BAB 7 FLEXIBLE BUDGET b7 flexi budget

Flexible Budgets and

Overhead Analysis

Chapter

Static Budgets and Performance

Reports

Hmm! Comparing

static budgets with

actual costs is like

comparing 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.

Static

Actual

Budget

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

Static

Actual

Budget

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

2,050

50

U

Total overhead costs

$

89,000

$

77,350

$11,650

F

Static

Actual

Budget

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.

Static

Actual

Budget

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

2,050

50

U

Total overhead costs

$

89,000

$

77,350

$11,650

F

Static

Actual

Budget

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

Static

Actual

Budget

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

2,050

50

U

Total overhead costs

$

89,000

$

77,350

$11,650

F

Static

Actual

Budget

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, have

we done a good job controlling costs?

Static Budgets and Performance

Reports

I don’t think I

can answer the

question using

a static budget.

Actual activity is below

budgeted activity which

is unfavorable.

So, shouldn’t variable costs

be lower if actual 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 must

the budget to the

actual level of activity.

Static Budgets and Performance

Reports

Flexible Budgets

Improve performance evaluation.

May be prepared for any activity

level in the relevant range.

Show revenues and expenses

that should have occurred at the

actual level of activity.

Reveal variances due to good cost

control or lack of cost control.

Flexible Budgets

Central Concept

If you can tell me what your activity was

for the period, I will tell you what your costs

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 remain}

unchanged

within the

relevant range.

Fixed

Va

ria

ble

Preparing a Flexible Budget

Let’s prepare

budgets

for CheeseCo.

Cost Total Flexible Budgets

Formula 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 cost

Total overhead costs

Preparing a Flexible Budget

Fixed costs are

expressed as a

total amount.

Variable costs are expressed as

a constant amount per hour.

$40,000 ÷ 10,000 hours is

$4.00 per hour.

Cost Total Flexible Budgets

Formula 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 cost

Total overhead costs

Preparing a Flexible Budget

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

CheeseCo

Preparing a Flexible Budget

Cost Total Flexible Budgets

Formula 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

Preparing a Flexible Budget

Cost Total Flexible Budgets

Formula 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

Total fixed costs

do not change in

the relevant range.

Let’s prepare a

budget performance report

for CheeseCo.

Flexible Budget

Cost Total

Formula 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

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 Budget

Performance Report

Flexible budget is

prepared for the

same activity level

(8,000 hours) as

actually achieved.

Cost Total

Formula 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 F

Total variable costs $ 7.50 $ 60,000 $ 63,300 $ 3,300 U

Fixed Expenses

Depreciation $ 12,000 $ 12,000 $ 12,000 0 Insurance 2,000 2,000 2,050 50 U

Total fixed costs $ 14,000 $ 14,050 50 U

Total overhead costs $ 74,000 $ 77,350 $ 3,350 U

Flexible Budget

Performance Report

Remember the question:

“How much of the total

variance is due to activity

and how much is due to

cost control?”

Flexible Budget

Static

Actual

Budget

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?

Flexible Budget

Performance Report

Difference between original static budget

and actual overhead = $11,650 F.

Overhead Variance Analysis

Static Actual Overhead Overhead

Budget at at

10,000 Hours 8,000 Hours 89,000

$ $ 77,350

Let’s place

the flexible

budget for

8,000 hours

Flexible Budget

Performance Report

This $15,000F variance is

due to lower activity.

Overhead Variance Analysis

Activity

This $3,350

U

flexible

budget variance is due

to poor cost control.

Cost control

Static Flexible Actual Overhead Overhead Overhead

Budget at Budget at at

10,000 Hours 8,000 Hours 8,000 Hours 89,000

Flexible Budget

Performance Report

What causes

the cost

control variance?

There are two primary

reasons for unfavorable

variable overhead variances:

1.

Spending

too much for

resources.

2. Using the resources

Overhead Rates and Overhead

Analysis

Overhead from the

flexible budget for the

denominator level of activity

POHR =

Recall that overhead costs are assigned

to products and services using a

predetermined overhead rate (POHR)

:

Assigned Overhead = POHR × Standard Activity

Overhead Rates and Overhead

Analysis – Example

Let’s look at overhead

rates in a

ColaCo prepared this budget for overhead:

Overhead Rates and Overhead

Analysis – Example

Total

Variable

Total

Fixed

Machine

Variable

Overhead

Fixed

Overhead

Hours

Overhead

Rate

Overhead

Rate

2,000

$

4,000

?

$

9,000

?

4,000

8,000

?

9,000

?

ColaCo applies overhead based

on machine hour activity.

ColaCo applies overhead based

on machine hour activity.

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

Fixed

Machine

Variable

Overhead

Fixed

Overhead

Hours

Overhead

Rate

Overhead

Rate

2,000

$

4,000

$

2.00

$

9,000

?

4,000

Total

Variable

Total

Fixed

Machine

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:

Total

Variable

Total

Fixed

Machine

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 of

the fixed and variable rates

for a given activity level.

Overhead Variances

Let’s use the

overhead rates, to

determine variable

and fixed overhead

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

Variable Overhead Variances

AH × SR

AH × AR

Spending variance =

AH(AR - SR)

Efficiency variance =

SR(AH - SH)

SH × SR

Spending

Variance

Efficiency

Variance

Actual Flexible Budget Flexible Budget

Variable for Variable

for Variable

Overhead Overhead at Overhead at

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

Variable Overhead Variances – A

Closer Look

Spending Variance

Efficiency Variance

Results from paying more

or less than expected for

overhead items and from

excessive usage of

overhead items.

Controlled by

managing the

Overhead Variances

Now let’s turn

our attention

to

fixed

overhead

.

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

Fixed

Machine

Variable

Overhead

Fixed

Overhead

Hours

Overhead

Rate

Overhead

Rate

2,000

$

4,000

$

2.00

$

9,000

$

4.50

4,000

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?

FR = $9,000 ÷ 3,000 machine hours

Fixed Overhead Rate

FR = $3.00 per machine hour

Total

Variable

Total

Fixed

Machine

Variable

Overhead

Fixed

Overhead

Hours

Overhead

Rate

Overhead

Rate

2,000

$

4,000

$

2.00

$

9,000

$

4.50

4,000

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

Fixed Overhead Variances

Budget

Variance

Variance

Volume

FR = Standard Fixed Overhead Rate

SH = Standard Hours Allowed

SH × FR

Actual Fixed Fixed Fixed

Overhead Overhead Overhead

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

Fixed Overhead Variances –

A Closer Look

Budget Variance

Volume Variance

Results from paying more

or less than expected for

overhead items.

Results from operating

at an activity level

different from the

denominator activity.

Overhead Variances

Let’s look at a

graph showing

fixed overhead

variances. We will

use ColaCo’s

numbers from the

previous example.

Volume

Cost

3,200

Standard

3,000 Hours

Expected

Fixed Overhead Variances

Fix

ed

ov

erh

ea

d

ap

plie

d t

o p

rod

uc

ts

Fixed Overhead Variances

$8,450 actual fixed OH

Volume

Cost

$9,600 applied fixed OH

$9,000 budgeted fixed OH

3,200

Standard

3,000 Hours

Expected

Fix

ed

ov

erh

ea

d

ap

plie

d t

o p

rod

uc

ts

{

$600

Favorable

Volume

Variance

Fixed Overhead Variances

{

$550

Favorable

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

3,000 Hours

Expected

Fix

ed

ov

erh

ea

d

ap

plie

d t

o p

rod

uc

ts

3,200 machine hours × $3.00 fixed overhead rate

Results when standard hours

allowed for actual output differs

from the denominator activity.

Volume Variance – A Closer Look

Volume

Variance

Favorable

when standard hours

> denominator hours

Unfavorable

when standard hours

< denominator hours

Results when standard hours

allowed for actual output differs

from the denominator activity.

Volume Variance – A Closer Look

Volume

Variance

Favorable

when standard hours

> denominator hours

Unfavorable

when standard hours

< denominator hours

Does not measure

or under spending

Explainable by and

controllable only through

activity

Overhead Variances and Under- or

Overapplied Overhead Cost

The sum of the overhead variances

equals the under- or overapplied

overhead cost for a period.

Favorable

variances are equivalent

to overapplied overhead.

Unfavorable

variances are equivalent

to underapplied overhead.

In a standard

cost system:

End of Chapter 11

I’m here to

your

budget. Are you ready to

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

Expected Activity

Fixed

overh ead

applie

d to p

roduc ts

{

$600 Favorable

Volume Variance

Fixed Overhead Variances

{

$550 Favorable

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 3,000 Hours Expected Fixed overh ead applie

d to p

roduc ts

3,200 machine hours × $3.00 fixed overhead rate

Results when standard hours

allowed for actual output differs

from the denominator activity.

Volume Variance – A Closer Look

Volume

Variance

Favorable

when standard hours > denominator hours

Unfavorable

when standard hours < denominator hours

Results when standard hours

allowed for actual output differs

from the denominator activity.

Volume Variance – A Closer Look

Volume

Variance

Favorable

when standard hours > denominator hours

Unfavorable

when standard hours < denominator hours

Does not measure

or under spending

Explainable by and

controllable only through

activity

Overhead Variances and Under- or

Overapplied Overhead Cost

The sum of the overhead variances

equals the under- or overapplied

overhead cost for a period.

Favorable

variances are equivalent to overapplied overhead.

Unfavorable

variances are equivalent to underapplied overhead.

In a standard

cost system:

End of Chapter 11

I’m here to your

budget. Are you ready to