Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 11 Flexible Budgeting and the Management of Overhead

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Chapter 11Chapter 11

Flexible Budgeting and the Management of

Overhead and Support Activity Costs

Flexible Budgeting and the Management of

Overhead and Support Activity Costs


McGraw-Hill/Irwin

Learning Objective

1

Learning Objective

1

11-3

Flexible BudgetsFlexible BudgetsHmm! Comparing

static budgetswith actual costsis like comparing

apples and oranges.

Static budgets are prepared for a single,

planned level of activity.

Performance evaluation for overhead is difficult

when actual activity differs from the planned

level of activity.

11-4

Considerthe following example from the Cheese

Company . . .

Hmm! Comparingstatic budgets

with actual costsis like comparing

apples and oranges.

Flexible BudgetsFlexible Budgets

11-5

Static ActualBudget 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 costs Depreciation 12,000 Insurance 2,000

Total overhead costs 89,000$

Static Budgets andStatic Budgets andPerformance ReportsPerformance Reports

U = Unfavorable varianceCheese Company wasunable to achieve the

budgeted level of activity.

11-6

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 2,000 0

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


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

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

11-7

I don’t think I can answer this question

using a static budget.

I do know thatactual activity is belowbudgeted activity which

is unfavorable.

But shouldn’t variable costsbe lower if actual activity

is below budgeted activity?


11-8

• 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.


11-9

Flexible BudgetsFlexible Budgets

Central Concept

If you can tell me what your activity wasfor the period, I will tell you what your costs

and revenue should have been.

11-10

Advantages of Flexible BudgetsAdvantages of Flexible Budgets

Improve performance evaluation.

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

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

Reveal variances due to good costcontrol or lack of cost control.


McGraw-Hill/Irwin

Learning Objective

2

Learning Objective

2

11-12

Preparing a Flexible BudgetPreparing a Flexible Budget

Let’s prepare budgets for the Cheese Company.

11-13

Variable Total Flexible BudgetsCost 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 costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs


11-14



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


Variable costs are expressed as a constant amount per hour.

Fixed costs are expressed as a total amount that does not change within the relevant

range of activity.

11-15




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

11-16




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$

11-17




Machine hours 8,000 10,000 12,000



Note: There is no flexin the fixed costs.

11-18




Machine hours 8,000 10,000 12,000



Budgeted variable Total overhead cost per activity activity unit units

× + Budgeted fixedoverhead cost

Total budgetedoverhead cost =

11-19

Flexible BudgetFlexible BudgetPerformance ReportPerformance Report

Now let’s prepare a budget performance report at 8,000 actual machine hours for the Cheese Co.

11-20


Variable TotalCost Fixed Flexible Actual

Per Hour Costs Budget Results Variances

Machine hours 8,000 0

Variable costs Indirect labor 4.00$ 34,000$ Indirect material 3.00 25,500 Power 0.50 3,800 Total variable costs 7.50$ 63,300$Fixed Expenses Depreciation 12,000$ 12,000$ Insurance 2,000 2,000 Total fixed costs 14,000$Total overhead costs 77,300$

11-21




Machine hours 8,000 8,000 0

Variable costs Indirect labor 4.00$ 34,000$ Indirect material 3.00 25,500 Power 0.50 3,800 Total variable costs 7.50$ 63,300$Fixed Expenses Depreciation 12,000$ 12,000$ Insurance 2,000 2,000 Total fixed costs 14,000$Total overhead costs 77,300$

Flexible budget is prepared for the

same activity level (8,000 hours) as

actually achieved.

11-22





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 costs 7.50$ 60,000$ 63,300$ $ 3,300 UFixed Expenses Depreciation 12,000$ 12,000$ 12,000$ 0 Insurance 2,000 2,000 2,000 0Total fixed costs 14,000$ 14,000$ 0Total overhead costs 74,000$ 77,300$ $ 3,300 U

11-23






Indirect labor and indirect material have unfavorable variances because actual costs

are more than the flexible budget costs.

11-24






Power has a favorable variance because the

actual cost is less than the flexible budget cost.


McGraw-Hill/Irwin

Learning Objective

3

Learning Objective

3

11-26

Overhead Application in a Overhead Application in a Standard Costing SystemStandard Costing System

Actual Applied Appliedoverhead overhead: overhead:

Actual hours Actual hoursx x

Predetermined Predeterminedoverhead rate overhead rate

Difference lies in the quantity of hours used.


Standard Standardallowed hours allowed hours

x xPredetermined Predeterminedoverhead rate overhead rate

Normal CostingManufacturing Overhead Work-in-Process Inventory

Manufacturing Overhead Work-in-Process InventoryStandard Costing

11-27

Overhead Application in a Overhead Application in a Standard Costing SystemStandard Costing System

BudgetedOverhead

Variable . . . . . . . 60,000$ * . . . . . . . . . 8,000 machine hours . . . . . . . . . 7.50$ per process hourFixed . . . . . . . . . 14,000 * . . . . . . . . . 8,000 machine hours . . . . . . . . . 1.75 per process hourTotal . . . . . . . . . 74,000$ . . . . . . . . . 8,000 machine hours . . . . . . . . . 9.25$ per process hour

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

PlannedMonthly Activity

PredeterminedOverhead Rate


McGraw-Hill/Irwin

Learning Objective

4

Learning Objective

4

11-29

Choice of Activity MeasureChoice of Activity Measure

Variable overhead and the activity measure should vary in a similar pattern. Identify variable overhead cost drivers.

Examples: machine hours, labor hours, process time.

Dollar measures should be avoided as they are subject to price-level changes.


McGraw-Hill/Irwin

Learning Objective

5

Learning Objective

5

11-31

Cost Management Using Cost Management Using Overhead Cost VariancesOverhead Cost Variances

Let’s turn our attentionto the computation of

overhead cost variances. We will begin withvariable overhead.

11-32

Spending Variance

EfficiencyVariance

AH × SVR

AH × AR

AH = Actual Hours of Activity AR = Actual Variable Overhead RateSVR = Standard Variable Overhead RateSH = Standard Hours Allowed

SH × SVR

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

Variable Overhead Variances

11-33

Spending Variance

EfficiencyVariance

AH × SVR

AH × AR SH × SVR


Variable Overhead Variances

Spending variance = AH(AR - SVR)

Efficiency variance = SVR(AH - SH)

11-34

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.

Compute the variable overhead spending and efficiency variances.

Variable Overhead Variances – Variable Overhead Variances – ExampleExample

11-35

ColaCo prepared this budget for overhead:


Budgeted variable Total overhead cost per x activity activity unit units

+ Budgeted fixedoverhead cost



$2.00 permachine

hour×

Totalmachine hours

+ $9,000

11-36

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


11-37

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 $200 unfavorable efficiency variance result in a $340

unfavorable flexible budget variance.

11-38

Variable Overhead Variances – A Variable Overhead Variances – A Closer LookCloser Look

Spending Variance Efficiency VarianceResults from paying moreor less than expected foroverhead items and from

excessive usage ofoverhead items.

A function of the selected cost driver.

It does not reflectoverhead control.

11-39

Fixed OverheadFixed Overhead

Now let’s turn our attention to fixed overhead.

11-40

Budget Variance

VolumeVariance

PFOHR = Predetermined Fixed Overhead Rate SH = Standard Hours Allowed

SH × PFOHR

Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied

Fixed Overhead Variances

11-41

PFOHR =

Applied Fixed Overhead = PFOHR × Standard Hours

Budgeted Fixed Overhead

Planned Activity in Hours

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

fixed overhead rate (PFOHR):

Fixed OverheadFixed Overhead

11-42

ColaCo used the following predeterminedfixed overhead rate:

PFOHR =Budgeted Fixed Overhead

Planned Activity in Hours

PFOHR =$9,000

3,000 machine hours

PFOHR = $3.00 per machine hour

Fixed Overhead Variances – Fixed Overhead Variances – ExampleExample

11-43

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

overhead was $8,450.

Compute the fixed overhead budget and volume variances.


11-44

3,200 hours × $3.00 per hour


Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied

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

Budget variance$550 favorable

Volume variance$600 (neither favorable

nor unfavorable)

11-45

Fixed Overhead VariancesFixed Overhead Variances

Let’s look at a graph showing fixed

overhead variances. We will use ColaCo’s

numbers from the previous example.

11-46

Fixed Overhead Variances –Fixed Overhead Variances –A Closer LookA Closer Look

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 for cost control.

11-47

Volume

Cost

$9,600 applied fixed OH

$9,000 budgeted fixed OH

3,200 machine hours × $3.00 fixed overhead rate

Fixed overhead

applied to products

Fixed Overhead VariancesFixed Overhead Variances

{$600

Volume Variance

{$550Favorable

Budget Variance

$8,450 actual

fixed OH

3,200 Standard

Hours

3,000 Hours PlannedActivity


McGraw-Hill/Irwin

Learning Objective

6

Learning Objective

6

11-49

Overhead Cost Performance ReportOverhead Cost Performance Report

Variable costs:Indirect material:

WaxPlastic wrapPaper productsMisc. supplies

Indirect labor:MaintenanceJanitorial

Utilities:ElectricityNatural gasWater

Total variable cost

Fixed costs:Indirect labor:

InspectionProduction supervisorSet up

Depreciation:Equipment

InsuranceProperty taxesTotal fixed cost

Total overhead cost


McGraw-Hill/Irwin

Learning Objective

7

Learning Objective

7

11-51

Activity-Based Flexible BudgetActivity-Based Flexible Budget



Machine hours 8,000 10,000 12,000



The Cheese Co. flexible budget is based on a single cost driver, machine hours

11-52

Activity-Based Flexible BudgetActivity-Based Flexible Budget



Machine hours 8,000 10,000 12,000



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

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


McGraw-Hill/Irwin

Learning Objective

8

Learning Objective

8

11-54

Standard Costs and Product CostingStandard Costs and Product Costing


Standard Standardallowed hours allowed hours

x xPredetermined Predeterminedoverhead rate overhead rate

Manufacturing Overhead Work-in-Process InventoryStandard Costing

11-55

Standard Costs and Product CostingStandard Costs and Product Costing

Actual Applied Balance (1) Balance (2)overhead overhead: Actual Applied

Standard overhead overheadallowed hours greater than greater than

x Applied ActualPredetermined overhead overheadoverhead rate

Balance (1) Balance (2)Balance (2) Balance (1)

Manufacturing Overhead Cost of Goods SoldDisposition of Variances


McGraw-Hill/Irwin

Learning Objective

9

Learning Objective

9

11-57

A General Model for Variance A General Model for Variance Analysis Analysis

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance Variable overhead Variable overhead spending variance efficiency variance

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

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

11-58

A General Model for Variance A General Model for Variance Analysis Analysis

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 Price ASP = Actual Sales Price BSV = Budgeted Sales Volume

11-59

End of Chapter 11End of Chapter 11

I’m here to your budget. Are you ready to

ante up?

Documents

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 11 Flexible Budgeting and the Management of Overhead