Hilton 5th Edition Chapter Eleven

Flexible Budgeting and Analysis of Overhead Costs

CHAPTER 11

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Flexible BudgetsFlexible Budgets

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.

Hmm! Comparingstatic budgets

with actual costsis like comparing

apples and oranges.

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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.

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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?

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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 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 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.

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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.

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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.

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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

Preparing a Flexible BudgetPreparing a Flexible Budget

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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 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

Preparing a Flexible BudgetPreparing a Flexible Budget

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.

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Preparing a Flexible BudgetPreparing a Flexible BudgetVariable Total Flexible Budgets

Cost Fixed 8,000 10,000 12,000Per 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$Total overhead costs 74,000$

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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$

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Machine hours 8,000 10,000 12,000



Note: There is no flexin the fixed costs.

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Machine hours 8,000 10,000 12,000



Budgeted variable Total overhead cost per activity activity unit units

× + Budgeted fixedoverhead cost

Total budgetedoverhead cost =

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Flexible BudgetFlexible BudgetPerformance ReportPerformance Report

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

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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$Total overhead costs 77,300$

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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.

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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

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Indirect labor and indirect material have unfavorable variances because actual costs

are more than the flexible budget costs.

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Power has a favorable variance because the

actual cost is less than the flexible budget cost.

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Overhead Application in a Standard Overhead Application in a Standard Costing SystemCosting System

Actual Applied Appliedoverhead overhead: overhead:

Actual hours Actual hoursx x

Predetermined Predeterminedoverhead rate overhead rate

Difference lies in the quantity of hours used.

Actual Applied Appliedoverhead overhead: overhead:

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

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Overhead Application in a Standard Overhead Application in a Standard Costing SystemCosting 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

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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.

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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..

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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 VariancesVariable Overhead Variances

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Spending Variance

EfficiencyVariance

AH × SVR

AH × AR SH × SVR


Variable Overhead VariancesVariable Overhead Variances

Spending variance = AH(AR - SVR)Efficiency variance = SVR(AH - SH)

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Variable Overhead Variances – Variable Overhead Variances – ExampleExample

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.

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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

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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 $200 unfavorable efficiency variance results in a $340

unfavorable flexible budget variance.11-30

Variable Overhead Variances – A Variable Overhead Variances – A Closer LookCloser LookSpending 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.

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Fixed OverheadFixed Overhead

Now let’s turn our attention to fixed overhead.

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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 VariancesFixed Overhead Variances

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PFOHR =

Applied Fixed Overhead = PFOHR × Standard Hours

Budgeted Fixed OverheadPlanned Activity in Hours

Fixed OverheadFixed OverheadRecall that fixed overhead costs are applied to products and services using a predetermined

fixed overhead rate (PFOHR):

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Fixed Overhead Variances – Fixed Overhead Variances – ExampleExample

ColaCo used the following predeterminedfixed overhead rate:

PFOHR = Budgeted Fixed OverheadPlanned Activity in Hours

PFOHR =$9,000

3,000 machine hours

PFOHR = $3.00 per machine hour

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Fixed Overhead Variances – Fixed Overhead Variances – ExampleExample

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

was $8,450.

Compute the fixed overhead budget and volume variances.

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3,200 hours × $3.00 per hour

Fixed Overhead Variances – Fixed Overhead Variances – ExampleExample 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)11-37

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

Budget Variance Volume VarianceResults 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.

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End of Chapter 11End of Chapter 11I’m here to your

budget. Are you ready to ante up?

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Hilton 5th Edition Chapter Eleven

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Transcript of Hilton 5th Edition Chapter Eleven