Chap011 7e Edited

8/3/2019 Chap011 7e Edited

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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 11Chapter 11

Flexible Budgeting andthe Management of

Overhead and SupportActivity Costs

Flexible Budgeting andthe Management of

Overhead and SupportActivity Costs


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L

earningObjective1

L

earningObjective1


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Flexible BudgetsFlexible Budgets

Hmm! Comparingstatic budgets

with actual costsis like comparing

apples and oranges.

Static budgets areprepared for a single,

planned level ofactivity.

Performanceevaluation for

overhead is difficultwhen actual activity

differs from theplanned level of

activity.


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Considerthe followingexample from

the CheeseCompany . . .

Hmm! Comparingstatic budgets

with actual costsis like comparing

apples and oranges.



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Static Actual

Budget Results Variances

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

Variable costs

Indirect labor 40,000$

Indirect materials 30,000

Power 5,000

Fixed costsDepreciation 12,000

Insurance 2,000

Total overhead costs 89,000$

Static Budgets andStatic Budgets and

Performance ReportsPerformance Reports

U = Unfavorable varianceCheese Company wasunable to achieve the

budgeted level of activity.


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Static Actual


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 costsDepreciation 12,000 12,000 0

Insurance 2,000 2,000 0

Total overhead costs 89,000$ 77,300$ $11,700 F



F = Favorable variance since actual costsare less than budgeted costs.


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Static Actual


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 costsDepreciation 12,000 12,000 0

Insurance 2,000 2,000 0

Total overhead costs 89,000$ 77,300$ $11,700 F

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




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I dont think I cananswer this question

using a static budget.

I do know thatactual activity is belowbudgeted activity which

is unfavorable.But shouldnt variable costs

be lower if actual activityis below budgeted activity?




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The relevant question is . . .

How much of the favorable cost variance is dueto lower activity, and how much is due to good

cost control?

To answer the question,we must

the budget to theactual level of activity.




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Central Concept

I

f you can tell me what your activity wasfor the period, I will tell you what your costsand revenue should have been.


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Advantages of Flexible BudgetsAdvantages of Flexible Budgets

Improve performance evaluation.

May be prepared for any activitylevel in the relevant range.

Show revenues and expensesthat should have occurred at theactual level of activity.

Reveal variances due to good cost

control or lack of cost control.


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L

earningObjective2

L

earningObjective2


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Preparing a Flexible BudgetPreparing a Flexible Budget


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Variable Total Flexible Budgets

Cost Fixed 8,000 10,000 12,000

Per 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 costsDepreciation 12,000$

Insurance 2,000

Total fixed cost

Total overhead costs



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Cost Fixed 8,000 10,000 12,000


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$


Insurance 2,000

Total fixed cost



Variable costs are expressed asa constant amount per hour.


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Cost Fixed 8,000 10,000 12,000


Machine hours 8,000 10,000 12,000

Variable costs



Power 0.50 4,000



Insurance 2,000

Total fixed cost



Fixed costs are expressed as atotal amount that does notchange within the relevant

range of activity.


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Cost Fixed 8,000 10,000 12,000


Machine hours 8,000 10,000 12,000

Variable costs



Power 0.50 4,000


Fixed costsDepreciation 12,000$ 12,000$

Insurance 2,000 2,000

Total fixed cost 14,000$



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Cost Fixed 8,000 10,000 12,000


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 costsDepreciation 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$


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Cost Fixed 8,000 10,000 12,000


Machine hours 8,000 10,000 12,000

Variable costs

Indirect labor 4.00 32,000$ 40,000$ 48,000$


Power 0.50 4,000 5,000 6,000



Insurance 2,000 2,000 2,000 2,000

Total fixed cost 14,000$ 14,000$ 14,000$


Note: There is no flexin the fixed costs.


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Cost Fixed 8,000 10,000 12,000


Machine hours 8,000 10,000 12,000

Variable costs

Indirect labor 4.00 32,000$ 40,000$ 48,000$


Power 0.50 4,000 5,000 6,000



Insurance 2,000 2,000 2,000 2,000

Total fixed cost 14,000$ 14,000$ 14,000$


Budgeted variable Totaloverhead cost per activity

activity unit units

+Budgeted fixed

overhead cost

Total budgetedoverhead cost =


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Flexible BudgetFlexible BudgetPerformance ReportPerformance Report


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Variable Total

Cost Fixed Flexible Actual

Per Hour Costs Budget Results Variances

Machine hours 8,000 0

Variable costs

Indirect labor 4.00$ 34,000$


Power 0.50 3,800

Total variable costs 7.50$ 63,300$

Fixed ExpensesDepreciation 12,000$ 12,000$


Total fixed costs 14,000$



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Variable Total



Machine hours 8,000 8,000 0

Variable costs

Indirect labor 4.00$ 34,000$


Power 0.50 3,800

Total variable costs 7.50$ 63,300$

Fixed ExpensesDepreciation 12,000$ 12,000$


Total fixed costs 14,000$


Flexible budget isprepared for the

same activity level

(8,000 hours) asactually achieved.


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Variable Total




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 F

Total variable costs 7.50$ 60,000$ 63,300$ $ 3,300 U

Fixed ExpensesDepreciation 12,000$ 12,000$ 12,000$ 0

Insurance 2,000 2,000 2,000 0

Total fixed costs 14,000$ 14,000$ 0

Total overhead costs 74,000$ 77,300$ $ 3,300 U


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Variable Total




Variable costs

Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U


Power 0.50 4,000 3,800 200 F



Insurance 2,000 2,000 2,000 0



Indirect labor andindirect material have

unfavorable variancesbecause actual costs

are more than theflexible budget costs.


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Variable Total




Variable costs

Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U


Power 0.50 4,000 3,800 200 F



Insurance 2,000 2,000 2,000 0



Power has a favorablevariance because the

actual cost is less thanthe flexible budget cost.


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LearningObjective

3

LearningObjective

3


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Overhead Application in aOverhead Application in aStandard Costing SystemStandard Costing System

Actual Applied Appliedoverhead overhead: overhead:

Actual hours Actual hours

x x

Predetermined Predetermined

overhead rate overhead rate

Difference lies in the

quantity of hours used.

Actual Applied Applied

overhead overhead: overhead:

Standard Standard

allowed hours allowed hours

x x

Predetermined Predeterminedoverhead rate overhead rate

Normal Costing

Manufacturing Overhead Work-in-Process Inventory


Standard Costing


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Overhead Application in aOverhead Application in aStandard Costing SystemStandard Costing System

Budgeted

Overhead

Variable . . . . 60,000$ * . . . . . . . . . 8,000 machine hours . . . . . . . . 7.50$ per process hourFixed . . . . . . 14,000 * . . . . . . . . . 8,000 machine hours . . . . . . . . 1.75 per process hour

Total . . . . . . 74,000$ . . . . . . . . . 8,000 machine hours . . . . . . . . 9.25$ per process hour

* From the flexible budget for planned activity of 8,000 machine hours

Planned

Monthly Activity

Predetermined

Overhead Rate


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LearningObjective

4

LearningObjective

4


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Choice of Activity MeasureChoice of Activity Measure

Variable overhead and the activitymeasure should vary in a similarpattern.

Identify variable overhead costdrivers.

Examples: machine hours, laborhours, process time.

Dollar measures should be avoidedas they are subject to price-levelchanges.


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LearningObjective

5

LearningObjective

5


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Cost Management UsingCost Management UsingOverhead Cost VariancesOverhead Cost Variances

L

ets turn our attentionto the computation ofoverhead cost variances.

We will begin withvariable overhead.


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Spending

Variance

Efficiency

Variance

AH SVRAH AR

AH = Actual Hours of ActivityAR = Actual Variable Overhead RateSVR = Standard Variable Overhead RateSH = Standard Hours Allowed

SH SVR

Actual Flexible Budget Flexible BudgetVariable for Variable for VariableOverhead Overhead at Overhead atIncurred Actual Hours Standard Hours

Variable Overhead Variances


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Spending

Variance

Efficiency

Variance

AH SVRAH AR SH SVR


Variable Overhead Variances

Spending variance = AH(AR - SVR)

Efficiency variance = SVR(AH - SH)


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ColaCos actual production for the periodrequired 3,200 standard machine hours.

Actual variable overhead incurred for theperiod was $6,740. Actual machine hoursworked were 3,300.

Compute the variable overhead spending andefficiency variances.

Variable Overhead VariancesVariable Overhead Variances ExampleExample


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ColaCo prepared this budget for overhead:


Budgeted variable Totaloverhead cost per x activity

activity unit units+

Budgeted fixedoverhead cost

Total budgeted

overhead cost =

Total budgetedoverhead cost =

$2.00 permachine

hour

Totalmachine

hours+ $9,000


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

Spending variance$140 unfavorable

Efficiency variance$200 unfavorable


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



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


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


The $140 unfavorable spending variance and the $200unfavorable efficiency variance result in a $340

unfavorable flexible budget variance.


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Variable Overhead VariancesVariable Overhead Variances AACloserLookCloserLook

Spending Variance Efficiency Variance

Results from paying moreor less than expected for

overhead items and fromexcessive usage of

overhead items.

A function of theselected cost driver.

It does not reflectoverhead control.


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Fixed OverheadFixed Overhead

Now lets turnour attention tofixed overhead.


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BudgetVariance

VolumeVariance

PFOHR = Predetermined Fixed Overhead RateSH = Standard Hours Allowed

SH PFOHR

Actual Fixed Fixed FixedOverhead Overhead OverheadIncurred Budget Applied

Fixed Overhead Variances


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PFOHR =

Applied Fixed Overhead = PFOHR Standard Hours

Budgeted Fixed Overhead

Planned Activity in Hours

Recall that fixed overhead costs are appliedto products and services using a

predetermined fixed overhead rate

(PFOHR):

Fixed OverheadFixed Overhead


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ColaCos actual production required 3,200standard machine hours. Actual fixed

overhead was $8,450.

Compute the fixed overhead budget andvolume variances.

Fixed Overhead VariancesFixed Overhead Variances ExampleExample


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3,200 hours

$3.00 per hour

Fixed Overhead VariancesFixed Overhead Variances ExampleExample

Actual Fixed Fixed FixedOverhead Overhead OverheadIncurred Budget Applied

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

Budget variance$550 favorable

Volume variance$600 (neither favorable

nor unfavorable)


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Fixed Overhead VariancesFixed Overhead Variances

Lets look at a graph

showing fixedoverhead variances.We will use ColaCos

numbers from theprevious example.


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Fixed Overhead VariancesFixed Overhead Variances A CloserLookA CloserLook

Budget Variance Volume Variance

Results from paying moreor less than expected for

overhead items.

Results from the inabilityto operate at the activity

level planned for the period.

Has no significance forcost control.


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Volume

Cost

$9,600 applied fixed OH

$9,000 budgeted fixed OH

3,200 machine hours $3.00 fixed overhead rate

Fixed Overhead VariancesFixed Overhead Variances

{$600

VolumeVariance

{$550FavorableBudgetVariance

$8,450actual

fixed OH

3,200Standard

Hours

3,000 HoursPlannedActivity


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LearningObjective

6

LearningObjective

6


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Overhead Cost Performance ReportOverhead Cost Performance Report

Variable costs:

Indirect material:

Wax

Plastic wrap

Paper productsMisc. supplies

Indirect labor:

Maintenance

Janitorial

Utilities:

Electricity

Natural gas

Water

Total variable cost

Fixed costs:

Indirect labor:InspectionProduction supervisor

Set upDepreciation:

EquipmentInsuranceProperty taxesTotal fixed cost

Total overhead cost


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LearningObjective

7

LearningObjective

7


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ActivityActivity--Based Flexible BudgetBased Flexible Budget


Cost Fixed 8,000 10,000 12,000


Machine hours 8,000 10,000 12,000

Variable costsIndirect labor 4.00 32,000$ 40,000$ 48,000$


Power 0.50 4,000 5,000 6,000



Insurance 2,000 2,000 2,000 2,000

Total fixed cost 14,000$ 14,000$ 14,000$


The Cheese Co. flexiblebudget is based on a singlecost driver, machine hours


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ActivityActivity--Based Flexible BudgetBased Flexible Budget


Cost Fixed 8,000 10,000 12,000


Machine hours 8,000 10,000 12,000

Variable costsIndirect labor 4.00 32,000$ 40,000$ 48,000$


Power 0.50 4,000 5,000 6,000



Insurance 2,000 2,000 2,000 2,000

Total fixed cost 14,000$ 14,000$ 14,000$


If different cost drivers are identified for thedifferent variable costs, an activity-based flexible

budget should be prepared with different costformulas based on the different drivers.


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LearningObjective

8

LearningObjective

8


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Standard Costs and Product CostingStandard Costs and Product Costing

Actual Applied Applied

overhead overhead: overhead:

Standard Standard

allowed hours allowed hours

x x

Predetermined Predeterminedoverhead rate overhead rate


Standard Costing


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Standard Costs and Product CostingStandard Costs and Product Costing

Actual Applied Balance (1) Balance (2)

overhead overhead: Actual Applied

Standard overhead overhead

allowed hours greater than greater thanx Applied Actual

Predetermined overhead overhead

overhead rate

Balance (1) Balance (2)

Balance (2)

Balance (1)

Manufacturing Overhead Cost of Goods SoldDisposition ofVariances


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LearningObjective

9

LearningObjective

9

A G l M d l f V iA G l M d l f V i


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A General Model for VarianceA General Model for VarianceAnalysisAnalysis

Actual Quantity Actual Quantity Standard Quantity

Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Materials price variance Materials quantity varianceLabor rate variance Labor efficiency varianceVariable overhead Variable overheadspending variance efficiency variance

AQ(AP - SP) SP(AQ - SQ)

AQ = Actual Quantity SP = Standard PriceAP = Actual Price SQ = Standard Quantity

A G l M d l f V iA G l M d l f V i


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A General Model for VarianceA General Model for VarianceAnalysisAnalysis

Actual Sales Volume Actual Sales Volume Budgeted Sales Volume

Actual Sales Price Budgeted Sales Price Budgeted Sales Price

Sales Price Variance Sales Volume Variance

ASV(ASP - BSP) BSP(ASV - BSV)

ASV = Actual Sales Volume BSP = Budgeted Sales PriceASP = Actual Sales Price BSV = Budgeted Sales Volume


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End of Chapter 11End of Chapter 11

Im here to yourbudget. Are you ready to

ante up?

Documents

Chap011 7e Edited