set in stone before the period starts.
Flexible budget
A budget that adjusts revenues and variable costs to the actual level of output achieved, while keeping budgeted prices and efficiencies constant. In simple terms, it answers: "Given what we actually sold/produced, what should we have spent?"
Sales-volume variance
The difference between the flexible-budget amount and the static-budget amount. It arises purely because actual output volume differs from planned output volume. Think of it as the portion of the total variance explained by "we sold more (or fewer) units than planned."
Flexible-budget variance
The difference between the actual result and the flexible-budget amount. It arises from differences in prices paid and quantities used, holding volume at actual. In simple terms, this is the operational performance variance, after stripping out volume effects.
Direct material price variance (purchase price variance)
(Actual price - Budgeted price) x Actual quantity purchased or used. Measures whether you paid more or less per unit of material than expected.
Direct material efficiency variance (usage variance)
(Actual quantity used - Budgeted quantity allowed for actual output) x Budgeted price. Measures whether you used more or less material than expected for the output produced.
Direct labour rate variance (price variance)
(Actual rate - Budgeted rate) x Actual hours worked. Measures whether you paid more or less per hour of labour than planned.
Direct labour efficiency variance
(Actual hours - Budgeted hours allowed for actual output) x Budgeted rate. Measures whether workers took more or fewer hours than expected to produce the actual output.
Favourable variance (F)
Actual cost is less than budgeted cost, or actual revenue is more than budgeted revenue. The effect is positive on operating income.
Unfavourable variance (U)
Actual cost exceeds budgeted cost, or actual revenue falls short of budgeted revenue. The effect is negative on operating income.
The standard layout works like this:
Column 1: Actual results (actual price x actual quantity)
Column 2: Flexible budget (budgeted price x actual quantity allowed for actual output, or budgeted price x budgeted quantity per unit x actual units)
Column 3: Static budget (budgeted price x budgeted quantity per unit x budgeted units)
Column 1 vs. Column 2 = Flexible-budget variance Column 2 vs. Column 3 = Sales-volume variance Column 1 vs. Column 3 = Total static-budget variance (the sum of the other two)
Planned material cost: $150 per unit
Actual material cost: $147 per unit
Planned output: 1,100 units
Actual output: 900 units
Flexible-budget amount for materials: Budgeted cost per unit x Actual units = $150 x 900 = $135,000
This is what materials should have cost if the company had met its budgeted efficiency at the volume it actually produced.
Actual materials cost: $147 x 900 = $132,300
Flexible-budget variance: $132,300 - $135,000 = -$2,700 → $2,700 favourable (Actual cost was lower than the flexible budget, which is good.)
Sales-volume variance for materials: Flexible budget - Static budget = $135,000 - ($150 x 1,100) = $135,000 - $165,000 = -$30,000 Since costs are lower because fewer units were produced, this is a $30,000 favourable variance from a cost perspective. (Fewer units means less spending on materials, but it also means the company sold less than planned, which is typically a concern from a revenue standpoint.)
Unfavourable flexible-budget variance for variable costs can result from:
Using more input quantities than budgeted (efficiency problem)
Paying higher prices for inputs than budgeted (price problem)
It is not caused by selling different quantities or at different selling prices; those effects live in the sales-volume variance or the revenue side.
Sales-volume variance can arise from:
Quality problems leading to customer dissatisfaction (fewer sales)
Inaccurate demand forecasting
Competitive pressure or market shifts
Changes in customer preferences
Standards for one 10-gallon plastic container:
Direct materials: 0.10 pounds at $60 per pound = $6.00 per unit
Direct labour: 0.05 hours at $30 per hour = $1.50 per unit
June actuals: 20,000 containers produced using 1,900 pounds at $64/lb and 1,000 labour hours at $30.50/hr.
Direct material price variance: (Actual price - Budgeted price) x Actual quantity used = ($64 - $60) x 1,900 = $4 x 1,900 = $7,600 unfavourable
Direct material efficiency variance: (Actual quantity - Standard quantity allowed) x Budgeted price Standard quantity allowed = 20,000 x 0.10 = 2,000 pounds = (1,900 - 2,000) x $60 = (-100) x $60 = -$6,000 → $6,000 favourable (Used 100 fewer pounds than the standard allowed.)
Note: The exam only asks for the price variance here. The efficiency variance is favourable, meaning materials usage was better than standard.
Direct labour rate (price) variance: (Actual rate - Budgeted rate) x Actual hours = ($30.50 - $30.00) x 1,000 = $0.50 x 1,000 = $500 unfavourable
Direct labour efficiency variance: (Actual hours - Standard hours allowed) x Budgeted rate Standard hours allowed = 20,000 x 0.05 = 1,000 hours = (1,000 - 1,000) x $30 = 0 x $30 = $0 (Workers used exactly the hours the standard predicted.)
When a material has a favourable price variance but an unfavourable efficiency variance (or vice versa), look for a causal connection.
Material A: $1,000 F price + $3,000 U efficiency The most likely explanation is that a lower price was paid (perhaps buying cheaper, lower-quality material), which led to more waste or rework, causing the unfavourable efficiency variance. The net effect on spending: the actual amount spent = flexible budget + efficiency variance - price variance = $40,000 + $3,000 - $1,000 = $42,000.
Wait, let us be more precise. Actual cost = Flexible budget - Price variance (if F) + Efficiency variance (if U):
Actual spending = Flexible budget + (unfavourable variances) - (favourable variances)
For Material A: $40,000 - $1,000 (F price saves) + $3,000 (U efficiency costs) = $42,000. For Material B: $60,000 + $500 (U price) - $1,500 (F efficiency) = $59,000 → $59,000. For Direct labour: $80,000 + $500 (U rate) - $2,500 (F efficiency) = $78,000 → $78,000.
A favourable efficiency variance for direct manufacturing labour means that fewer labour hours were used than the standard allowed for the actual output. Workers were more productive than planned.
It does not say anything about the wage rate paid; that is the rate (price) variance.
Flexible-budget amount (variable cost): Budgeted cost per unit x Actual output units
Flexible-budget variance: Actual results - Flexible-budget amount (Positive = unfavourable for costs; negative = favourable for costs)
Sales-volume variance: Flexible-budget amount - Static-budget amount (For costs: lower flex budget than static = favourable, meaning fewer units so less cost)
Price variance (materials or labour): (Actual price - Standard price) x Actual quantity
Efficiency variance (materials or labour): (Actual quantity - Standard quantity for actual output) x Standard price
Students often confuse the flexible-budget variance with the sales-volume variance. The flexible budget adjusts to actual volume; comparing it to actual results isolates price/efficiency effects. Comparing it to the static budget isolates volume effects.
A favourable cost variance is not always good news. Buying cheaper materials (favourable price variance) may cause more waste (unfavourable efficiency variance) and a net loss.
The sales-volume variance for costs is favourable when volume drops (less cost), but a drop in volume usually means less revenue too, so the overall picture may be negative.
Students sometimes calculate the efficiency variance using actual price instead of standard price. The standard price is always used in the efficiency variance so that the efficiency measure is not contaminated by price differences.
⚠️ The flexible-budget amount uses the budgeted cost per unit multiplied by actual output, not planned output.
⚠️ Price variances always use actual quantity. Efficiency variances always use standard (budgeted) price.
⚠️ "Favourable" and "unfavourable" labels depend on whether the variance increases or decreases operating income, not on whether it is positive or negative arithmetically.
⚠️ When price and efficiency variances move in opposite directions (one F, one U), the exam may ask you to explain the likely cause. Think about input quality trade-offs.
⚠️ The actual amount spent = flexible budget + net unfavourable variances - net favourable variances. This is a common calculation on exams (see Berman's Camera Shop questions).
Fill in the blank: The flexible-budget variance isolates the effect of ________ and ________, while the sales-volume variance isolates the effect of ________. Price and efficiency; output volume.
True or false: A favourable direct labour efficiency variance means workers were paid less than the standard wage rate. False. It means fewer hours were used than the standard allowed. The wage rate is captured by the rate variance, not the efficiency variance.
Fill in the blank: Direct material price variance = (________ - ________) x actual quantity. Actual price; standard (budgeted) price.
True or false: If actual output is lower than budgeted output, the sales-volume variance for variable costs will be favourable. True (from a cost perspective), because fewer units means lower expected costs.
Q: A company planned to use $150 of material per unit and planned to make 1,100 units. It actually made 900 units at $147 per unit. What is the flexible-budget amount for materials?
A: $150 x 900 = $135,000.
Q: Using the same data, what is the flexible-budget variance for materials?
A: Actual cost ($147 x 900 = $132,300) minus flexible budget ($135,000) = -$2,700, which is $2,700 favourable.
Q: A company used 1,900 pounds of material at $64/lb. Standard is 0.10 lb per unit at $60/lb, and 20,000 units were produced. What is the direct material price variance?
A: ($64 - $60) x 1,900 = $7,600 unfavourable.
Q: Using the same data, what is the direct labour efficiency variance if 1,000 hours were used at $30.50/hr, and the standard is 0.05 hours at $30/hr?
A: Standard hours = 20,000 x 0.05 = 1,000. Variance = (1,000 - 1,000) x $30 = $0.
Q: Material A has a $40,000 flexible budget, a $1,000 F price variance, and a $3,000 U efficiency variance. A lower-quality material was likely purchased. What is the actual amount spent?
A: $40,000 - $1,000 + $3,000 = $42,000.
Q: Material B has a $60,000 flexible budget, $500 U price variance, and $1,500 F efficiency variance. What is the actual amount spent?
A: $60,000 + $500 - $1,500 = $59,000.
Flexible budgets tie into cost-volume-profit analysis because both rely on separating variable from fixed costs. Variance analysis also connects to overhead variances (covered in the companion notes), which extend the same price-and-efficiency framework to manufacturing overhead. Understanding variances feeds back into relevant cost decisions, since variance data helps managers assess whether cost estimates used in pricing and make-or-buy decisions were accurate.
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