Chapter 11

Flexible Budget and Overhead

Analysis–A Tool for Cost
Control and Performance
Evaluation
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 Introduction

The purpose of the control

function in management is to make
sure that the goals of the
organization are being attained.
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 Static Budgets

A static budget is prepared for only one level of a given type of activity.

All actual results are compared with the original budgeted amounts,
even if sales volume is more or less than originally planned.

A static budget is prepared at beginning of the

Budgeting period and is valid for only the
Planned level of activity.A static budget is sjitable
For planning but is inappropriate for evaluation how well
Cost are controlled.
 Flexible Budget
•Flexible budget is a projection of budget data for various levels of
activity. A flexible budget makes it easy to estimate what costs should
be for any level of activity within a specified range.
•Flexible budget take into account how changes in activity affect
costs. When a flexible budget is used in performance evaluation,
actual costs are compared to what the costs should have been for the
actual level of activity during the period rather than to the budgeted
cost from the original budget. This is a very important distinction-
particularly for variable cost. If adjustment for the level of activity are
not made, it is very difficult to interpret discrepencies between
budgeted and actual costs.
 Flexible Budget Formulas

The flexible budget is based on the same

assumptions of revenue and cost behavior
(within the relevant range) as is the master budget.

The flexible budget incorporates effects on each

cost and revenue caused by changes in activity.
 Overhead Analysis

Variance Analysis
•At the end of the an accounting period, managers use the
budget as a control tool by comparing budgeted sales,
budgeted production, and budgeted manufacturing costs with
actual sales, production, and manufacturing costs.
•Variance analysis allows managers to see whether sales,
production, and manufacturing costs are higher or lower than
planned, and WHY actual sales, production, and costs differ
from those budgeted.

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 Flexible Budgeting with Standard Costs

Comparison of Budget to Actual

Static Flexible Actual
Units sold 1,500 1,600 1,600
Units produced 1,500 1,600 1,600
Sales revenue $375,000 $400,000 $396,800
Variable manufacturing costs 172,500 184,000 189,200
Variable selling & administrative 37,500 40,000 40,800
Contribution margin $165,000 $176,000 $166,800
Fixed manufacturing costs 15,000 15,000 16,000
Fixed selling & administrative 18,000 18,000 16,000
Operating income $132,000 $143,000 $134,800
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 Sales Volume Variance
Sales Volume Variance =
(Actual – Budgeted Sales Volume)
X
(Budgeted Contribution Margin Per Unit)
For Corrine’s:
$11,000 = (1,600 – 1,500) x $110
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 Sales Volume Variance
Static Budget Sales Vol Var Flexible Budget
Units sold 1,500 1,600
Units produced 1,500 1,600
Sales revenue $375,000 $25,000 $400,000
Variable manufacturing costs 172,000 11,500 184,000
Variable selling & administrative 37,500 2,500 40,000
Contribution margin $165,000 $11,000 $176,000
Fixed manufacturing costs 15,000 15,000
Fixed selling & administrative 18,000 18,000
Operating income $132,000 $11,000 $143,000
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 Flexible Budget Variance

The difference between the flexible budget

operating income and actual operating
income is called the flexible budget variance.
The flexible budget removes any differences
due to volume.

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 Flexible Budget Variance
Flexible Flexible Budget Actual
Budget Variance Results
Units sold 1,600 1,600
Avg. sales price per unit $250 $248
Sales revenue $400,000 $(3,200) $396,800
Variable manufacturing costs 184,000 5,200 189,200
Variable selling & administrative 40,000 800 40,800
Contribution margin $176,000 $(9.200) $166,800
Fixed manufacturing costs 15,000 1,000 16,000
Fixed selling & administrative 18,000 (2,000) 16,000
Operating income $143,000 $(8,200) $134,800 11
 Sales Price Variance

Sales Price Variance =

(Actual - Expected Sales Price)
x
Actual volume
$3,200 = ($248 - $250) x 1,600
Why?
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 Variance Analysis
Basic Variance Analysis Model
SQ x SP
AQ x AP Flexible
Actual Cost AQ x SP Budget
Amount

AQ (AP - SP) SP (AQ - SQ)

Price Variance Usage Variance

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 Direct Material Variances
SQ = 20 ft./unit x 1,600 chairs

AQ x AP AQ x SP SQ x SP
33,600 x $1.90 = 33,600 x $2.00 = 32,000 x $2.00 =
$63,840 $67,200 $64,000
Price Usage
33,600 ($1.90 - $2.00) $2.00 (33,600 - 32,000)
$3,360 F $3,200 U

Total Direct Material Variance = $3,360 F + $3,200 U = $160 F

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 Direct Material Variances When Quantity
Purchased Differs from Quantity Used

AQ X AP AQ X SP AQ X SP SQ X SP
35,000 X $1.90 35,000 X $2.00 33,600 X $2.00 32,000 X $2.00
$66,500 $70,000 $67,200 $64,000

$3,500 F $3,200 U
Price Variance Usage Variance

The model above is used when quantities purchased are not the same
as quantities used.

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 Direct Labor Variances
SH = 1,600 chairs X 5 hrs/chair

AH X AR AH X SR SH X SR
8,400 X $12.10 8,400 X $12.00 8,000 X $12.00
$101,640 $100,800 $96,000

$840 U $4,800 U
Rate Variance Efficiency Variance

Total Direct Labor Variance = $840 U + $4,800 U = $5,640 U

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 Multiple Choice p. 391 1-8

1. B.
2. C.
3. & 4. Flexible budget Actual Variance
Sales (6,000 x $30) $180,000 $180,000 ---
Direct material 12,600 12,900 300 U
[(6,000 x 1.4 lbs) x $1.5] (given)

Direct labor 189,000 178,350 10,650 F

[(6,000 x 3) x $10.5] (given)

Net loss $(21,600) $(11,250) $10,350F

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 Multiple Choice p. 391 1-8

5. SVV = Sales volume variance

SVV = (Actual – Budgeted sales volume) x (Budgeted contribution margin/unit)
SVV = (10,500 – 11,000) x ($14.75 - $3 - $9)
SVV = $1,375
6. SPV = Sales price variance
SPV = (Actual – Expected sales price) x Actual volume
SPV = ($14.75 - $14.75) x 10,500
SPV = $0
7. Direct material price variance = AQpurchased x (AP- SP)
= 22,000 x ($1.54 - $1.50) = $880 U

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 Multiple Choice p. 391 1-8

8. Direct material usage variance = SP x (AQused - SQ)

= $1.50 x (22,000 - 21,000) = $1,500 U

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 Variable Overhead Variances
Actual Variable AH X SVR SH X SVR
Overhead Expense 8,400 X $3.00 8,000 X $3.00
$23,720 $25,200 $24,000

Spending Variance Efficiency Variance

$1,480 F $1,200 U

Total Variable Overhead Variance = $1,480 F + $1,200 U = $280 F

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Variable Overhead Variances

The variable overhead efficiency

variance does not measure the efficient
use of overhead but rather the efficient
use of the cost driver, or overhead
allocation base, used in the flexible
budget.
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 Fixed Overhead Variances
Budget Variance: the difference between the
amount of fixed overhead actually incurred
and the flexible budget amount (also called
spending variance).
Volume Variance: the difference between the
flexible budget amount and the amount of
fixed overhead applied to products.

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 Fixed Overhead Variances

Actual Fixed Budgeted Applied

Overhead Expense Fixed Overhead Fixed Overhead
$16,000 $15,000 $16,000
$1,000 U $1,000
Spending Variance Volume Variance

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Fixed Overhead Variances

The fixed overhead volume variance

should not be interpreted as favorable
or unfavorable, or as a measure of the
efficient utilization of facilities.

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Overhead Variance Analysis Using
Activity-Based Costing

The advantages of variance analysis

for overhead costs are enhanced in
companies using Activity-Based
Costing (ABC)

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 Variance Analysis

Variance analysis is most effective in

stable companies with mature
production environments and has a
number of drawbacks when used in
many modern manufacturing
environments.
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 Variance Analysis

“Favorable” and “unfavorable”

variances should not necessarily be
interpreted as “good” or “bad.”

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Interpreting and Using Variance Analysis

An unfavorable direct material usage

variance generally points to a problem in
production.

However, further analysis might reveal that

usage was high because of an unusual
number of defective parts, and the large
number of defective parts was a result of the
purchasing manager buying materials of
inferior quality.

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 Behavioral Considerations

Standards Costs and Variance Analysis can

be very useful for control and performance
evaluations, or they can cause dysfunctional
behavior among employees and
management.

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 End of Chapter 11

How’s your budget?

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