Flexible Budgets, Overhead Cost Management and Activity ... · PDF fileWhy are the activity levels in the flexible budget based on machine hours, an input measure, instead of number

©McGraw-Hill Ryerson, 2001Irwin/McGraw-Hill Ryerson

17-1

Flexible Budgets, OverheadCost Management and

Activity-Based Budgeting

Student Tutorial

17


17-2

What Are Flexible OverheadBudgets?

A flexible budget is valid for a range of activity


A static budget is based on a

particular planned level of activity



This range of activity isthe relevant range


A flexible overhead budget is defined as a detailed plan for controlling overhead cost

valid in the firm’s relevant range of activity




17-3

What Are Flexible OverheadBudgets?













Let’s look at theKoala Camp Gearexample from the

text.

Let’s look at theKoala Camp Gearexample from the

text.


17-4

Flexible budgetActivity (machine hours) 4,500 6,000 7,500Budgeted electricity cost $900 $1,200 $1,500

Static Budget Versus FlexibleBudget

Static budget

Activity (machine hours) 6,000Budgeted electricity cost $1,200

Based on planned Juneproduction of4,00 tents, at1.5 machine

hours per tent

Based ononly one

anticipatedactivity

level

Includes several possible activity levels


17-5

Static budget

Activity (direct labour hours) 10,000Budgeted indirect labour cost $20,000


Convert the following static budget to a flexible budget

Based on planned

production of10,000 directlabour hours

× $2

Flexible budgetActivity (direct labour hours)

9,000 10,000 11,000

Budgeted indirect labour cost

? ? ?


17-6

Flexible budgetActivity (direct labour hours)

9,000 10,000 11,000

Budgeted indirect labour cost

$18,000 $20,000 $22,000


Static budget

Activity (direct labour hours) 10,000Budgeted indirect labour cost $20,000

Convert the following static budget to a flexible budget

Based on planned

production of10,000 directlabour hours

× $2


17-7

Advantages Of Flexible Budgets

ActualElectricity Cost


BudgetedElectricity Cost(static budget)

BudgetedElectricity Cost(static budget)

Cost VarianceCost Variance

$1,050 $1,200 $150 Favourable

The manager is comparing the electricity cost incurred at the ACTUAL activity level, 3,000 tents with the

budgeted electricity cost at the PLANNEDactivity level, 4000 tents


budgeted electricity cost at the PLANNEDactivity level, 4000 tents

These activity levels are different, therefore we wouldexpect the electricity cost to be different

These activity levels are different, therefore we wouldexpect the electricity cost to be different


17-8

Advantages Of Flexible BudgetsBudgeted

Electricity Cost(flexible budget)

BudgetedElectricity Cost(flexible budget)

Cost VarianceCost Variance

$1,050 $900 $150 Unfavourable


budgeted electricity cost at the ACTUAL activity level, (3,000 tents x 1.5 machine hours) = 4,500 machine hours


budgeted electricity cost at the ACTUAL activity level, (3,000 tents x 1.5 machine hours) = 4,500 machine hours

Electrical cost was greater than it should have been, given theactual level of output

Electrical cost was greater than it should have been, given theactual level of output




17-9

The Activity Measure: Based OnInput Or Output

Why are the activity levels in the flexible budget based onmachine hours, an input measure, instead of number of

tents produced, an output measure?

Why are the activity levels in the flexible budget based onmachine hours, an input measure, instead of number of

tents produced, an output measure?

ProductUnits Produced

Standard Machine Hours Per Unit

Total Standard Allowed Machine Hours

Tree Line Model 1,200 1.5 1,800River's Edge Model 900 1.8 1,620Valley Model 700 2 1,400

Total 2,800 4,820

Output measures requiredifferent inputs

Output measurescan be used if

you onlymanufactureone product

Flexible budgetmust be based on outputs that can

be compared

Flexible budgetfor electrical cost

4,820 x .20 = $964

Flexible budgetfor electrical cost

4,820 x .20 = $964


17-10Flexible Budgets: Inputs VersusOutputs

1.5 standardallowed

machine hours per

tent

1.5 standardallowed

machine hours per

tent

Flexible budget (based on input)

Activity: Standard allowed machine hours 4,500 6,000 7,500

Budgeted electricity costs$900 $1,200 $1,500

Flexible budget (based on output)Activity: tents manufactured 3,000 4,000 5,000Budgeted electricity costs $900 $1,200 $1,500

Usually not a meaningful measure in a multi-product firm because it would require us to add

numbers of unlike products

Output is measuredin terms of of thestandard allowedinput, given actual

output


17-11

Formula Flexible Budget

If you recall, thisis similar to thePredetermined

Cost-Driver Ratediscussed in

Chapter 6.

If you recall, thisis similar to thePredetermined

Cost-Driver Ratediscussed in

Chapter 6.

.

Assume that the company needsflexible budget numbers for threeactivity levels: 4,500 hours, 6,000

hours, and 7,500 hours.Also, assume that the Predetermined

Budgeted Variable-Overhead Costper Activity Unit is $6 per hour.

Budgeted Fixed-Overhead Cost forthe month is $30,000.

Total Budgeted Monthly

Overhead Cost =

Budgeted Variable-

Overhead Cost per Activity Unit

×Total

Activity Units

+Budgeted Fixed-Overhead Cost

per Month


17-12

Formula Flexible Budget

Total Budgeted Monthly

Overhead Cost =

Budgeted Variable-

Overhead Cost per Activity Unit

×Total

Activity Units

+Budgeted Fixed-Overhead Cost

per Month

$57,000 $66,000 $75,000

= $6 ×4,500 6,000 7,500

+ $30,000

The flexed total budgeted monthlyoverhead for each activity level cannow be used effectively in planning

and variance analysis.


17-13

Overhead Application

Normal Costing

Manufacturing Overhead Work-in-Process Inventory

Actualoverhead

Appliedoverhead

Actualhours

Predeterminedoverhead

rate

×

Appliedoverhead

Actualhours

Predeterminedoverhead

rate

×

The Differencebetween Normal

Costing andStandard

Costing lies inthe quantity of

hours used


Costing andStandard


hours used


17-14

Standard Costing

Manufacturing Overhead Work-in-Process Inventory

Actualoverhead

Appliedoverhead

Standardallowedhours

Predeterminedor standardoverhead

rate

×

Appliedoverhead

Standardallowedhours

Predeterminedor standardoverhead

rate

×


Costing andStandard


hours used


Costing andStandard


hours used

Overhead Application


17-15

Predetermined Overhead Rates

Budgeted Overhead

Planned Monthly Activity

Predetermined Overhead Rate

Variable $100,000 ? ?Fixed $500,000 ? ?

Total $600,000 ? ?

Sparta Company’s expected annual fixed overhead is $500,000and its expected variable overhead is $100,000. The companyhas a relevant range of 75,000 to 125,000 machine hours. Sparta estimates the activity level to be 100,000 machine hours.Compute the predetermined overhead rate.



17-16


Budgeted Overhead



Variable $100,000 100,000 machine hrs. $1.00Fixed $500,000 100,000 machine hrs. $5.00

Total $600,000 100,000 machine hrs. $6.00




17-17


Both normal-costing and standard-costing systemsuse an overhead rate computed at the beginning of

the accounting period (predetermined overhead rate)

Both normal-costing and standard-costing systemsuse an overhead rate computed at the beginning of

the accounting period (predetermined overhead rate)

Budgeted Overhead



Variable $36,000 6,000 machine hours $6.00Fixed $30,000 6,000 machine hours $5.00

Total $66,000 6,000 machine hours $11.00

Computed annually


17-18

Choice Of Activity Measure

How should the cost manager select the activity measure for theflexible budget?

How should the cost manager select the activity measure for theflexible budget?

The variable overhead cost

and the activity measure

should move together

The variable overhead cost

and the activity measure

should move together

Direct labour time hastraditionally been the most

popular activity measure inmanufacturing firms

Direct labour time hastraditionally been the most

popular activity measure inmanufacturing firms

As automation increases, more

firms are switching to machinehours or process time

As automation increases, more

firms are switching to machinehours or process time

Dollar measures, such as

direct-labour or material costs

can be misleading because

they are subject to price-level

changes and other fluctuations

Dollar measures, such as

direct-labour or material costs

can be misleading because

they are subject to price-level

changes and other fluctuations


17-19Overhead Cost VariancesKoala manufactured 3,000 tree line tents X 1.5 machine hours per tent

= standard allowed 4,500 machine hoursKoala manufactured 3,000 tree line tents X 1.5 machine hours per tent

= standard allowed 4,500 machine hours

For standard allowed 4,500 machine hours the budget overhead (from Exhibit 17-3 in the text) for June =

Variable overhead $27,000Fixed overhead $30,000

For standard allowed 4,500 machine hours the budget overhead (from Exhibit 17-3 in the text) for June =

Variable overhead $27,000Fixed overhead $30,000

From the cost accounting records, the actual overhead for June =Variable overhead $30,480Fixed overhead $32,500

$62,980

From the cost accounting records, the actual overhead for June =Variable overhead $30,480Fixed overhead $32,500

$62,980

Actual machinehours

for June = 4,800

Actual machinehours

for June = 4,800

The total variable overhead variance for June =

Actual variable overhead $30,480Budget variable overhead $27,000

$ 3,480 U

The total variable overhead variance for June =

Actual variable overhead $30,480Budget variable overhead $27,000

$ 3,480 U


17-20

The Nashville Toy Company makes toy airplanes at .5machine hours per airplane. During the fiscal period

they manufactured 2,000 airplanes. Standard Allowed Machine Hrs = 1,000 machine hrs

For 1,000 standard allowed machine hrs, the budgetedoverhead for the fiscal period =Variable overhead $50,000

Fixed overhead $100,000From the cost accounting records, the actual overhead

for June =Variable overhead $ 51,500Fixed overhead $105,000

$156,500Compute the total variable

overhead variance

The Nashville Toy Company makes toy airplanes at .5machine hours per airplane. During the fiscal period

they manufactured 2,000 airplanes. Standard Allowed Machine Hrs = 1,000 machine hrs

For 1,000 standard allowed machine hrs, the budgetedoverhead for the fiscal period =Variable overhead $50,000

Fixed overhead $100,000From the cost accounting records, the actual overhead

for June =Variable overhead $ 51,500Fixed overhead $105,000

$156,500Compute the total variable

overhead variance

Overhead Cost Variances


17-21Overhead Cost Variances

Total Variable Overhead VarianceActual machine hours

for June = 1,050

Total Variable Overhead VarianceActual machine hours

for June = 1,050

Actual Machine Hours Overhead

Actual Variable Overhead 1,050 $51,500

Budget Variable Overhead 1,050 $50,000

Variable Overhead Variance -$1,500 U


17-22

Variable Overhead VariancesThe VARIABLE-OVERHEAD SPENDING VARIANCE is the difference between

the actual variable overhead cost and the product of the standardvariable -overhead rate and the actual hours of an activity base

(or cost driver)

The VARIABLE-OVERHEAD SPENDING VARIANCE is the difference betweenthe actual variable overhead cost and the product of the standardvariable -overhead rate and the actual hours of an activity base

(or cost driver)

Actual variable overheadActual variable overhead

Actual machine hours (AH)


Actual rate (AVR)

Actual rate (AVR)



Standard rate (SVR)

Standard rate (SVR)

4,800 machinehours

4,800 machinehours

$6.35 permachine hour


4,800 machine hours

4,800 machine hours

$6.00 per machine hour


$30,480$30,480 $28,800$28,800

Actual machine hours timesthe standard rate


$1,680 UnfavourableVariable-overheadspending variance

$1,680 UnfavourableVariable-overheadspending variance


17-23

Standards:Machine hours per unit = 2

Variable overhead standard rate = $5 per hourBudgeted level of production 4,000 units

Actual:Machine hours = 7,900Production 3,900 units

Variable Overhead = $40,290

The variable overhead spending variance is:A. $500 UB. $290 UC. $790 UD. $290 F






Variable Overhead Variances


17-24

Variable Overhead VariancesStandards:

Machine hours per unit = 2Variable overhead standard rate = $5 per hour

Budgeted level of production 4,000 units









Try again. You want the differencebetween actual overhead and budgeted

overhead for actual hours.


17-25















17-26












40,290 - ( 7,900 × 5 ) = 790


17-27















17-28


The VARIABLE-OVERHEAD EFFICIENCY VARIANCE is the difference betweenthe actual and the standard hours of an activity base (or cost driver)

multiplied by the standard variable overhead rate

The VARIABLE-OVERHEAD EFFICIENCY VARIANCE is the difference betweenthe actual and the standard hours of an activity base (or cost driver)

multiplied by the standard variable overhead rate

Flexible budget:variable overheadFlexible budget:

variable overhead

Standard allowed machine hours (SH)Standard allowed

machine hours (SH)

Standard rate (SVR)

Standard rate (SVR)



Standard rate (SVR)

Standard rate (SVR)

4,500 machinehours

4,500 machinehours



4,800 machine hours

4,800 machine hours



$27,000$27,000$28,800$28,800



$1,800 UnfavourableVariable-overheadefficiency variance

$1,800 UnfavourableVariable-overheadefficiency variance


17-29





The variable overhead efficiency variance isA. $500 UB. $500 FC. $1,000 UD. $1,000 F








17-30












( 7,800 × 5 ) - ( 7,900 × 5 ) = 500


17-31












Try again. You want the differencebetween actual hours @ standard price

and flexible budget overhead.


17-32















17-33















17-34Variable Overhead Variances

The flexible budget amount for variable overhead $27,000is the amount that will be applied to Work-in-Process for

product-costing purposes

The flexible budget amount for variable overhead $27,000is the amount that will be applied to Work-in-Process for

product-costing purposes

Flexible budget:variable overheadFlexible budget:

variable overhead


machine hours (SH)

Standard rate (SVR)

Standard rate (SVR)

4,500 machinehours

4,500 machinehours



$27,000$27,000

Variable overhead appliedto work in process

Variable overhead appliedto work in process

No differenceNo difference


machine hours (SH)

Standard rate (SVR)

Standard rate (SVR)

4,500 machinehours

4,500 machinehours



$27,000$27,000


17-35

The unfavourable variance resulting from using more

machine hours than the standard quantity, given actual output

The unfavourable variance resulting from using more

machine hours than the standard quantity, given actual output

Efficiency varianceEfficiency variance

The variable overhead efficiency variance has

nothing to do with efficient or inefficient use of

variable overhead items

The variable overhead efficiency variance has

nothing to do with efficient or inefficient use of

variable overhead items

The actual variable overheadrate per hour differs from the

standard rate

The actual variable overheadrate per hour differs from the

standard rate

Spending varianceSpending variance

An unfavourable variance meansthat the total actual variable

overhead > than expected, afteradjusting for the actual quantity

of machine hours used

An unfavourable variance meansthat the total actual variable

overhead > than expected, afteradjusting for the actual quantity

of machine hours used

The spending variance is thereal control variance for variable

overhead

The spending variance is thereal control variance for variable

overhead

How To Interpret The VariableOverhead Variances


17-36

Fixed Overhead VariancesThe FIXED-OVERHEAD BUDGET VARIANCE is the difference between actual fixed overhead and budgeted fixed overheadThe FIXED-OVERHEAD BUDGET VARIANCE is the difference between actual fixed overhead and budgeted fixed overhead

Fixed-overheadbudget varianceFixed-overheadbudget variance

Actual Fixedoverhead


Budgeted fixedoverhead


== --


Actual Fixedoverhead =

$32,500


$32,500

Budgeted fixedoverhead =

$30,000


$30,000

== --

Unfavourable variance of $2,500, because we spent

more than budgeted


17-37

Fixed Overhead VariancesThe FIXED-OVERHEAD VOLUME VARIANCE is the difference between budgeted fixed overhead and actual fixed overheadThe FIXED-OVERHEAD VOLUME VARIANCE is the difference between budgeted fixed overhead and actual fixed overhead



Applied fixedoverhead


== --

Applied fixedoverhead =

$22,500


$22,500

Fixed-overheadvolume varianceFixed-overheadvolume variance

Budgeted fixed overhead =

$30,000


$30,000

==--

Unfavourable variance of $7,500, becausewe produced less than budgeted.

Predeterminedfixed overhead

rate = $5.00 per MH


rate = $5.00 per MH

Standard allowedhours = 4,500

machine hours


machine hours

--



17-38

Managerial Interpretation Of Fixed-Overhead Variances

Budget VarianceBudget VarianceVolume VarianceVolume Variance

The real control variance for

fixed overhead because it

compares actualexpenditures withbudgeted fixed overhead costs

The real control variance for

fixed overhead because it

compares actualexpenditures withbudgeted fixed overhead costs

Reconciles the two different purposes of the cost accounting system

Reconciles the two different purposes of the cost accounting system

For cost-managementpurposes, the cost-accounting system

recognizes that fixedoverhead does not

change as production activity varies

For cost-managementpurposes, the cost-accounting system

recognizes that fixedoverhead does not

change as production activity varies

For product-costingpurposes, budgeted

fixed overheadis divided by planned

activity to obtain aor standard fixed-

overhead rate

For product-costingpurposes, budgeted

fixed overheadis divided by planned

activity to obtain aor standard fixed-

overhead rate


17-39Fixed Overhead Budget AndVolume Variances

(1)Actualfixed

overhead

(1)Actualfixed

overhead

(2)Budgeted

fixedoverhead

(2)Budgeted

fixedoverhead

(3)Fixed overhead applied

to work in process

(3)Fixed overhead applied

to work in process

Standardallowedmachine

hours

Standardallowedmachine

hours

Standardfixed

overheadrate

Standardfixed

overheadrateXX

4,500machine

hours

4,500machine

hours

$5.00 permachine

hour

$5.00 permachine

hourXX

$22,500$22,500$30,000$30,000$32,500$32,500

$7,500 U$7,500 U$2,500 U$2,500 U




17-40

Budgeted Versus Applied FixedOverhead

Fixed overhead

$30,000

$22,500

0

Applied fixedoverhead ($5.00

per standardallowed machine

hour)


Machinehours

Volume variance$7,500

4,500 Standardallowed hours,

given actualoutput

6,000Plannedmonthlyactivity

Appliedfixed

overheadin June


17-41Four-, Three- And Two-wayVariance Analysis

Four-way analysis

Three-way analysis

Two-way analysis

Variable-overheadspendingvariance

Fixed-overheadbudget

variance

Variable-overheadefficiencyvariance

Fixed-overheadvolumevariance

$1,680 U $2,500 U $1,800 U $7,500 U

Combined spending variance

$4,180 U $1,800 U $7,500 U

Combined budget variance

Underappliedoverhead

$5,980 U $7,500 U

$62,980 actual overhead -overhead applied to WIP, 49,500 =

$13,480


17-42

Fixed Overhead VariancesThe FIXED-OVERHEAD BUDGET VARIANCE is the difference between actual fixed overhead and budgeted fixed overheadThe FIXED-OVERHEAD BUDGET VARIANCE is the difference between actual fixed overhead and budgeted fixed overhead






== --



$81,500


$81,500


$80,000


$80,000

== --

Unfavourable variance of $1,500, because we spent

more than budgeted


17-43

Fixed Overhead Variances


Fixed overhead standard rate = $10 per hourBudgeted level of production 4,000 units


Fixed Overhead = $81,500What is the fixed overhead volume variance?


Fixed overhead standard rate = $10 per hourBudgeted level of production 4,000 units


Fixed Overhead = $81,500What is the fixed overhead volume variance?


17-44

Fixed Overhead VariancesThe FIXED-OVERHEAD VOLUME VARIANCE is the difference between budgeted fixed overhead and actual fixed overheadThe FIXED-OVERHEAD VOLUME VARIANCE is the difference between budgeted fixed overhead and actual fixed overhead






== --


$78,000


$78,000



$80,000


$80,000

==--

Unfavourable variance of $2,000, becausewe produced less than budgeted.


rate = $10.00 per MH


rate = $10.00 per MH


machine hours


machine hours

--


17-45Four-, Three- And Two-wayVariance Analysis

Four-way analysis

Three-way analysis

Two-way analysis

Variable-overheadspendingvariance

Fixed-overheadbudget

variance

Variable-overheadefficiencyvariance

Fixed-overheadvolumevariance

$790 U $1,500 U $500 U $2,000 U

Combined spending variance

$2,290 U $500 U $2,000 U

Combined budget variance

Underappliedoverhead

$2,790 U $2,000 U

$121,790 actual overhead -overhead applied to WIP:

117,000 = $4,790


17-46

Activity-Based Flexible Budget

An activity-based flexible budget may provide more useful cost management information than a conventional flexible budget

An activity-based flexible budget may provide more useful cost management information than a conventional flexible budget

The traditional budgetThe traditional budget Activity-based flexible budgetActivity-based flexible budget

Costs are categorizedas variable based on

volume measures

Costs are categorizedas variable based on

volume measures

Machinehours

Machinehours

Directlabourhours

Directlabourhours

Costs are categorizedas variable based onseveral cost drivers

Costs are categorizedas variable based onseveral cost drivers

Cost that may seem fixed withrespect to a single volume-based cost driver may be variable with

respect to other non-volume related cost drivers

Cost that may seem fixed withrespect to a single volume-based cost driver may be variable with

respect to other non-volume related cost drivers


17-47

End of Chapter 17

I wish Icould figureout how toFLEX my

paycheque!

Documents

Flexible Budgets, Overhead Cost Management and Activity ... · PDF fileWhy are the activity levels in the flexible budget based on machine hours, an input measure, instead of number