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Flexible Budgeting and the Management of Overhead and Support Activity Costs

11. Chapter Eleven. Flexible Budgeting and the Management of Overhead and Support Activity Costs. Flexible Budgets. Hmm! Comparing static budgets with actual costs is like comparing apples and oranges. Static budgets are prepared for a single, planned level of activity.

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Flexible Budgeting and the Management of Overhead and Support Activity Costs

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  1. 11 Chapter Eleven Flexible Budgeting and the Management of Overhead and Support Activity Costs

  2. Flexible Budgets Hmm! Comparingstatic budgetswith actual costsis like comparingapples 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.

  3. Flexible Budgets Hmm! Comparingstatic budgetswith actual costsis like comparingapples and oranges. Considerthe following example from the Cheese Company . . .

  4. U = Unfavorable varianceCheese Company wasunable to achieve thebudgeted level of activity. Static Budgets andPerformance Reports

  5. Static Budgets andPerformance Reports

  6. Static Budgets andPerformance Reports F = Favorable variance since actual costs are less than budgeted costs.

  7. Static Budgets andPerformance Reports Since cost variances are favorable, havewe done a good job controlling costs?

  8. I do know thatactual activity is belowbudgeted activity which is unfavorable. But shouldn’t variable costsbe lower if actual activityis below budgeted activity? Static Budgets andPerformance Reports I don’t think I can answer this question using a static budget.

  9. Static Budgets andPerformance 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.

  10. Flexible Budgets Central Concept If you can tell me what your activity wasfor the period, I will tell you what your costs and revenue should have been.

  11. Variable Fixed Preparing a Flexible Budget To a budget for different activity levels, we must know how costs behave with changes in activity levels. • Total variable costs changein direct proportion to changes in activity. • Total fixed costs remainunchanged within therelevant range.

  12. Advantages of Flexible Budgets Show revenues and expensesthat should have occurred at theactual 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.

  13. Preparing a Flexible Budget Let’s prepare budgets for the Cheese Company.

  14. Preparing a Flexible Budget

  15. Preparing a Flexible Budget Using an input activity measureas units of output may not be meaningful in a multiproduct firm.

  16. Preparing a Flexible Budget Variable costs are expressed as a constant amount per hour. In the original static budget, indirect labor was $40,000 for 10,000 hours resulting in a rate of $4.00 per hour.

  17. Preparing a Flexible Budget Fixed costs are expressed as a total amount that does not change within the relevant range of activity.

  18. Preparing a Flexible Budget

  19. Preparing a Flexible Budget

  20. Preparing a Flexible Budget Note: There is no flexin the fixed costs.

  21. Total budgetedoverhead cost = Budgeted variable Total overhead cost per activity activity unit units Budgeted fixedoverhead cost × + Preparing a Flexible Budget

  22. Now let’s prepare a budget performance report at 8,000 actual machine hours for the Cheese Co. Flexible BudgetPerformance Report

  23. Flexible BudgetPerformance Report

  24. Original actual results for Cheese Company that we saw earlier. Flexible BudgetPerformance Report

  25. Flexible budget is prepared for thesame activity level (8,000 hours) as actually achieved. Flexible BudgetPerformance Report

  26. Flexible BudgetPerformance Report

  27. Indirect labor and indirect material have unfavorable variances because actual costs are more than the flexible budget costs. Flexible BudgetPerformance Report

  28. Power has a favorable variance because the actual cost is less than the flexible budget cost. Flexible BudgetPerformance Report

  29. 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. Choice of Activity Measure

  30. Let’s turn our attentionto the computation of overhead cost variances. We will begin withvariable overhead. Cost Management Using Overhead Cost Variances

  31. 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 Variance EfficiencyVariance AH = Actual Hours of Activity AR = Actual Variable Overhead RateSVR = Standard Variable Overhead RateSH = Standard Hours Allowed

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

  33. 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. Compute the variable overhead spending and efficiency variances.

  34. Total budgetedoverhead cost = Budgeted variable Total overhead cost per activity activity unit units Budgeted fixedoverhead cost × + $2.00 permachine hour Totalmachine hours Total budgetedoverhead cost = × + $9,000 Variable Overhead Variances – Example ColaCo prepared this budget for overhead:

  35. Spending variance$140 unfavorable Efficiency variance$200 unfavorable 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

  36. 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 The $140 unfavorable spending variance and the $200 unfavorable efficiency variance result in a $340 unfavorable flexible budget variance.

  37. Spending Variance Efficiency Variance Variable Overhead Variances – A Closer Look Results from paying moreor less than expected foroverhead items and from excessive usage ofoverhead items. A function of the selected cost driver. It does not reflectoverhead control.

  38. Fixed Overhead Now let’s turn our attention to fixed overhead.

  39. Fixed Overhead Variances Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied SH × PFOHR Budget Variance VolumeVariance PFOHR = Predetermined Fixed Overhead Rate SH = Standard Hours Allowed

  40. Budgeted Fixed OverheadPlanned Activity in Hours 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 =

  41. Budgeted Fixed OverheadPlanned Activity in Hours PFOHR = $9,0003,000 machine hours PFOHR = PFOHR = $3.00 per machine hour Fixed Overhead Variances – Example ColaCo used the following predeterminedfixed overhead rate:

  42. Fixed Overhead Variances – Example ColaCo’s actual production required 3,200 standard machine hours. Actual fixed overhead was $8,450. Compute the fixed overhead budget and volume variances.

  43. Budget variance$550 favorable Volume variance$600 (neither favorable nor unfavorable) Fixed Overhead Variances – Example Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied 3,200 hours × $3.00 per hour $8,450 $9,000 $9,600

  44. Budget Variance Volume Variance Fixed Overhead Variances –A Closer Look Results from paying moreor less than expected foroverhead items. Results from the inabilityto operate at the activitylevel planned for the period. Has no significance for cost control.

  45. Fixed Overhead Variances Let’s look at a graph showing fixed overhead variances. We will use ColaCo’s numbers from the previous example.

  46. 3,200 machine hours × $3.00 fixed overhead rate $9,600 applied fixed OH $600Volume Variance { $9,000 budgeted fixed OH { $550FavorableBudget Variance $8,450 actual fixed OH Fixed Overhead Variances Cost Fixed overhead applied to products Volume 3,000 Hours PlannedActivity 3,200 StandardHours

  47. The Cheese Co. flexible budget is based on a single cost driver, machine hours Activity-Based Flexible Budget

  48. Activity-Based Flexible Budget If different cost drivers are identified for the different variable costs, an activity-based flexible budget should be prepared with different costformulas based on the different drivers.

  49. End of Chapter 11 I’m here to your budget. Are you ready to ante up?

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