Chapter11 140823230340-phpapp02

11th EditionChapter 11

Flexible Budgets and Overhead Analysis

Chapter Eleven

Static Budgets and Performance Reports

Static budgetsare prepared fora single, plannedlevel of activity.

Performance evaluation is difficult when actual activity

differs from the planned level of

activity.

Hmm! Comparingstatic budgets withactual costs is likecomparing apples

and oranges.

Flexible Budgets

Improve performance evaluation.

May be prepared for any activity level in the relevant range.

Show costs that should have beenincurred at the actual level ofactivity, enabling “apples to apples”cost comparisons.

Reveal variances related tocost control.

Let’s look at CheeseCo.

CheeseCoStatic Actual

Budget Results Variances

Machine hours 10,000

Variable costs Indirect labor 40,000$ Indirect materials 30,000 Power 5,000

Fixed costs Depreciation 12,000 Insurance 2,000

Total overhead costs 89,000$

CheeseCoStatic Actual

Budget Results Variances

Machine hours 10,000 8,000

Variable costs Indirect labor 40,000$ 34,000$ Indirect materials 30,000 25,500 Power 5,000 3,800

Fixed costs Depreciation 12,000 12,000 Insurance 2,000 2,050

Total overhead costs 89,000$ 77,350$

Static ActualBudget Results Variances

Machine hours 10,000 8,000 2,000 U

Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F

Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,050 50 U

Total overhead costs 89,000$ 77,350$ $11,650 F

U = Unfavorable variance CheeseCo was unable to achieve

the budgeted level of activity.

CheeseCo

Machine hours 10,000 8,000 2,000 U

CheeseCo

F = Favorable variance that occurs when actual costs are less than budgeted costs.

Machine hours 10,000 8,000 2,000 U

Since cost variances are favorable, havewe done a good job controlling costs?

CheeseCo

I don’t think Ican answer thequestion usinga static budget.

Actual activity is belowbudgeted activity.

So, shouldn’t variable costsbe lower if actual activity

is lower?

The relevant question is . . .

“How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?”

To answer the question,we mustthe budget to theactual level of activity.

The relevant question is . . .

“How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?”

To answer the question,we mustthe budget to theactual level of activity.

Preparing a Flexible Budget

To a budget we need to know that:

Total variable costs changein direct proportion to changes in activity.

Total fixed costs remainunchanged within therelevant range. Fixed

Variable

Let’s prepare budgets for CheeseCo.

Cost Total Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours

Machine hours 8,000 10,000 12,000

Variable costs Indirect labor 4.00$ Indirect material 3.00 Power 0.50 Total variable cost 7.50$

Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs

Flexible Budgets

Fixed costs areexpressed as atotal amount.

Variable costs are expressed as a constant amount per hour.

$40,000 ÷ 10,000 hours is$4.00 per hour.

CheeseCo

Machine hours 8,000 10,000 12,000

Variable costs Indirect labor 4.00$ 32,000$ Indirect material 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$

Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs

Flexible Budgets

$4.00 per hour × 8,000 hours = $32,000

CheeseCo

CheeseCoCost Total

Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours

Machine hours 8,000 10,000 12,000

Fixed costs Depreciation 12,000$ 12,000$ Insurance 2,000 2,000 Total fixed cost 14,000$ Total overhead costs 74,000$

Flexible Budgets

Machine hours 8,000 10,000 12,000

Variable costs Indirect labor 4.00$ 32,000$ 40,000$ Indirect material 3.00 24,000 30,000 Power 0.50 4,000 5,000 Total variable cost 7.50$ 60,000$ 75,000$

Fixed costs Depreciation 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ ?

Flexible Budgets

Total fixed costsdo not change in

the relevant range.

CheeseCo

Quick Check

What should be the total overhead costs for the Flexible Budget at 12,000 hours?

a. $92,500.

b. $89,000.

c. $106,800.

d. $104,000.

a. $92,500.

b. $89,000.

c. $106,800.

d. $104,000.

a. $92,500.

b. $89,000.

c. $106,800.

d. $104,000.

a. $92,500.

b. $89,000.

c. $106,800.

d. $104,000.

Quick Check

Total overhead cost

= $14,000 + $7.50 per hour × 12,000 hours

= $14,000 + $90,000 = $104,000

Machine hours 8,000 10,000 12,000

Variable costs Indirect labor 4.00$ 32,000$ 40,000$ 48,000$ Indirect material 3.00 24,000 30,000 36,000 Power 0.50 4,000 5,000 6,000 Total variable cost 7.50$ 60,000$ 75,000$ 90,000$

Fixed costs Depreciation 12,000$ 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ 104,000$

Flexible Budgets

Let’s prepare a budget performance report for CheeseCo.

Flexible Budget Performance Report

Cost Total Formula Fixed Flexible Actualper Hour Cost Budget Results Variances

Machine hours 8,000 8,000 0

CheeseCoFlexible budget is prepared for the

same activity level (8,000 hours) as

actually achieved.

Quick Check

What is the variance for indirect labor when the flexible budget for 8,000 hours is compared to the actual results?

a. $2,000 U

b. $2,000 F

c. $6,000 U

d. $6,000 F

a. $2,000 U

b. $2,000 F

c. $6,000 U

d. $6,000 F

a. $2,000 U

b. $2,000 F

c. $6,000 U

d. $6,000 F

a. $2,000 U

b. $2,000 F

c. $6,000 U

d. $6,000 F

Quick Check

Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 25,500 Power 0.50 3,800 Total variable cost 7.50$ 63,300$

CheeseCo

Quick Check

What is the variance for indirect material when the flexible budget for 8,000 hours is compared to the actual results?

a. $1,500 U

b. $1,500 F

c. $4,500 U

d. $4,500 F

a. $1,500 U

b. $1,500 F

c. $4,500 U

d. $4,500 F

a. $1,500 U

b. $1,500 F

c. $4,500 U

d. $4,500 F

a. $1,500 U

b. $1,500 F

c. $4,500 U

d. $4,500 F

Quick Check

Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 24,000 25,500 1,500 U Power 0.50 4,000 3,800 200 FTotal variable cost 7.50$ 60,000$ 63,300$ $ 3,300 U

Fixed costs Depreciation 12,000$ 12,000$ 12,000$ $ 0 Insurance 2,000 2,000 2,050 50 UTotal fixed cost 14,000$ 14,050$ 50 UTotal overhead costs 74,000$ 77,350$ $ 3,350 U

CheeseCo

Remember the question: “How much of the total variance is due to lower activity and how much isdue to cost control?”

Machine hours 10,000 8,000 2,000 U

Static Budgets and Performance

How much of the $11,650 favorable variance is due to lower activity and how much is due to cost control?

Difference between original static budgetand actual overhead = $11,650 F.

Overhead Variance Analysis

Static ActualOverhead OverheadBudget at at

10,000 Hours 8,000 Hours

89,000$ 77,350$

Let’s place the flexible budget for

8,000 hours here.

Overhead Variance Analysis

This $15,000F variance is due to lower activity.

Activity

This $3,350Uvariance is due

to poor cost control.

Cost control

Static Flexible ActualOverhead Overhead OverheadBudget at Budget at at

10,000 Hours 8,000 Hours 8,000 Hours

89,000$ 74,000$ 77,350$

The Measure of Activity– A Critical Choice

Three importantfactors in selecting an

activity base for an overheadflexible budget

Activity base andvariable overhead

should becausally related.

Activity base andvariable overhead

should becausally related.

Activity base shouldnot be expressed

in dollars orother currency.

Activity base shouldnot be expressed

in dollars orother currency.

Activity base shouldbe simple and

easily understood.

Activity base shouldbe simple and

easily understood.

Variable Overhead Variances –A Closer Look

If flexible budgetis based onactual hours

If flexible budgetis based on

standard hours

Only a spendingvariance can be

computed.

Both spendingand efficiency

variances can be computed.

ColaCo’s actual production for the period required 3,200 standard machine hours. Actual variable overhead incurred for the period was $6,740. Actual machine hours worked were 3,300. The

standard variable overhead cost per machine hour is $2.00.

Compute the variable overhead spending variance

first using actual hours. Then use standard hours allowed to calculate the variable overhead

efficiency variance.

Variable Overhead Variances – Example

Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours

AH × SRAH × AR

Spending Variance

Spending variance = AH(AR – SR)

Variable Overhead Variances

AH = Actual hoursAR = Actual variable overhead rateSR = Standard variable overhead rate

Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours

3,300 hours×

$2.00 per hour= $6,600$6,740

Spending Variance= $140 unfavorable

Spending Variance

Results from paying moreor less than expected foroverhead items and from

excessive usage ofoverhead items.

Now, let’s use the standard hours allowed,

along with the actual hours, to compute the

Now, let’s use the standard hours allowed,

along with the actual hours, to compute the

AH × SR

AH × AR

Spending variance = AH(AR - SR)

Efficiency variance = SR(AH - SH)

SH × SR

Spending Variance

EfficiencyVariance

Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours

Variable Overhead Variances

3,300 hours 3,200 hours × × $2.00 per hour $2.00 per hour

$6,740 $6,600 $6,400

Spending variance$140 unfavorable

Efficiency variance$200 unfavorable

$340 unfavorable flexible budget total variance$340 unfavorable flexible budget total variance

Efficiency Variance

Controlled bymanaging the

overhead cost driver.

Quick Check

Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the spending variance?a. $450 Ub. $450 Fc. $700 Fd. $700 U

Quick Check

Spending variance = AH (AR - SR)

= Actual variable overhead incurred – (AH × SR)

= $10,950 – (2,050 hours × $5 per hour)

= $10,950 – $10,250

= $700 U

Quick Check

Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the efficiency variance?a. $450 Ub. $450 Fc. $250 Fd. $250 U

Quick Check

Efficiency variance = SR (AH – SH)

= $5 per hour (2,050 hours – 2,100 hours)

= $250 F

2,050 hours 2,100 hours × × $5 per hour $5 per hour

Quick Check Summary

$10,950 $10,250 $10,500

Spending variance$700 unfavorable

Efficiency variance$250 favorable

$450 unfavorable flexible budget total variance$450 unfavorable flexible budget total variance

Activity-based Costingand the Flexible Budget

It is unlikely that allvariable overhead will bedriven by a single activity.

Activity-based costingcan be used when multiple

activity bases drivevariable overhead costs.

Activity-based costingcan be used when multiple

activity bases drivevariable overhead costs.

Overhead Rates and Overhead Analysis

Overhead from theflexible budget for the

denominator level of activityPOHR =

Recall that overhead costs are assigned to products and services using a predetermined

overhead rate (POHR):

Assigned Overhead = POHR × Standard Activity

Denominator level of activity

The predetermined overhead ratecan be broken down into fixed

and variable components.

The variablecomponent is useful

for preparing and analyzingvariable overhead

variances.

The fixedcomponent is useful

for preparing and analyzingfixed overhead

variances.

Overhead Rates and Overhead Analysis

Normal versus Standard Cost Systems

In a normal costsystem, overhead isapplied to work inprocess based onthe actual numberof hours worked

in the period.

In a standard costsystem, overhead isapplied to work inprocess based onthe standard hours

allowed for the outputof the period.

Budget Variance

VolumeVariance

FR = Standard Fixed Overhead RateSH = Standard Hours AllowedDH = Denominator Hours

SH × FR

Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied

Fixed Overhead Variances

DH × FR

ColaCo prepared this budget for overhead:

Overhead Rates and OverheadAnalysis – Example

Total Variable Total FixedMachine Variable Overhead Fixed Overhead

Hours Overhead Rate Overhead Rate

3,000 6,000$ ? 9,000$ ?

4,000 8,000 ? 9,000 ?

ColaCo applies overhead basedon machine-hour activity.

Let’s calculate overhead rates.

Rate = Total Variable Overhead ÷ Machine Hours

This rate is constant at all levels of activity.

3,000 6,000$ 2.00$ 9,000$ ?

4,000 8,000 2.00 9,000 ?

3,000 6,000$ 2.00$ 9,000$ 3.00$

4,000 8,000 2.00 9,000 2.25

Rate = Total Fixed Overhead ÷ Machine Hours

This rate decreases when activity increases.

3,000 6,000$ 2.00$ 9,000$ 3.00$

4,000 8,000 2.00 9,000 2.25

The total POHR is the sum ofthe fixed and variable ratesfor a given activity level.

ColaCo’s actual production required 3,200 standard machine hours. Actual fixed

overhead was $8,450. The predetermined overhead rate is based on 3,000 machine

hours.

Fixed Overhead Variances – Example

Overhead Variances

Now let’s turn our attention to calculating

fixed overhead variances.

Budget variance$550 favorable

$8,450 $9,000

Fixed Overhead Variances –A Closer Look

Budget Variance

Results from spendingmore or less thanexpected for fixedoverhead items.

Now, let’s use the standard hours allowed

to compute the fixed overhead volume

variance.

Now, let’s use the standard hours allowed

to compute the fixed overhead volume

variance.

3,200 hours × $3.00 per hour

Budget variance$550 favorable

$8,450 $9,000 $9,600

Volume variance$600 favorable

SH × FR

Volume Variance – A Closer Look

VolumeVariance

Results when standard hoursallowed for actual output differsfrom the denominator activity.

Unfavorablewhen standard hours< denominator hours

Favorablewhen standard hours> denominator hours

Volume Variance – A Closer Look

VolumeVariance

Results when standard hoursallowed for actual output differsfrom the denominator activity.

Unfavorablewhen standard hours< denominator hours

Favorablewhen standard hours> denominator hours

Does not measure over- or under spending

It results from treating fixedoverhead as if it were a

variable cost.

Quick Check

Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the budget variance?a. $350 Ub. $350 Fc. $100 Fd. $100 U

Quick Check

Budget variance

= Actual fixed overhead – Budgeted fixed overhead

= $14,800 – $14,450

= $350 U

Quick Check

Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the volume variance?a. $250 Ub. $250 Fc. $100 Fd. $100 U

Quick Check

Volume variance

= Budgeted fixed overhead – (SH × FR)

= $14,450 – (2,100 hours × $7 per hour)

= $14,450 – $14,700

= $250 F

2,100 hours × $7.00 per hour

Budget variance$350 unfavorable

$14,800 $14,450 $14,700

Volume variance$250 favorable

SH × FR

Quick Check Summary

Overhead Variances

Let’s look at a graph showing fixed overhead

variances. We will use ColaCo’s

numbers from the previous example.

Activity

3,000 Hours ExpectedActivity

$9,000 budgeted fixed OH

Fixed overhead

applied to products

$8,450 actual fixed OH

Activity

Fixed overhead

applied to products

$8,450 actual fixed OH$550Favorable

Budget Variance

$8,450 actual fixed OH

3,200 machine hours × $3.00 fixed overhead rate

$600FavorableVolume

Variance

$9,600 applied fixed OH

3,200 Standard

Activity

Fixed overhead

applied to products

$550Favorable

Budget Variance

{ $8,450 actual fixed OH

Overhead Variances and Under- or Overapplied Overhead Cost

In a standardcost system:

Unfavorablevariances are equivalent

to underapplied overhead.

Favorablevariances are equivalentto overapplied overhead.

The sum of the overhead variancesequals the under- or overapplied

overhead cost for a period.

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