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Chapter 11

Flexible Budgeting and


the Management of
Overhead and Support
Activity Costs

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning
Objective
1

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Flexible Budgets
Static budgets are
prepared for a single,
planned level of
activity.

Hmm! Comparing
static budgets
with actual costs
is like comparing
apples and oranges.

Performance
evaluation for
overhead is difficult
when actual activity
differs from the
planned level of
activity.
1-3

Flexible Budgets

Consider
the following
example from
the Cheese
Company . . .

Hmm! Comparing
static budgets
with actual costs
is like comparing
apples and oranges.

1-4

Static Budgets and


Performance Reports
Static
Budget
Machine hours
Variable costs
Indirect labor
Indirect materials
Power
Fixed costs
Depreciation
Insurance
Total overhead costs

10,000
$ 40,000
30,000
5,000

Actual
Results

Variances

8,000

2,000 U

U = Unfavorable variance
Cheese Company was
unable to achieve the
budgeted level of activity.

12,000
2,000
$ 89,000
1-5

Static Budgets and


Performance Reports
F = Favorable variance since actual costs
Static
Actual
are less than budgeted
costs.
Budget
Machine hours
Variable costs
Indirect labor
Indirect materials
Power

Results

Variances

10,000

8,000

2,000 U

$ 40,000
30,000
5,000

$ 34,000
25,500
3,800

$6,000 F
4,500 F
1,200 F

Since cost variances are favorable, have


job controlling
costs?
12,000
12,000

Fixed costs
we
done a good
Depreciation
Insurance

2,000

2,000

Total overhead costs

$ 89,000

$ 77,300

0
0
$11,700 F
1-6

Static Budgets and


Performance Reports
I dont think I can
answer this question
using a static budget.

I do know that
actual activity is below
budgeted activity which
is unfavorable.
But shouldnt variable costs
be lower if actual activity
is below budgeted activity?

1-7

Static Budgets and


Performance Reports

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.
1-8

Flexible Budgets
Central Concept

If you can tell me what your activity was


for the period, I will tell you what your costs
and revenue should have been.

1-9

Advantages of Flexible Budgets


Show revenues and expenses
that should have occurred at the
actual level of activity.
May be prepared for any activity
level in the relevant range.
Reveal variances due to good cost
control or lack of cost control.
Improve performance evaluation.

1-10

Learning
Objective
2

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Preparing a Flexible Budget

1-12

Preparing a Flexible Budget


Variable
Cost
Per Hour

Total
Fixed
Cost

Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs

Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000

10,000

12,000

4.00
3.00
0.50
7.50
$12,000
2,000

1-13

Preparing a Flexible Budget


Variable
Cost
Per Hour
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs

Total
Fixed
Cost

Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours

10,000
12,000
Variable8,000
costs are
expressed
as
a constant amount per hour.

4.00
3.00
0.50
7.50

$ 32,000
24,000
Fixed
4,000 costs are expressed as a
total amount that does not
$ 60,000

change within the relevant


range of activity.

$12,000
2,000

1-14

Preparing a Flexible Budget


Variable
Cost
Per Hour

Total
Fixed
Cost

Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs

Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000

4.00
3.00
0.50
7.50

10,000

12,000

$ 32,000
24,000
4,000
$ 60,000
$12,000
2,000

$ 12,000
2,000
$ 14,000
$ 74,000
1-15

Preparing a Flexible Budget


Variable
Cost
Per Hour

Total
Fixed
Cost

Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs

4.00
3.00
0.50
7.50
$12,000
2,000

Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000

10,000

12,000

$ 32,000
24,000
4,000
$ 60,000

$ 40,000
30,000
5,000
$ 75,000

$ 48,000
36,000
6,000
$ 90,000

$ 12,000
2,000
$ 14,000
$ 74,000

$ 12,000
2,000
$ 14,000
$ 89,000

$ 12,000
2,000
$ 14,000
$ 104,000
1-16

Preparing a Flexible Budget


Variable
Cost
Per Hour

Total
Fixed
Cost

Machine hours
Variable costs
IndirectThere
labor is no
Note:
material
inIndirect
the
fixed
costs.
Power
Total variable cost
$
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs

4.00
flex
3.00
0.50
7.50
$12,000
2,000

Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000

10,000

12,000

$ 32,000
24,000
4,000
$ 60,000

$ 40,000
30,000
5,000
$ 75,000

$ 48,000
36,000
6,000
$ 90,000

$ 12,000
2,000
$ 14,000
$ 74,000

$ 12,000
2,000
$ 14,000
$ 89,000

$ 12,000
2,000
$ 14,000
$ 104,000
1-17

Preparing a Flexible Budget


Variable
Cost
Per Hour

Total
Fixed
Cost

Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours

Machine hours

8,000

10,000

12,000

Total budgeted
Variable costs
Indirect labor
4.00
$ 32,000
overhead cost
Indirect material
3.00
24,000
Power
0.50
Budgeted variable
Total 4,000
Total variable
cost cost
$ per
7.50
$ 60,000
overhead
activity

$ 40,000
30,000
5,000
Budgeted
$ 75,000

$ 48,000
36,000
6,000
fixed
$ 90,000

Fixed costsactivity unit


Depreciation
Insurance
Total fixed cost
Total overhead costs

units

$12,000
2,000

$ 12,000
2,000
$ 14,000
$ 74,000

overhead cost
$ 12,000
2,000
$ 14,000
$ 89,000

$ 12,000
2,000
$ 14,000
$ 104,000
1-18

Flexible Budget
Performance Report

1-19

Flexible Budget
Performance Report
Variable
Cost
Per Hour

Total
Fixed
Costs

Machine hours
Variable costs
Indirect labor
$
Indirect material
Power
Total variable costs $
Fixed Expenses
Depreciation
Insurance
Total fixed costs
Total overhead costs

Flexible
Budget

Actual
Results
8,000

4.00
3.00
0.50
7.50

Variances
0

$ 34,000
25,500
3,800
$ 63,300
$12,000
2,000

$ 12,000
2,000
$ 14,000
$ 77,300

1-20

Flexible Budget
Performance Report
Total
FlexibleVariable
budget
is
Cost
Fixed
prepared
Per for
HourtheCosts
same activity level
Machine hours
(8,000 hours) as
Variable costs
actually$achieved.
Indirect labor
4.00
Indirect material
Power
Total variable costs $
Fixed Expenses
Depreciation
Insurance
Total fixed costs
Total overhead costs

3.00
0.50
7.50
$12,000
2,000

Flexible
Budget

Actual
Results

8,000

8,000

Variances
0

$ 34,000
25,500
3,800
$ 63,300
$ 12,000
2,000
$ 14,000
$ 77,300

1-21

Flexible Budget
Performance Report
Variable
Cost
Per Hour

Total
Fixed
Costs

Machine hours
Variable costs
Indirect labor
$
Indirect material
Power
Total variable costs $
Fixed Expenses
Depreciation
Insurance
Total fixed costs
Total overhead costs

4.00
3.00
0.50
7.50
$12,000
2,000

Flexible
Budget

Actual
Results

8,000

8,000

$ 32,000
24,000
4,000
$ 60,000

$ 34,000
25,500
3,800
$ 63,300

$ 2,000 U
1,500 U
200 F
$ 3,300 U

$ 12,000
2,000
$ 14,000
$ 74,000

$ 12,000
2,000
$ 14,000
$ 77,300

0
0
0
$ 3,300 U

Variances
0

1-22

Flexible Budget
Performance Report
Variable Total
Cost
Fixed
labor
and Costs
Per Hour

Indirect
indirect material have
Machine hours
unfavorable variances
Variable costs
because
costs
Indirect
labor actual
$ 4.00
are
more than3.00
the
Indirect
material
Power
flexible budget 0.50
costs.
Total variable costs $
Fixed Expenses
Depreciation
Insurance
Total fixed costs
Total overhead costs

7.50
$12,000
2,000

Flexible
Budget

Actual
Results

8,000

8,000

$ 32,000
24,000
4,000
$ 60,000

$ 34,000
25,500
3,800
$ 63,300

$ 2,000 U
1,500 U
200 F
$ 3,300 U

$ 12,000
2,000
$ 14,000
$ 74,000

$ 12,000
2,000
$ 14,000
$ 77,300

0
0
0
$ 3,300 U

Variances
0

1-23

Flexible Budget
Performance Report
Variable
Cost
Per Hour

Total
Fixed
Costs

Machine hours

Power has a favorable


Variable costs
variance because
the
Indirect labor
$ 4.00
actualmaterial
cost is less
than
Indirect
3.00
Power
0.50
the flexible budget
cost.
Total variable costs $
Fixed Expenses
Depreciation
Insurance
Total fixed costs
Total overhead costs

7.50
$12,000
2,000

Flexible
Budget

Actual
Results

8,000

8,000

$ 32,000
24,000
4,000
$ 60,000

$ 34,000
25,500
3,800
$ 63,300

$ 2,000 U
1,500 U
200 F
$ 3,300 U

$ 12,000
2,000
$ 14,000
$ 74,000

$ 12,000
2,000
$ 14,000
$ 77,300

0
0
0
$ 3,300 U

Variances
0

1-24

Learning
Objective
3

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Overhead Application in a
Standard Costing System
Normal Costing
Manufacturing Overhead
Actual
Applied
overhead
overhead:

Work-in-Process Inventory
Applied
overhead:

Actual hours
x
Predetermined
overhead rate
Difference lies in the
quantity of hours used.

Actual hours
x
Predetermined
overhead rate

Standard Costing
Manufacturing Overhead
Actual
Applied
overhead
overhead:
Standard
allowed hours
x
Predetermined
overhead rate

Work-in-Process Inventory
Applied
overhead:
Standard
allowed hours
x
Predetermined
overhead rate

1-26

Overhead Application in a
Standard Costing System
Budgeted
Overhead

Planned
Monthly Activity

Predetermined
Overhead Rate

Variable . . . . . $. . 60,000 * . . . . . . . . . 8,000 machine hours . . . . . . . . .$ 7.50 per process hour


Fixed . . . . . . . . . 14,000 * . . . . . . . . . 8,000 machine hours . . . . . . . . . 1.75 per process hour
Total . . . . . . . .$. 74,000 . . . . . . . . .
8,000 machine hours . . . . . . . . .$ 9.25 per process hour
* From the flexible budget for planned activity of 8,000 machine hours

1-27

Learning
Objective
4

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Choice 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.
1-29

Learning
Objective
5

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Cost Management Using


Overhead Cost Variances
Lets turn our attention
to the computation of
overhead cost variances.
We will begin with
variable overhead.

1-31

Variable Overhead Variances


Actual
Variable
Overhead
Incurred

Flexible Budget
for Variable
Overhead at
Actual Hours

AH AR

AH
SVR

Spending
Variance
AH
AR
SVR
SH

Flexible Budget
for Variable
Overhead at
Standard Hours
SH
SVR

Efficiency
Variance

= Actual Hours of Activity


= Actual Variable Overhead Rate
= Standard Variable Overhead Rate
= Standard Hours Allowed
1-32

Variable Overhead Variances


Actual
Variable
Overhead
Incurred

Flexible Budget
for Variable
Overhead at
Actual Hours

AH AR

Spending
Variance

Flexible Budget
for Variable
Overhead at
Standard Hours

AH
SVR

SH
SVR

Efficiency
Variance

Spending variance = AH(AR - SVR)


Efficiency variance = SVR(AH - SH)

1-33

Variable Overhead Variances


Example
ColaCos 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.
1-34

Variable Overhead Variances


Example
ColaCo prepared this

budget for overhead:

Total budgeted
overhead cost
Budgeted variable
overhead cost per
activity unit

Total budgeted
overhead cost

Total
x activity
units

$2.00 per
machine
hour

=
+

Budgeted fixed
overhead cost

Total
machine
hours

$9,000

1-35

Variable Overhead Variances


Example
Actual
Variable
Overhead
Incurred

Flexible Budget
for Variable
Overhead at
Actual Hours
3,300 hours

$2.00 per hour

Flexible Budget
for Variable
Overhead at
Standard Hours
3,200 hours

$2.00 per hour

$6,740

$6,600

$6,400

Spending variance
$140 unfavorable

Efficiency variance
$200 unfavorable
1-36

Variable Overhead Variances


Example
Actual
Variable
Overhead
Incurred

Flexible Budget
for Variable
Overhead at
Actual Hours
3,300 hours

$2.00 per hour

Flexible Budget
for Variable
Overhead at
Standard Hours
3,200 hours

$2.00 per hour

$6,740

$6,600

$6,400

The $140 unfavorable spending variance and the $200


unfavorable efficiency variance result in a $340
unfavorable flexible budget variance.
1-37

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.

A function of the
selected cost driver.
It does not reflect
overhead control.

1-38

Fixed Overhead

Now lets turn


our attention to
fixed overhead.

1-39

Fixed Overhead Variances


Actual Fixed
Overhead
Incurred

Fixed
Overhead
Budget

Fixed
Overhead
Applied
SH
PFOHR

Budget
Variance

Volume
Variance

PFOHR = Predetermined Fixed Overhead Rate


SH = Standard Hours Allowed

1-40

Fixed Overhead
Recall that fixed overhead costs are applied
to products and services using a
predetermined fixed overhead rate
(PFOHR):
Applied Fixed Overhead = PFOHR Standard Hours

PFOHR

Budgeted Fixed Overhead


Planned Activity in Hours

1-41

Fixed Overhead Variances


Example
ColaCo used the following predetermined
fixed overhead rate:
=

Budgeted Fixed Overhead


Planned Activity in Hours

PFOHR

$9,000
3,000 machine hours

PFOHR

PFOHR

$3.00 per machine hour

1-42

Fixed Overhead Variances


Example
ColaCos actual production required 3,200
standard machine hours. Actual fixed
overhead was $8,450.
Compute the fixed overhead budget and
volume variances.

1-43

Fixed Overhead Variances


Example
Actual Fixed
Overhead
Incurred

Fixed
Overhead
Budget

Fixed
Overhead
Applied
3,200 hours

$3.00 per hour

$8,450

Budget variance
$550 favorable

$9,000

$9,600

Volume variance
$600 (neither favorable
nor unfavorable)
1-44

Fixed Overhead Variances


Lets look at a graph
showing fixed
overhead variances.
We will use ColaCos
numbers from the
previous example.
1-45

Fixed Overhead Variances


A Closer Look
Budget Variance

Volume Variance

Results from paying more


or less than expected for
overhead items.

Results from the inability


to operate at the activity
level planned for the period.
Has no significance for
cost control.

1-46

Fixed Overhead Variances


Cost
$600
Volume
Variance
$550
Favorable
Budget
Variance

3,200 machine hours $3.00 fixed overhead rate

$9,600 applied fixed OH

{ $9,000 budgeted fixed OH


{ $8,450
actual
fixed OH

3,000 Hours
Planned
Activity

Volume
3,200
Standard
Hours
1-47

Learning
Objective
6

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Overhead Cost Performance


Report
Variable costs:
Indirect material:
Wax
Plastic wrap
Paper products
Misc. supplies
Indirect labor:
Maintenance
Janitorial
Utilities:
Electricity
Natural gas
Water
Total variable cost

Fixed costs:
Indirect labor:
Inspection
Production supervisor
Set up
Depreciation:
Equipment
Insurance
Property taxes
Total fixed cost
Total overhead cost

1-49

Learning
Objective
7

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Activity-Based Flexible Budget


Variable
Cost
Per Hour

Total
Fixed
Cost

Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost

4.00
3.00
0.50
7.50

Fixed costs
Depreciation
$12,000
The
Cheese Co. flexible
Insurance
2,000
budget
is
based
on
a
single
Total fixed cost
costoverhead
driver,costs
machine hours
Total

Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000

10,000

12,000

$ 32,000
24,000
4,000
$ 60,000

$ 40,000
30,000
5,000
$ 75,000

$ 48,000
36,000
6,000
$ 90,000

$ 12,000
2,000
$ 14,000
$ 74,000

$ 12,000
2,000
$ 14,000
$ 89,000

$ 12,000
2,000
$ 14,000
$ 104,000
1-51

Activity-Based Flexible Budget


Variable
Cost
Per Hour
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost

4.00
3.00
0.50
7.50

Total
Fixed
Cost

Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000

10,000

12,000

$ 32,000
24,000
4,000
$ 60,000

$ 40,000
30,000
5,000
$ 75,000

$ 48,000
36,000
6,000
$ 90,000

If costs
different cost drivers are identified for the
Fixed
Depreciation
$ 12,000
$ 12,000
$ 12,000
different
variable costs,$12,000
an activity-based
flexible
Insurance
2,000
2,000
2,000
2,000
budget
should be prepared $with
different
cost$ 14,000
Total
fixed cost
14,000
$ 14,000
Total overhead
costs
$ 74,000 drivers.
$ 89,000
$ 104,000
formulas
based on the different
1-52

Learning
Objective
8

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Standard Costs and Product


Costing
Standard Costing
Manufacturing Overhead
Actual
Applied
overhead
overhead:
Standard
allowed hours
x
Predetermined
overhead rate

Work-in-Process Inventory
Applied
overhead:
Standard
allowed hours
x
Predetermined
overhead rate

1-54

Standard Costs and Product


Costing

Disposition of Variances
Manufacturing Overhead
Cost of Goods Sold
Actual
Applied
Balance (1)
Balance (2)
overhead
overhead:
Actual
Applied
Standard
overhead
overhead
allowed hours
greater than
greater than
x
Applied
Actual
Predetermined
overhead
overhead
overhead rate
Balance (1)
Balance (2)
Balance (2)
Balance (1)

1-55

Learning
Objective
9

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

A General Model for Variance


Analysis
Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance
Materials
price- SP)
variance
AQ(AP
Labor rate variance
AQ =Variable
Actual overhead
Quantity
AP = spending
Actual Price
variance

Standard Quantity

Standard Price

Quantity Variance
Materials
quantity
variance
SP(AQ
- SQ)
Labor efficiency variance
SP
= Standard
Price
Variable
overhead
SQ
= Standard
Quantity
efficiency
variance
1-57

A General Model for Variance


Analysis
Actual Sales Volume

Actual Sales Price

Actual Sales Volume

Budgeted Sales Price

Sales Price Variance


ASV(ASP - BSP)

ASV = Actual Sales Volume


ASP = Actual Sales Price

Budgeted Sales Volume

Budgeted Sales Price

Sales Volume Variance


BSP(ASV - BSV)

BSP = Budgeted Sales Price


BSV = Budgeted Sales Volume

1-58

End of Chapter 11
Im here to
your
budget. Are you ready to
ante up?

1-59