flexible budgets and overhead analysis chapter 11

Flexible Budgets and Overhead Analysis

Chapter 11

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Static Budgets and Performance Reports

Let’s look at CheeseCo.

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.

Hmm! Comparingstatic budgets withactual costs is likecomparing apples

and oranges.



CheeseCo



U = Unfavorable variance CheeseCo was unable to achieve

the budgeted level of activity.

CheeseCo



CheeseCo

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



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

CheeseCo



I don’t think Ican answer thequestion usinga static budget.

Actual activity is belowbudgeted activity.

So, shouldn’t variable costsbe lower if actual activity

is lower?


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.

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.



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.


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.


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



Let’s prepare budgets for CheeseCo.


Preparing a Flexible BudgetCheeseCo

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

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.



Machine hours 8,000 10,000 12,000


Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs


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

CheeseCo




Machine hours 8,000 10,000 12,000


Fixed costs Depreciation 12,000$ 12,000$ Insurance 2,000 2,000 Total fixed cost 14,000$ Total overhead costs 74,000$ ?

CheeseCo


Quick Check

What should be the total overhead costs for the Flexible Budget at 10,000 hours?

a. $92,500.

b. $74,000.

c. $89,000.

d. $94,000.


a. $92,500.

b. $74,000.

c. $89,000.

d. $94,000.




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$

CheeseCo

Total fixed costsdo not change in

the relevant range.


Quick Check


a. $92,500.

b. $89,000.

c. $106,800.

d. $104,000.


a. $92,500.

b. $89,000.

c. $106,800.

d. $104,000.




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


Let’s prepare a budget performance report for CheeseCo.

Flexible BudgetPerformance Report



Cost TotalFormula Fixed Flexible ActualPer 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 2,050 Total fixed costs 14,050$ Total overhead costs 77,350$

Flexible budget is prepared for the

same activity level (8,000 hours) as

actually achieved.

CheeseCo


Quick Check

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

a. $2,000 U

b. $2,000 F

c. $6,000 U

d. $6,000 F

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

a. $2,000 U

b. $2,000 F

c. $6,000 U

d. $6,000 F




Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 24,000 Power 0.50 4,000 Total variable costs 7.50$ 60,000$ Fixed Expenses Depreciation 12,000$ 12,000$ Insurance 2,000 2,000 Total fixed costs 14,000$ Total overhead costs 74,000$


CheeseCo


Quick Check

What is the variance for indirect materials when the flexible budget for 8,000 hours is compared to the actual results?

a. $1,500 U

b. $1,500 F

c. $4,500 U

d. $4,500 F

What is the variance for indirect materials when the flexible budget for 8,000 hours is compared to the actual results?

a. $1,500 U

b. $1,500 F

c. $4,500 U

d. $4,500 F





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 Total variable costs 7.50$ 60,000$ Fixed Expenses Depreciation 12,000$ 12,000$ Insurance 2,000 2,000 Total fixed costs 14,000$ Total overhead costs 74,000$

CheeseCo


Quick Check

What is the variance for depreciation when the flexible budget for 8,000 hours is compared to the actual results?

a. $0

b. $1,000 F

c. $2,000 U

d. $2,000 F

What is the variance for depreciation when the flexible budget for 8,000 hours is compared to the actual results?

a. $0

b. $1,000 F

c. $2,000 U

d. $2,000 F




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


CheeseCo


Remember the question: “How much of the total variance is due to activityand how much is due tocost control?”



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?



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.



Overhead Variance Analysis

This $15,000F variance is due to lower activity.

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$



What causesthe cost

control variance?

There are two primaryreasons for unfavorablevariable overhead variances:

1. Spending too much for resources.

2. Using the resources inefficiently.

flexible budgets and overhead analysis chapter 11

Documents

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actual activity

activity level

actual level of activity

lower activity

actual costs

budgeted activity

budgeted level of activity