b7 flexi budget
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Flexible Budgets and Overhead Analysis
Chapter
7
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Static Budgets and Performance Reports
Hmm! Comparingstatic budgets withactual costs is likecomparing apples
and oranges.
Static budgets are prepared for a single,
planned level of activity.
Performance evaluation is difficult when actual activity
differs from the planned level of
activity.Let’s look at CheeseCo.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Static ActualBudget Results Variances
Machine hours 10,000 8,000
Variable costs Ind irect labor 40,000$ 34,000$ Indirect materials 30,000 25,500 Power 5,000 3,800
Fixed costs Depreciation 12,000 12,000 Insurance 2,000 2,050
Total overhead costs 89,000$ 77,350$
Static Budgets and Performance Reports
CheeseCo
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Static ActualBudget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs Ind irect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,050 50 U
Total overhead costs 89,000$ 77,350$ $11,650 F
Static Budgets and Performance Reports
U = Unfavorable variance CheeseCo was unable to achieve
the budgeted level of activity.
CheeseCo
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Static ActualBudget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs Ind irect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,050 50 U
Total overhead costs 89,000$ 77,350$ $11,650 F
Static Budgets and Performance Reports
F = Favorable variance that occurs when actual costs are less than budgeted costs.
CheeseCo
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Static ActualBudget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs Ind irect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,050 50 U
Total overhead costs 89,000$ 77,350$ $11,650 F
Static Budgets and Performance Reports
Since cost variances are favorable, havewe done a good job controlling costs?
CheeseCo
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Static Budgets and Performance Reports
I don’t think Ican answer thequestion usinga static budget.
Actual activity is belowbudgeted activity which
is unfavorable.
So, shouldn’t variable costsbe lower if actual activity
is lower?
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
The relevant question is . . .
“How much of the favorable cost variance isdue to lower activity, and how much is due to good cost control?”
To answer the question,we mustthe budget to theactual level of activity.
Static Budgets and Performance Reports
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Flexible Budgets
Improve performance evaluation.
May be prepared for any activity level in the relevant range.
Show revenues and expensesthat should have occurred at theactual level of activity.
Reveal variances due to good costcontrol or lack of cost control.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Flexible Budgets
Central Concept
If you can tell me what your activity wasfor the period, I will tell you what your costs
and revenue should have been.
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Preparing a Flexible Budget
To a budget we need to know that:Total variable costs change
in direct proportion to changes in activity.
Total fixed costs remainunchanged within therelevant range. Fixed
Variable
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Preparing a Flexible Budget
Let’s prepare budgets for CheeseCo.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ Indirect material 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$
Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs
Preparing a Flexible Budget
Fixed costs areexpressed as atotal amount.
Variable costs are expressed as a constant amount per hour.
$40,000 ÷ 10,000 hours is$4.00 per hour.
CheeseCo
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ Indirect material 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$
Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs
Preparing a Flexible Budget
$4.00 per hour × 8,000 hours = $32,000
CheeseCo
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Preparing a Flexible Budget
Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ 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$
CheeseCo
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Preparing a Flexible Budget
Cost Total Flexible BudgetsFormula 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$ 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$
Total fixed costsdo not change in
the relevant range.
CheeseCo
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Let’s prepare a budget performance report for CheeseCo.
Flexible BudgetPerformance Report
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Cost TotalFormula Fixed Flexible ActualPer Hour Costs Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs Indirect labor 4.00$ 32,000$ 34,000$ Indirect material 3.00 24,000 25,500 Power 0.50 4,000 3,800 Total variable costs 7.50$ 60,000$ 63,300$ Fixed Expenses Depreciation 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,050 Total fixed costs 14,000$ 14,050$ Total overhead costs 74,000$ 77,350$
Flexible BudgetPerformance Report
Flexible budget is prepared for the
same activity level (8,000 hours) as
actually achieved.
CheeseCo
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Cost TotalFormula Fixed Flexible ActualPer Hour Costs 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 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 2,050 50 UTotal fixed costs 14,000$ 14,050$ 50 UTotal overhead costs 74,000$ 77,350$ $ 3,350 U
Flexible BudgetPerformance Report
CheeseCo
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Remember the question: “How much of the total variance is due to activityand how much is due tocost control?”
Flexible BudgetPerformance Report
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Static ActualBudget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs Ind irect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,050 50 U
Total overhead costs 89,000$ 77,350$ $11,650 F
Static Budgets and Performance How much of the $11,650 is due to activity
and how much is due to cost control?
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Flexible BudgetPerformance Report
Difference between original static budgetand actual overhead = $11,650 F.
Overhead Variance Analysis
Static ActualOverhead OverheadBudget at at
10,000 Hours 8,000 Hours
89,000$ 77,350$
Let’s place the flexible budget for
8,000 hours here.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Flexible BudgetPerformance Report
This $15,000F variance is due to lower activity.
Overhead Variance Analysis
Activity
This $3,350U flexiblebudget variance is dueto poor cost control.
Cost control
Static Flexible ActualOverhead Overhead OverheadBudget at Budget at at
10,000 Hours 8,000 Hours 8,000 Hours
89,000$ 74,000$ 77,350$
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Flexible BudgetPerformance Report
What causesthe cost
control variance?
There are two primaryreasons for unfavorablevariable overhead variances:
1. Spending too much for resources.
2. Using the resources inefficiently.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Overhead Rates and Overhead Analysis
Overhead from theflexible budget for the
denominator level of activityPOHR =
Recall that overhead costs are assigned to products and services using a
predetermined overhead rate (POHR):
Assigned Overhead = POHR × Standard Activity
Denominator level of activity
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Overhead Rates and Overhead Analysis – Example
Let’s look at overhead
rates in a
budget for ColaCo.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
ColaCo prepared this budget for overhead:
Overhead Rates and Overhead Analysis – Example
Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
2,000 4,000$ ? 9,000$ ?
4,000 8,000 ? 9,000 ?
ColaCo applies overhead basedon machine hour activity.
ColaCo applies overhead basedon machine hour activity.
Let’s calculate overhead rates.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Overhead Rates and Overhead Analysis – Example
Rate = Total Variable Overhead ÷ Machine Hours
ColaCo prepared this budget for overhead:
This rate is constant at all levels of activity.
Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
2,000 4,000$ 2.00$ 9,000$ ?
4,000 8,000 2.00 9,000 ?
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Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
2,000 4,000$ 2.00$ 9,000$ 4.50$
4,000 8,000 2.00 9,000 2.25
Overhead Rates and Overhead Analysis – Example
Rate = Total Fixed Overhead ÷ Machine Hours
ColaCo prepared this budget for overhead:
This rate decreases when activity increases.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
2,000 4,000$ 2.00$ 9,000$ 4.50$
4,000 8,000 2.00 9,000 2.25
Overhead Rates and Overhead Analysis – Example
The total POHR is the sum ofthe fixed and variable ratesfor a given activity level.
ColaCo prepared this budget for overhead:
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Overhead Variances
Let’s use the overhead rates, to determine variable and fixed overhead
variances.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
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.
Variable Overhead Variances – Example
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Variable Overhead Variances
AH × SR
AH × AR
Spending variance = AH(AR - SR)
Efficiency variance = SR(AH - SH)
SH × SR
Spending Variance
EfficiencyVariance
Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
3,300 hours 3,200 hours × × $2.00 per hour $2.00 per hour
Variable Overhead Variances – Example
Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
$6,740 $6,600 $6,400
Spending variance$140 unfavorable
Efficiency variance$200 unfavorable
$340 unfavorable flexible budget total variance$340 unfavorable flexible budget total variance
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Variable Overhead Variances – A Closer Look
Spending Variance Efficiency Variance
Results from paying moreor less than expected foroverhead items and from
excessive usage ofoverhead items.
Controlled bymanaging the
overhead cost driver.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Overhead Variances
Now let’s turn our attention
to fixed overhead.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Overhead Rates and Overhead Analysis – Example
ColaCo prepared this budget for overhead:
What is ColaCo’s fixed overhead rate for an estimated activity of 3,000 machine hours?
Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
2,000 4,000$ 2.00$ 9,000$ 4.50$
4,000 8,000 2.00 9,000 2.25
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Overhead Rates and Overhead Analysis – Example
ColaCo prepared this budget for overhead:
What is ColaCo’s fixed overhead rate for an estimated activity of 3,000 machine hours? Fixed Overhead Rate
FR = $9,000 ÷ 3,000 machine hours FR = $3.00 per machine hour
Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
2,000 4,000$ 2.00$ 9,000$ 4.50$
4,000 8,000 2.00 9,000 2.25
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
ColaCo’s actual production required 3,200 standard machine hours. Actual fixed overhead
was $8,450.
Compute the fixed overhead budget and volume variances.
Fixed Overhead Variances – Example
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Fixed Overhead Variances
Budget Variance
VolumeVariance
FR = Standard Fixed Overhead RateSH = Standard Hours Allowed
SH × FR
Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
3,200 hours × $3.00 per hour
Budget variance$550 favorable
Fixed Overhead Variances – Example
$8,450 $9,000 $9,600
Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
Volume variance$600 favorable
SH × FR
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Fixed Overhead Variances –A Closer Look
Budget Variance Volume Variance
Results from paying moreor less than expected for
overhead items.
Results from operatingat an activity leveldifferent from the
denominator activity.
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Overhead Variances
Let’s look at a graph showing fixed overhead
variances. We will use ColaCo’s
numbers from the previous example.
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Volume
Cost
3,200 Standard
Hours
3,000 Hours ExpectedActivity
Fixed Overhead Variances
Fixed overhead
applied to products
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Fixed Overhead Variances
$8,450 actual fixed OH
Volume
Cost
$9,600 applied fixed OH
$9,000 budgeted fixed OH
3,200 Standard
Hours
3,000 Hours ExpectedActivity
Fixed overhead
applied to products
3,200 machine hours × $3.00 fixed overhead rate
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
{$600
FavorableVolume
Variance
Fixed Overhead Variances
{$550Favorable
Budget Variance
$8,450 actual fixed OH$8,450 actual fixed OH
Volume
Cost
$9,600 applied fixed OH
$9,000 budgeted fixed OH
3,200 Standard
Hours
3,000 Hours ExpectedActivity
Fixed overhead
applied to products
3,200 machine hours × $3.00 fixed overhead rate
{
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Results when standard hoursallowed for actual output differsfrom the denominator activity.
Volume Variance – A Closer Look
VolumeVariance
Favorablewhen standard hours> denominator hours
Unfavorablewhen standard hours< denominator hours
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Results when standard hoursallowed for actual output differsfrom the denominator activity.
Volume Variance – A Closer Look
VolumeVariance
Favorablewhen standard hours> denominator hours
Unfavorablewhen standard hours< denominator hours
Does not measure over- or under spending
Explainable by and controllable only through
activity
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Overhead Variances and Under- or Overapplied Overhead Cost
The sum of the overhead variancesequals the under- or overapplied
overhead cost for a period.
Favorablevariances are equivalentto overapplied overhead.
Unfavorablevariances are equivalent
to underapplied overhead.
In a standardcost system:
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
End of Chapter 11
I’m here to your budget. Are you ready to
ante up?
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