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Chapter 11

Flexible Budgets andOverhead Analysis

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11-2

Learning Objective 1

Prepare a flexible

budget and explain theadvantages of the flexiblebudget approach over the

static budget approach.

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11-3

Static Budgets and Performance Reports

Static budgetsare prepared for

a single, plannedlevelof activity.

Performanceevaluation is difficult

when actual activitydiffers from theplanned level of

activity.

Hmm! Comparingstatic budgets withactual costs is likecomparing apples

and oranges.

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Flexible Budgets

Improve performance evaluation.

May be prepared for any activitylevel in the relevant range.

Show costs that should have been

incurred at the actual level ofactivity, enabling apples to applescost comparisons.

Reveal variances related to

cost control.

Lets look at CheeseCo.

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CheeseCo

Static Budgets and Performance Reports

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CheeseCo

Static Budgets and Performance Reports

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11-7

U = Unfavorable varianceCheeseCo was unable to achieve

the budgeted level of activity.

CheeseCo

Static Budgets and Performance Reports

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11-8

CheeseCo

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

Static Budgets and Performance Reports

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11-9

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

CheeseCo

Static Budgets and Performance Reports

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11-10

I dont think Ican answer thequestion using

a static budget.

Actual activity is belowbudgeted activity.

So, shouldnt variable costsbe lower if actual activityis lower?

Static Budgets and Performance Reports

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11-11

The relevant question is . . .

How much of the favorable cost variance is

due to lower activity, and how much is due togood cost control?

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

Static Budgets and Performance Reports

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11-12

Preparing a Flexible Budget

To a budget we need to know that:

Total variablecosts change

in direct proportion tochanges in activity.

Total fixedcosts remainunchanged within therelevant range. Fixed

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Preparing a Flexible Budget

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Cost Total

Formula 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 cost

Total overhead costs

Flexible Budgets

Preparing a Flexible Budget

Fixed costs areexpressed as atotal amount.

Variable costs are expressed asa constant amount per hour.

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

CheeseCo

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Cost Total

Formula 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$ 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 cost

Total overhead costs

Flexible Budgets

Preparing a Flexible Budget

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

CheeseCo

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Preparing a Flexible Budget

CheeseCo

Cost Total

Formula 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$ 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$

Flexible Budgets

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Cost Total

Formula 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$ 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

Preparing a Flexible Budget

Total fixed costsdo not change in

the relevant range.

CheeseCo

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Quick Check

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

a. $92,500.

b. $89,000.c. $106,800.

d. $104,000.

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11-19

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

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

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Preparing a Flexible Budget

Cost Total

Formula 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$ 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

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11-21

Learning Objective 2

Prepare a performance

report for both variableand fixed overhead costsusing the flexible budget

approach.

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Flexible Budget Performance Report

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Cost Total

Formula Fixed Flexible Actual

per Hour Cost Budget Results Variances

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 cost 7.50$ 63,300$

Fixed costs

Depreciation 12,000$ 12,000$

Insurance 2,000 2,050

Total fixed cost 14,050$

Total overhead costs 77,350$

CheeseCoFlexible budget isprepared for the

same activity level(8,000 hours) as

actually achieved.

Flexible Budget Performance Report

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Quick Check

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

a. $2,000 U

b. $2,000 F

c. $6,000 U

d. $6,000 F

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

a. $2,000 U

b. $2,000 F

c. $6,000 U

d. $6,000 F

Quick Check

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Cost Total

Formula Fixed Flexible Actual

per Hour Cost Budget Results Variances

Machine hours 8,000 8,000 0

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$

Fixed costs

Depreciation 12,000$ 12,000$

Insurance 2,000 2,050

Total fixed cost 14,050$

Total overhead costs 77,350$

CheeseCo

Flexible Budget Performance Report

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Quick Check

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

a. $1,500 U

b. $1,500 F

c. $4,500 U

d. $4,500 F

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

a. $1,500 U

b. $1,500 F

c. $4,500 U

d. $4,500 F

Quick Check

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Cost Total

Formula Fixed Flexible Actual

per Hour Cost Budget Results Variances

Machine hours 8,000 8,000 0

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 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 U

Total fixed cost 14,000$ 14,050$ 50 U

Total overhead costs 74,000$ 77,350$ $ 3,350 U

CheeseCo

Flexible Budget Performance Report

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Flexible Budget Performance Report

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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?

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

Overhead Variance Analysis

Static Actual

Overhead Overhead

Budget at at10,000 Hour 8,000 Hour

89,000$ 77,350$

Lets place

the flexible

budget for8,000 hours

here.

Flexible Budget Performance Report

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Overhead Variance Analysis

This $15,000F variance isdue to lower activity.

Activity

This $3,350Uvariance is due

to poor cost control.

Cost control

Static Flexible Actual

Overhead Overhead Overhead

Budget at Budget at at10,000 Hour 8,000 Hour 8,000 Hour

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

Flexible Budget Performance Report

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The Measure of Activity A Critical Choice

Three importantfactors in selecting an

activity base for an overhead

flexible budgetActivity base andvariable overhead

should be

causally related.

Activity base shouldnot be expressed

in dollars or

other currency.

Activity base shouldbe simple and

easily understood.

11-35 Variable Overhead Variances

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Variable Overhead VariancesA Closer Look

If flexible budgetis based onactual hours

If flexible budgetis based on

standard hours

Only a spending

variance can becomputed.

Both spending

and efficiencyvariances can becomputed.

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O

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ColaCos actual production for the period required3,200 standard machine hours. Actual variableoverhead incurred for the period was $6,740.

Actual machine hours worked were 3,300. Thestandard variable overhead cost per machine houris $2.00.

Compute the variable overhead spending variancefirst using actual hours. Then use standard hoursallowed to calculate the variable overhead

efficiency variance.

Variable Overhead Variances Example

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L i Obj i 3

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Learning Objective 3

Use a flexible budget

to prepare a variableoverhead performancereport containing only

a spending variance.

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V i bl O h d V i

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Actual Flexible BudgetVariable for VariableOverhead Overhead atIncurred Actual Hours

AH SRAH AR

Spending

Variance

Spending variance = AH(AR SR)

Variable Overhead Variances

AH = Actual hoursAR = Actual variable

overhead rate

SR = Standard variableoverhead rate

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V i bl O h d V i E l

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Actual Flexible BudgetVariable for VariableOverhead Overhead atIncurred Actual Hours

3,300 hours$2.00 per hour

= $6,600$6,740

Spending Variance= $140 unfavorable

Variable Overhead Variances Example

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Variable Overhead Variances

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Variable Overhead Variances A Closer Look

Spending Variance

Results from paying moreor less than expected for

overhead items and fromexcessive usage ofoverhead items.

Now, lets use thestandard hours allowed,

along with the actualhours, to compute the

efficiency variance.

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L i Obj ti 4

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Learning Objective 4

Use a flexible budgetto prepare a variable

overhead performancereport containing both a

spending and an efficiency

variance.

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V i bl O h d V i

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AH SRAH AR

Spending variance = AH(AR - SR)

Efficiency variance = SR(AH - SH)

SH SR

Spending

Variance

Efficiency

Variance

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

Variable Overhead Variances

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V i bl O h d V i E l

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3,300 hours 3,200 hours

$2.00 per hour $2.00 per hour

Variable Overhead Variances Example

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

Spending variance$140 unfavorable

Efficiency variance$200 unfavorable

$340 unfavorable flexible budget total variance

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

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Variable Overhead Variances

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Efficiency Variance

Controlled bymanaging the

overhead cost driver.

Variable Overhead Variances A Closer Look

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Q i k Ch k

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Quick Check

Yoder Enterprises actual production for theperiod required 2,100 standard direct laborhours. Actual variable overhead for the periodwas $10,950. Actual direct labor hours worked

were 2,050. The predetermined variableoverhead rate is $5 per direct labor hour. Whatwas the spending variance?

a. $450 U

b. $450 Fc. $700 F

d. $700 U

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Q i k Ch k

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Yoder Enterprises actual production for theperiod required 2,100 standard direct laborhours. Actual variable overhead for the periodwas $10,950. Actual direct labor hours worked

were 2,050. The predetermined variableoverhead rate is $5 per direct labor hour. Whatwas the spending variance?

a. $450 U

b. $450 Fc. $700 F

d. $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

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Quick Check

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Quick Check

Yoder Enterprises actual production for theperiod required 2,100 standard direct laborhours. Actual variable overhead for the periodwas $10,950. Actual direct labor hours worked

were 2,050. The predetermined variableoverhead rate is $5 per direct labor hour. Whatwas the efficiency variance?

a. $450 U

b. $450 Fc. $250 F

d. $250 U

11-48

Quick Check

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Yoder Enterprises actual production for theperiod required 2,100 standard direct laborhours. Actual variable overhead for the periodwas $10,950. Actual direct labor hours worked

were 2,050. The predetermined variableoverhead rate is $5 per direct labor hour. Whatwas the efficiency variance?

a. $450 U

b. $450 Fc. $250 F

d. $250 U

Quick Check

Efficiency variance = SR (AH SH)

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

= $250 F

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Quick Check Summary

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2,050 hours 2,100 hours

$5 per hour $5 per hour

Quick Check Summary

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

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

Spending variance$700 unfavorable

Efficiency variance$250 favorable

$450 unfavorable flexible budget total variance

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Activity-based Costing

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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.

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Learning Objective 5

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Learning Objective 5

Compute the

predetermined overheadrate and apply overheadto products in a standard

cost system.

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Overhead Rates and Overhead Analysis

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Overhead Rates and Overhead Analysis

Overhead from the

flexible budget for thedenominator level of activity

POHR =

Recall that overhead costs are assigned toproducts and services using apredetermined

overhead rate (POHR):

Assigned Overhead = POHR Standard Activity

Denominator level of activity

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Overhead Rates and Overhead Analysis

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The predetermined overhead ratecan be broken down into fixed

and variable components.

The variablecomponent is useful

for preparing and analyzingvariable overheadvariances.

The fixedcomponent is useful

for preparing and analyzingfixed overheadvariances.

Overhead Rates and Overhead Analysis

11-54

Normal versus Standard Cost Systems

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Normal versus Standard Cost Systems

In a normal costsystem, overhead isapplied to work in

process based onthe actual numberof hours worked

in the period.

In a standard costsystem, overhead isapplied to work in

process based onthe standard hoursallowed for the actualoutput of the period.

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Learning Objective 6

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Learning Objective 6

Compute and interpretthe fixed overhead budget

and volume variances.

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Fixed Overhead Variances

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BudgetVariance

VolumeVariance

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

SH FR

Actual Fixed Fixed FixedOverhead Overhead OverheadIncurred Budget Applied

Fixed Overhead Variances

DH FR

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Overhead Rates and OverheadA l i E l

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ColaCo prepared this budget for overhead:

O OAnalysis Example

Total Variable Total FixedMachine Variable Overhead Fixed Overhead

Hours Overhead Rate Overhead Rate3,000 6,000$ ? 9,000$ ?4,000 8,000 ? 9,000 ?

ColaCo applies overhead basedon machine-hour activity.

Lets calculate overhead rates.

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Overhead Rates and OverheadA l i E l

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Rate = TotalVariable Overhead Machine Hours

This rate is constant at all levels of activity.

Total Variable Total FixedMachine Variable Overhead Fixed Overhead

Hours Overhead Rate Overhead Rate3,000 6,000$ 2.00$ 9,000$ ?4,000 8,000 2.00 9,000 ?

ColaCo prepared this budget for overhead:

Analysis Example

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Overhead Rates and OverheadA l i E l

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Total Variable Total FixedMachine Variable Overhead Fixed Overhead

Hours Overhead Rate Overhead Rate3,000 6,000$ 2.00$ 9,000$ 3.00$4,000 8,000 2.00 9,000 2.25

Rate = TotalFixedOverhead Machine Hours

This rate decreases when activity increases.

ColaCo prepared this budget for overhead:

Analysis Example

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Overhead Rates and OverheadA l i E l

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Total Variable Total FixedMachine Variable Overhead Fixed Overhead

Hours Overhead Rate Overhead Rate3,000 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 rates

for a given activity level.

ColaCo prepared this budget for overhead:

Analysis Example

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Fixed Overhead Variances Example

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ColaCos actual production required 3,200standard machine hours. Actual fixed overheadwas $8,450. The predetermined overhead rate

is based on 3,000 machine hours.

Fixed Overhead Variances Example

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Overhead Variances

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Overhead Variances

Now lets turn

our attentionto calculating

fixed overheadvariances.

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Fixed Overhead Variances Example

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Fixed Overhead Variances Example

Budget variance$550 favorable

$8,450 $9,000

Actual Fixed Fixed FixedOverhead Overhead OverheadIncurred Budget Applied

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Fixed Overhead Variances

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A Closer Look

Budget Variance

Results from spendingmore or less than

expected for fixedoverhead items.

Now, lets use thestandard hours allowedto compute the fixed

overhead volumevariance.

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Fixed Overhead Variances Example

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3,200 hours

$3.00 per hour

Budget variance$550 favorable

Fixed Overhead Variances Example

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

Volume variance$600 favorable

SH FR

Actual Fixed Fixed FixedOverhead Overhead OverheadIncurred Budget Applied

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Volume Variance A Closer Look

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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

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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.

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Quick Check

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Quick Check

Yoder Enterprises actual production for theperiod required 2,100 standard direct laborhours. Actual fixed overhead for the periodwas $14,800. The budgeted fixed overhead

was $14,450. The predetermined fixedoverhead rate was $7 per direct labor hour.What was the budget variance?

a. $350 U

b. $350 F

c. $100 F

d. $100 U

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Quick Check

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Yoder Enterprises actual production for theperiod required 2,100 standard direct laborhours. Actual fixed overhead for the periodwas $14,800. The budgeted fixed overhead

was $14,450. The predetermined fixedoverhead rate was $7 per direct labor hour.What was the budget variance?

a. $350 U

b. $350 F

c. $100 F

d. $100 U

Quick Check

Budget variance

= Actual fixed overhead Budgeted fixed overhead

= $14,800 $14,450

= $350 U

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Quick Check

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Quick Check

Yoder Enterprises actual production for theperiod required 2,100 standard direct laborhours. Actual fixed overhead for the periodwas $14,800. The budgeted fixed overhead

was $14,450. The predetermined fixedoverhead rate was $7 per direct labor hour.What was the volume variance?

a. $250 U

b. $250 F

c. $100 F

d. $100 U

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Quick Check

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Yoder Enterprises actual production for theperiod required 2,100 standard direct laborhours. Actual fixed overhead for the periodwas $14,800. The budgeted fixed overhead

was $14,450. The predetermined fixedoverhead rate was $7 per direct labor hour.What was the volume variance?

a. $250 U

b. $250 F

c. $100 F

d. $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

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Quick Check Summary

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2,100 hours

$7.00 per hour

Budget variance$350 unfavorable

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

Actual Fixed Fixed FixedOverhead Overhead OverheadIncurred Budget Applied

Volume variance$250 favorable

SH FR

Quick Check Summary

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Fixed Overhead VariancesA Graphic Approach

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A Graphic Approach

Lets look at agraph showingfixed overhead

variances. We will

use ColaCosnumbers from theprevious example.

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Activity

Cost

3,000 HoursExpected

Activity

$9,000 budgeted fixed OH

A Graphic Approach

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$8,450 actual fixed OH

Activity

Cost

3,000 HoursExpected

Activity

$9,000 budgeted fixed OH

$8,450 actual fixed OH$550FavorableBudget

Variance

{

A Graphic Approach

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{

$8,450 actual fixed OH

3,200 machine hours $3.00 fixed overhead rate

$600FavorableVolumeVariance

$9,600 applied fixed OH

3,200Standard

Hours

Activity

Cost

3,000 HoursExpected

Activity

$9,000 budgeted fixed OH

$550FavorableBudget

Variance

{ $8,450 actual fixed OH

A Graphic Approach

11-77 Overhead Variances and Under- orOverapplied Overhead Cost

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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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