Flexible Budgets and Overhead Analysis

1. Flexible Budgets and Overhead Analysis

2. Learning Objective LO1 To prepare a flexible budget andexplain the advantages ofthe flexible budget approachover the static budgetapproach

3. Static Budgets and Performance Reports Static budgetsare prepared fora single, plannedlevelof activity. Hmm! Comparingstatic budgets withactual costs is likecomparing applesand oranges. Performance evaluation is difficult when actual activity differs from the planned level of activity.

4. Flexible Budgets May be prepared for any activity level within the relevant range. Show costs that should have beenincurred at the actual level ofactivity, enabling “apples to apples”cost comparisons. Reveal variances related tocost control. Improve performance evaluation. Flexible Budget Let’s look at a Specific Example.

5. Static Budgets and Performance Reports CheeseCo

6. Static Budgets and Performance Reports CheeseCo

7. Static Budgets and Performance Reports U = Unfavorable variance CheeseCo was unable to achieve the budgeted level of activity. CheeseCo

8. Static Budgets and Performance Reports CheeseCo F = Favorable variance that occurs when actual costs are less than budgeted costs.

9. Static Budgets and Performance Reports CheeseCo Since cost variances are favorable, havewe done a good job controlling costs?

10. Static Budgets and Performance Reports I don’t think Ican answer thequestion usinga static budget. Actual activity is belowbudgeted activity. So, shouldn’t variable costsbe lower if actual activityis lower?

11. 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 mustthe budget to theactual level of activity.

12. Learning Objective LO2 To prepare a performance reportfor both variable and fixedoverhead costs using theflexible budget approach

13. Preparing a Flexible Budget To a budget we need to know that: Total variablecosts changein direct proportion to changes in activity. Total fixedcosts remainunchanged within therelevant range. Variable Fixed

14. Preparing a Flexible Budget Give me a budget.

15. Preparing a Flexible Budget Variable costs are expressed as a constant amount per hour. $40,000 ÷ 10,000 hours is$4.00 per hour. Fixed costs areexpressed as atotal amount. CheeseCo

16. Preparing a Flexible Budget $4.00 per hour × 8,000 hours = $32,000 CheeseCo

17. Preparing a Flexible Budget CheeseCo

18. Preparing a Flexible Budget Total fixed costsdo not change inthe relevant range. CheeseCo

19. Quick Check  What should be the total overhead costs for the Flexible Budget at 12,000 hours? a. $92,500. b. $89,000. c. $106,800. d. $104,000.

20. Quick Check  What should be the total overhead costs for the Flexible Budget at 12,000 hours? a. $92,500. b. $89,000. c. $106,800. d. $104,000. Total overhead cost = $14,000 + $7.50 per hour  12,000 hours = $14,000 + $90,000 = $104,000

21. Preparing a Flexible Budget

22. Flexible Budget Performance Report Let’s use abudget for our performance report.

23. Flexible Budget Performance Report A flexible budget is prepared for thesame activity level (8,000 hours) as actually achieved. CheeseCo

24. 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

25. 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

26. Flexible Budget Performance Report CheeseCo

27. 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

28. 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

29. Flexible Budget Performance Report CheeseCo

30. Flexible Budget Performance Report Remember the question:“How much of the totalvariance is due to loweractivity and how muchis due to cost control?”

31. Static Budgets and Performance How much of the $11,650 favorable variance is due to lower activity and how much is due to cost control?

32. Flexible Budget Performance Report Difference between original static budgetand actual overhead = $11,650 F. Overhead Variance Analysis Let’s insert the flexible budget for 8,000 hours here.

33. Flexible Budget Performance Report Activity Cost control This $15,000F variance is due to lower activity. This $3,350Uvariance is dueto poor cost control. Overhead Variance Analysis

34. The Measure of Activity– A Critical Choice Activity base andvariable overheadshould becausally related. Activity base shouldbe simple andeasily understood. Activity base shouldnot be expressedin dollars orother currency. Three importantfactors in selecting anactivity base for an overheadflexible budget

35. Learning Objective LO3 To use a flexible budget to prepare a variable overhead performance report containing only a spending variance

36. Variable Overhead Variances –A Closer Look Only a spendingvariance can becomputed. Both spendingand efficiencyvariances can be computed. If flexible budgetis based onactual hours If flexible budgetis based onstandard hours

37. Variable Overhead Variances – Example 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. The standard variable overhead cost per machine hour is $2.00. Compute the variable overhead spending variance first using actual hours. Then use standard hours allowed to calculate the variable overhead efficiency variance.

38. Variable Overhead Variances Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours AH × AR AH × SR AH = Actual hoursAR = Actual variable overhead rateSR = Standard variable overhead rate Spending Variance Spending variance = AH(AR – SR)

39. Variable Overhead Variances – Example Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours 3,300 hours×$2.00 per hour= $6,600 $6,740 Spending Variance= $140unfavorable

40. Variable Overhead Variances –A Closer Look Spending Variance Results from paying moreor less than expected foroverhead items and from excessive usage ofoverhead items. Now, let’s use the standard hours allowed, along with the actual hours, to compute the efficiency variance.

41. Learning Objective LO4 To use a flexible budget to prepare a variable overhead performance report containing both a spending and an efficiency variance

42. 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 × SR SH × SR Spending Variance EfficiencyVariance Spending variance = AH(AR - SR) Efficiency variance = SR(AH - SH)

43. Variable Overhead Variances – Example Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours 3,300 hours 3,200 hours × × $2.00 per hour $2.00 per hour $6,740 $6,600 $6,400 Spending variance$140 unfavorable Efficiency variance$200 unfavorable $340 unfavorable flexible budget total variance

44. Variable Overhead Variances –A Closer Look Efficiency Variance Controlled bymanaging theoverhead cost driver.

45. Quick Check  Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the spending variance? a. $450 U b. $450 F c. $700 F d. $700 U

46. Quick Check  Spending variance = AH (AR - SR) = Actual variable overhead incurred – (AH  SR) = $10,950 – (2,050 hours  $5 per hour) = $10,950 – $10,250 = $700 U Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the spending variance? a. $450 U b. $450 F c. $700 F d. $700 U

47. Quick Check  Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the efficiency variance? a. $450 U b. $450 F c. $250 F d. $250 U

48. Quick Check  Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the efficiency variance? a. $450 U b. $450 F c. $250 F d. $250 U Efficiency variance = SR (AH – SH) = $5 per hour (2,050 hours – 2,100 hours) = $250 F

49. Quick Check Summary Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours 2,050 hours 2,100 hours × × $5 per hour $5 per hour $10,950 $10,500 $10,250 Spending variance$700 unfavorable Efficiency variance$250 favorable $450 unfavorable flexible budget total variance

50. Activity-based Costingand the Flexible Budget It is unlikely that allvariable overhead will bedriven by a single activity. Activity-based costingcan be used when multipleactivity bases drivevariable overhead costs.