1Copyright © 2008 Cengage Learning South-Western.

Heitger/Mowen/Hansen

Flexible Budgets and Overhead Analysis

Chapter Nine

Cornerstones of Managerial Accounting 2e

Cornerstones of Managerial Accounting 2e

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Objective # 1Objective # 1

Prepare a flexible budget, and use it for performance reporting.

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Performance Reports

• Compare actual costs with budgeted costs

• Two ways:◦ Compare actual costs with budgeted costs

for the budgeted level of activity

∙ Based on a static budget

◦ Compare actual costs with the actual level of activity∙ Based on a flexible budget

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Static Budget

• A budget for one particular level of activity• Performance report will compare:

◦ Direct materials, direct labor, and overhead costs budgeted for the planned level of activity with

◦ Actual costs for the actual level of activity∙ Resulting in unfavorable variances when actual

production exceeds the planned level

• To create a meaningful performance report:◦ Actual costs and expected costs must be compared

at the same level of activity

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Flexible Budget• Enables a firm to compute expected costs for a

range of activity levels• Two types:

◦ Before-the-fact -- Allows managers to see the expected outcomes for a range of activity levels ∙ Used to generate financial results for a number of

plausible scenarios◦ After-the-fact -- Created for the actual level of activity

∙ Used to compute what costs should have been for the actual level of activity

∙ Expected costs are then compared with the actual costs in order to assess performance

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Objective # 2Objective # 2

Calculate the variable overhead variances and explain their

meaning

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Total Overhead Variance

• Difference between applied and actual overhead

• Broken down into:◦ Total Variable Overhead Variance

∙ Broken further into:▫ Variable Overhead Spending Variance▫ Variable Overhead Efficiency Variance

◦ Total Fixed Overhead Variance∙ Broken further into:

▫ Fixed Overhead Spending Variance▫ Fixed Overhead Volume Variance

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Total Variable Overhead Variance

Actual Costs Applied Costs Total Variance– =

(AH X AVOR) – (SH X SVOR)

Hours allowed for production (SH)x

Standard Variable Overhead Rate (SVOR)

Actual Hours x Actual Variable Overhead Rate

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Variable Overhead Spending Variance

• Measures the aggregate effect of the differences between

◦ Actual variable overhead rate (AVOR)◦ Standard variable overhead rate (SVOR)

• Two ways to calculate:◦ Three-pronged columnar approach◦ Formula approach

∙ (AVOR – SVOR)AH

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Variable Overhead Efficiency Variance

• Measures the change in variable overhead consumption that occurs because of efficient (or inefficient) use of direct labor

• Two ways to calculate:◦ Three-pronged columnar approach◦ Formula approach

∙ (AH – SH)SVOR

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Example

VOH spending variance

(AVOR – SVOR)AH

Formula Approach:

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Example

VOH efficiency variance

(AH – SH) SVOR

Formula Approach:

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Objective # 3Objective # 3

Calculate the fixed overhead variances, and explain their

meaning

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Total Fixed Overhead Variance

• Difference between actual and applied fixed overhead

• When applied overhead = standard fixed overhead rate x standard hours allowed for the actual output

• Broken down into:◦ Fixed Overhead Spending Variance◦ Fixed Overhead Volume Variance

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Fixed Overhead Spending Variance

• Difference between◦ Actual fixed overhead rate (AFOH)◦ Budgeted fixed overhead rate (BFOH)

• Two ways to calculate:◦ Three-pronged columnar approach◦ Formula approach

∙ AFOH – SFOH

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Fixed Overhead Volume Variance

• Difference between◦ Budgeted fixed overhead (BFOH)

◦ Applied fixed overhead (ApFOH)

• Two ways to calculate:◦ Three-pronged columnar approach

◦ Formula approach∙ (SHp – SH)SFOR

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Example

Information:

• Standard fixed overhead rate (SFOR) $10.00 per direct labor hour

• Budgeted fixed overhead (BFOH) $1,800• Number of tee shirts produced 1,200 units• Hours allowed for production (SH) 144 hours

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Example

Fixed Overhead (FOH) Volume Variance

AFOH – BFOH

Formulas:

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Example

Fixed Overhead (FOH) Efficiency Variance

(SHp - SH) SFOR

Formulas:

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Objective # 4Objective # 4

Prepare an activity-based flexible budget.

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Activity-Based Budgeting

• A powerful planning and control tool

• Can be used to emphasize cost reduction through the elimination of wasteful activities and improving efficiency of necessary activities

• Two types:◦ Static activity budgets◦ Activity-based flexible budget