Flexible Budgeting and overhead Variance

(C) Ghanendra Fago (M Phil, MBA) 1

Flexible Budgeting and overhead Variance

By Ghanendra Fago


Meaning and definitionsA budget prepared at different level of activities is a flexible budget Flexible budget will furnish the budgeted figures for any level of activity, which a company may actually attain.It reflects costs, revenues and profits at the various level of budgeted activity. A flexible budget as a budget designed to change in accordance with the level of activity actually attained. Also called a variable budget, step budget, sliding-scale budget, expense-formula budget, dynamic budget and expense control budget.


Contd.Master budget is static or fixed budgets, which forecast revenues and expenses for one level of sales and production.A flexible budget is a summary of A flexible budget is a summary of anticipated costs for a range of activity anticipated costs for a range of activity levels, geared to changes in product output.levels, geared to changes in product output.


Characteristics Of Flexible BudgetIt covers a range of activity.

It provides a dynamic basis for comparison with the actual results because it is automatically matched to change in activities.

It can be changed according to actual production level.

It facilitates performance measurement and evaluation.

These are based upon adequate knowledge of cost behaviour pattern.


Use of Flexible BudgetWhere the level of activity during the year varies from period to period, either due to the seasonal nature of the industry or to variation in demand. Where the business is a new one and it is difficult to foresee the demand.The level of activity depends upon the availability of a factor of production such as materials, labor, plant capacity etc.Where an industry is influenced by changes in fashion.Where there are general changes in sales.Where the business units keep or introducing new product or make changes in the design of its products frequently.Where the industries are engaged in make to order business like ship-building.


Needs of Flexible BudgetingHelps to obtain detailed information of cost, sales, output and profit at different level of operation, useful for analysis.Makes possible the comparison of actual performance and budgeted one for actual level of operation in a very easy and understanding way.Helps to attain the objective of cost reduction and better cost control.Helps to estimate the profit and cost of the products such as luxury goods, fashionable goods or soft drinks, whose production and sales are uncertain.Helps to present a monthly report based upon comparative analysis of budgeted and actual cost at given level of operation.Helps to measure the capacity utilization of plant or labour force, in term of level of activity.Helps on planning the expenditure of responsible centres, who care responsible for tactical profit plan.Helps to develop the labour oriented business sector, where labour are scare.Helps in taking localized decision, identifying the possible factors affection the cost and profit.


Classification Of CostsFixed Cost: Fixed costs remain constant within the given range of activity in spite of change in volume of production. The unit fixed cost per unit decreases as the level of production increases within the volume. They are the period cost and capacity, should be incurred for a period of time.Variable Cost: Those costs which increase directly and proportionately with the level of activity are called variable costs. Total cost increases or decreases towards the direction of production or sales units. Where as the variable cost per unit will remain constant, if other thing remaining the same. Semi-variable Cost (Mixed Cost): Composition of fixed and variable cost is the mixed cost or semi variable cost. Such costs increase with the level of activity, but by intermittent jumps than continuously. In other words the cost does not change proportionately with the level of output.


Methods for flexible budgeting

Formula ApproachColumnar or Tabular ApproachGraphical Approach


Formula ApproachFixed cost and the variable cost per unit are found outBA = FC + (UVC * Q)

where, BA= Budget Allowance FC= Fixed Cost UVC= Unit Variable Cost Q = Output level, i.e. labour hour,

machine hour, or units produced


Example:Level of activity 50,000 hours 100,000 hours

Total Cost Rs. 500,000 Rs. 800,000

Variable Cost = Difference in Cost / Difference in activity level

= Rs. (800,000 – 500,000)/(100,000-50,000)

= Rs. 300,000/50,000

= Rs.6

Fixed Cost = Total Cost – Variable Cost * Level of activity

= Rs. 500,000 – Rs.6 * 50,000

= Rs.(500,000 – 300,000)

= Rs. 200,000


contd…Therefore, the required formula is:BA = 200,000 + 6Q

So using the formula the required budget for 60,000 labor hours would be:

BA = Rs. 200,000 + (Rs. 6 * 60,000) = Rs. (200,000 + 360,000) = Rs. 560,000


Activity level in units Flexible Formula

6,000 units

8,000 units

A. Variable Costs: Direct material

Direct labor Variable expenses Selling expenses (90%)

Distribution expenses (80%)

Total Variable CostB. Fixed Costs: Fixed Overheads Administrative Expenses Selling Expenses 10% of

6.5 * 10,000 Distribution Expenses 20%

of 3.5 * 10,000 Total Fixed CostC. Total Costs (A + B)

Rs. 35Rs. 12.5Rs. 10

Rs. 5.85 Rs. 2.8

50,00025,0006,5007,000

88,500

210,00075,00060,00035,10016,800

396,900

50,00025,000

6,5007,000

88,500

485,400

280,000100,000

80,00046,80022,400

529,200

50,00025,000

6,5007,000

88,500

617,700


Columnar or Tabular Approach

Example: Cost of output levels of 10,000 units in a

factory are as follows: Details Cost per unit

Direct MaterialDirect LaborVariable OverheadsFixed Overheads Rs.50,000Selling expenses (10% fixed)]Administrative expenses (100% fixed)Distribution expenses (20% fixed)Total Costs

Rs. 35 2.5 10 5 6.5 2.5 3.5 75


Preparation of Flexible Budget

Activity level in units 6,000 units

8,000 units

A. Variable Costs: Direct material @ Rs. 35 Direct labor @ Rs. 12.5 Variable expenses @ Rs. 10 Selling expenses (90%) @ Rs. 5.85 Distribution expenses (80%) @ Rs.

2.8) Total Variable CostB. Fixed Costs: Fixed Overheads Administrative Expenses Selling Expenses 10% of 6.5 * 10,000 Distribution Expenses 20% of 3.5 *

10,000 Total Fixed Cost

C. Total Costs (A + B)

210,00075,00060,00035,10016,800

396,900

50,00025,000

6,5007,000

88,500

485,400

280,000100,000

80,00046,80022,400

529,200

50,00025,000

6,5007,000

88,500

617,700


Manufacturing Overhead Variance

The total manufacturing overhead variance is equal to the difference between the actual manufacturing overhead costs incurred and the standard manufacturing overhead costs applied to production


Types Of Overhead VarianceCapacity or volume variance Spending variance Efficiency variance


Calculation of Overhead VarianceAnalytical Table

d. Overhead Applied (SOR x SLA)

SOR=FOR+VOR, FOR=FO/NC

xxx

c. Budget Allowance for Standard Level of Activities(SLA) (Fixed Overhead + VOR x SLA) xxx

b. Budget Allowance for Actual Level of Activities (ALA) (Fixed Overhead + VOR x Actual of Activities (hrs)) (FO + VOR x ALA)

xxx

a. Actual Overhead Incurred

(Actual Fixed Overhead + Actual Variable Overhead) xxx


Variances Capacity variance (a-b)=Overhead Applied-Budget

Allowance for Standard Level of Activities (SLA) Efficiency variance(b-c)=Budget Allowance for Actual

Level of Activities (ALA)- Actual Overhead Incurred Spending variance (c-d)=Budget Allowance for Standard

Level of Activities (SLA)- Budget Allowance for Actual Level of Activities (ALA)


The following are the data relating to overhead expenses of a company: BA = Rs.400,000 + Rs.5 x DLHNormal capacity 100,000DLHStandard time per unit of output 2 DLHActual output 52,000 unitsActual hours worked 98,000 DLHActual overheads paid Rs.865,500 Required: The three overhead variances


Solution Analytical Table

a. Overhead Applied (SOR x SLA) (Rs.9x2x52,000) FOR=FO/NC=400,000/100,000=4 SOR=FOR+VOR=4+5=9

936,000

b. Budget Allowance for Standard Level of Activities(SLA) (400,000+Rs.5x2x52,000)

920,000

c. Budget Allowance for Actual Level of Activities (ALA)(400,000+Rs.5x98,000)

890,000

d. Actual Overhead Paid 865,500


VariancesCapacity Variance (a-b) = Rs.(936,000-920,000)

= Rs.16,000(F) Efficiency Variance (b-c) = Rs.(920,000-890,000)

= Rs.30,000(F) Spending Variance (s-d) = Rs.(890,000-865,500)

= Rs.24,500(F)

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Flexible Budgeting and overhead Variance