copyright © 2009 by the mcgraw-hill companies, inc. all rights reserved. mcgraw-hill/irwin chapter...
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Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Chapter 11Chapter 11
Flexible Budgeting and the Management of
Overhead and Support Activity Costs
Flexible Budgeting and the Management of
Overhead and Support Activity Costs
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
1
Learning Objective
1
11-3
Flexible BudgetsFlexible BudgetsHmm! Comparing
static budgetswith actual costsis like comparing
apples and oranges.
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.
11-4
Considerthe following example from the Cheese
Company . . .
Hmm! Comparingstatic budgets
with actual costsis like comparing
apples and oranges.
Flexible BudgetsFlexible Budgets
11-5
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.
11-6
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$ $11,700 F
Static Budgets andStatic Budgets andPerformance ReportsPerformance Reports
F = Favorable variance since actual costs are less than budgeted costs.
Since cost variances are favorable, havewe done a good job controlling costs?
11-7
I don’t think I can answer this question
using a static budget.
I do know thatactual activity is belowbudgeted activity which
is unfavorable.
But shouldn’t variable costsbe lower if actual activity
is below budgeted activity?
Static Budgets andStatic Budgets andPerformance ReportsPerformance Reports
11-8
• The relevant question is . . .
“How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?”
• To answer the question,we mustthe budget to theactual level of activity.
Static Budgets andStatic Budgets andPerformance ReportsPerformance Reports
11-9
Flexible BudgetsFlexible Budgets
Central Concept
If you can tell me what your activity wasfor the period, I will tell you what your costs
and revenue should have been.
11-10
Advantages of Flexible BudgetsAdvantages of Flexible Budgets
Improve performance evaluation.
May be prepared for any activity level in the relevant range.
Show revenues and expensesthat should have occurred at theactual level of activity.
Reveal variances due to good costcontrol or lack of cost control.
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
2
Learning Objective
2
11-12
Preparing a Flexible BudgetPreparing a Flexible Budget
Let’s prepare budgets for the Cheese Company.
11-13
Variable Total Flexible BudgetsCost Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00 Indirect material 3.00 Power 0.50 Total variable cost 7.50$
Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs
Preparing a Flexible BudgetPreparing a Flexible Budget
11-14
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.
11-15
Preparing a Flexible BudgetPreparing a Flexible Budget
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$ 12,000$ Insurance 2,000 2,000 Total fixed cost 14,000$Total overhead costs 74,000$
11-16
Preparing a Flexible BudgetPreparing a Flexible Budget
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$ 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$
11-17
Preparing a Flexible BudgetPreparing a Flexible Budget
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$ 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$
Note: There is no flexin the fixed costs.
11-18
Preparing a Flexible BudgetPreparing a Flexible Budget
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$ 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$
Budgeted variable Total overhead cost per activity activity unit units
× + Budgeted fixedoverhead cost
Total budgetedoverhead cost =
11-19
Flexible BudgetFlexible BudgetPerformance ReportPerformance Report
Now let’s prepare a budget performance report at 8,000 actual machine hours for the Cheese Co.
11-20
Flexible BudgetFlexible BudgetPerformance ReportPerformance Report
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$Total overhead costs 77,300$
11-21
Flexible BudgetFlexible BudgetPerformance ReportPerformance Report
Variable TotalCost Fixed Flexible Actual
Per Hour Costs 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 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.
11-22
Flexible BudgetFlexible BudgetPerformance ReportPerformance Report
Variable TotalCost Fixed Flexible Actual
Per 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 2,000 0Total fixed costs 14,000$ 14,000$ 0Total overhead costs 74,000$ 77,300$ $ 3,300 U
11-23
Flexible BudgetFlexible BudgetPerformance ReportPerformance Report
Variable TotalCost Fixed Flexible Actual
Per 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 2,000 0Total fixed costs 14,000$ 14,000$ 0Total overhead costs 74,000$ 77,300$ $ 3,300 U
Indirect labor and indirect material have unfavorable variances because actual costs
are more than the flexible budget costs.
11-24
Flexible BudgetFlexible BudgetPerformance ReportPerformance Report
Variable TotalCost Fixed Flexible Actual
Per 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 2,000 0Total fixed costs 14,000$ 14,000$ 0Total overhead costs 74,000$ 77,300$ $ 3,300 U
Power has a favorable variance because the
actual cost is less than the flexible budget cost.
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
3
Learning Objective
3
11-26
Overhead Application in a Overhead Application in a Standard Costing SystemStandard Costing 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
11-27
Overhead Application in a Overhead Application in a Standard Costing SystemStandard Costing 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
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
4
Learning Objective
4
11-29
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.
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
5
Learning Objective
5
11-31
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.
11-32
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 Variances
11-33
Spending Variance
EfficiencyVariance
AH × SVR
AH × AR SH × SVR
Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
Variable Overhead Variances
Spending variance = AH(AR - SVR)
Efficiency variance = SVR(AH - SH)
11-34
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 – Variable Overhead Variances – ExampleExample
11-35
ColaCo prepared this budget for overhead:
Variable Overhead Variances – Variable Overhead Variances – ExampleExample
Budgeted variable Total overhead cost per x activity activity unit units
+ Budgeted fixedoverhead cost
Total budgetedoverhead cost =
Total budgetedoverhead cost =
$2.00 permachine
hour×
Totalmachine hours
+ $9,000
11-36
3,300 hours 3,200 hours × × $2.00 per hour $2.00 per hour
Spending variance$140 unfavorable
Efficiency variance$200 unfavorable
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
Variable Overhead Variances – Variable Overhead Variances – ExampleExample
11-37
3,300 hours 3,200 hours × × $2.00 per hour $2.00 per hour
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
Variable Overhead Variances – Variable Overhead Variances – ExampleExample
The $140 unfavorable spending variance and the $200 unfavorable efficiency variance result in a $340
unfavorable flexible budget variance.
11-38
Variable Overhead Variances – A Variable Overhead Variances – A Closer LookCloser Look
Spending 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.
11-39
Fixed OverheadFixed Overhead
Now let’s turn our attention to fixed overhead.
11-40
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 Variances
11-41
PFOHR =
Applied Fixed Overhead = PFOHR × Standard Hours
Budgeted Fixed Overhead
Planned Activity in Hours
Recall that fixed overhead costs are applied to products and services using a predetermined
fixed overhead rate (PFOHR):
Fixed OverheadFixed Overhead
11-42
ColaCo used the following predeterminedfixed overhead rate:
PFOHR =Budgeted Fixed Overhead
Planned Activity in Hours
PFOHR =$9,000
3,000 machine hours
PFOHR = $3.00 per machine hour
Fixed Overhead Variances – Fixed Overhead Variances – ExampleExample
11-43
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 – Fixed Overhead Variances – ExampleExample
11-44
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)
11-45
Fixed Overhead VariancesFixed Overhead Variances
Let’s look at a graph showing fixed
overhead variances. We will use ColaCo’s
numbers from the previous example.
11-46
Fixed Overhead Variances –Fixed Overhead Variances –A Closer LookA Closer Look
Budget Variance Volume Variance
Results 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.
11-47
Volume
Cost
$9,600 applied fixed OH
$9,000 budgeted fixed OH
3,200 machine hours × $3.00 fixed overhead rate
Fixed overhead
applied to products
Fixed Overhead VariancesFixed Overhead Variances
{$600
Volume Variance
{$550Favorable
Budget Variance
$8,450 actual
fixed OH
3,200 Standard
Hours
3,000 Hours PlannedActivity
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
6
Learning Objective
6
11-49
Overhead Cost Performance ReportOverhead Cost Performance Report
Variable costs:Indirect material:
WaxPlastic wrapPaper productsMisc. supplies
Indirect labor:MaintenanceJanitorial
Utilities:ElectricityNatural gasWater
Total variable cost
Fixed costs:Indirect labor:
InspectionProduction supervisorSet up
Depreciation:Equipment
InsuranceProperty taxesTotal fixed cost
Total overhead cost
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
7
Learning Objective
7
11-51
Activity-Based Flexible BudgetActivity-Based Flexible Budget
Variable Total Flexible BudgetsCost Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ 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$
The Cheese Co. flexible budget is based on a single cost driver, machine hours
11-52
Activity-Based Flexible BudgetActivity-Based Flexible Budget
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$ 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$
If different cost drivers are identified for the different variable costs, an activity-based flexible
budget should be prepared with different costformulas based on the different drivers.
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
8
Learning Objective
8
11-54
Standard Costs and Product CostingStandard Costs and Product Costing
Actual Applied Appliedoverhead overhead: overhead:
Standard Standardallowed hours allowed hours
x xPredetermined Predeterminedoverhead rate overhead rate
Manufacturing Overhead Work-in-Process InventoryStandard Costing
11-55
Standard Costs and Product CostingStandard Costs and Product Costing
Actual Applied Balance (1) Balance (2)overhead overhead: Actual Applied
Standard overhead overheadallowed hours greater than greater than
x Applied ActualPredetermined overhead overheadoverhead rate
Balance (1) Balance (2)Balance (2) Balance (1)
Manufacturing Overhead Cost of Goods SoldDisposition of Variances
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
9
Learning Objective
9
11-57
A General Model for Variance A General Model for Variance Analysis Analysis
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Price Variance Quantity Variance
Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance Variable overhead Variable overhead spending variance efficiency variance
AQ(AP - SP) SP(AQ - SQ)
AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity
11-58
A General Model for Variance A General Model for Variance Analysis Analysis
Actual Sales Volume Actual Sales Volume Budgeted Sales Volume
× × × Actual Sales Price Budgeted Sales Price Budgeted Sales Price
Sales Price Variance Sales Volume Variance
ASV(ASP - BSP) BSP(ASV - BSV)
ASV = Actual Sales Volume BSP = Budgeted Sales Price ASP = Actual Sales Price BSV = Budgeted Sales Volume
11-59
End of Chapter 11End of Chapter 11
I’m here to your budget. Are you ready to
ante up?