Chapter 11

Ale Imran Siddiqi

 Chapter 11
Flexible Budgeting and
the Management of
Overhead and Support
Activity Costs

Ale Imran Siddiqi

 Flexible Budgets
Hmm! Comparing
static budgets
Static budgets are with actual costs
prepared for a single, is like comparing
planned level of activity. apples and oranges.
Performance evaluation
for overhead is difficult
when actual activity
differs from the planned
level of activity.

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 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.

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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.

11-5
 Preparing a Flexible Budget
Variable Total Flexible Budgets
Cost Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
IndirectThere
Note: labor is no 4.00
flex $ 32,000 $ 40,000 $ 48,000
Indirect material 3.00 24,000 30,000 36,000
inPower
the fixed costs. 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

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 Preparing a Flexible Budget
Variable Total Flexible Budgets
Cost Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Total budgeted
Indirect labor overhead cost
4.00 $ 32,000 = $ 40,000 $ 48,000
Indirect material 3.00 24,000 30,000 36,000
Power 0.50
Budgeted variable Total 4,000 5,000 6,000
Budgeted fixed
Total variable cost $ 7.50
× $ 60,000
+ $ 75,000
overhead cost
$ 90,000
overhead cost per
Fixed costs activity
Depreciation $12,000 $ 12,000 $ 12,000 $ 12,000
activity unit
Insurance units 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

11-7
 Flexible Budget
Performance Report
Variable Total
Cost 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 2,000 0
Total fixed costs $ 14,000 $ 14,000 0
Total overhead costs $ 74,000 $ 77,300 $ 3,300 U

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 Overhead Application in a
Standard Costing System
Normal Costing
Manufacturing Overhead Work-in-Process Inventory
Actual Applied Applied
overhead overhead: overhead:
Actual hours Actual hours
x x
Predetermined Predetermined
overhead rate overhead rate

Difference lies in the

quantity of hours used. Standard Costing
Manufacturing Overhead Work-in-Process Inventory
Actual Applied Applied
overhead overhead: overhead:
Standard Standard
allowed hours allowed hours
x x
Predetermined Predetermined
overhead rate overhead rate

11-9
 Overhead Application in a
Standard Costing System

Budgeted Planned Predetermined

Overhead Monthly Activity 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

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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.
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 Variable Overhead Variances
Actual Flexible Budget Flexible Budget
Variable for Variable for Variable
Overhead Overhead at Overhead at
Incurred Actual Hours Standard Hours
AH × AR AH × SVR SH × SVR

Spending Efficiency
Variance Variance
Spending variance = AH(AR - SVR)
Efficiency variance = SVR(AH - SH)

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Variable Overhead Variances – A
Closer Look
Spending Variance Efficiency Variance
Results from paying more A function of the
or less than expected for selected cost driver.
overhead items and from
It does not reflect
excessive usage of
overhead control.
overhead items.

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 Fixed Overhead Variances
Actual Fixed Fixed Fixed
Overhead Overhead Overhead
Incurred Budget Applied
SH × PFOHR

Budget Volume
Variance Variance
PFOHR = Predetermined Fixed Overhead Rate
SH = Standard Hours Allowed

11-14
 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

Budgeted Fixed Overhead

PFOHR =
Planned Activity in Hours

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Overhead Cost Performance
Report
Variable costs: Fixed costs:
Indirect material: Indirect labor:
Wax Inspection
Plastic wrap Production supervisor
Paper products Set up
Misc. supplies Depreciation:
Indirect labor: Equipment
Maintenance Insurance
Janitorial Property taxes
Utilities: Total fixed cost
Electricity Total overhead cost
Natural gas
Water
Total variable cost

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