Flexible Budgeting and overhead Variance

1. Flexible Budgeting and overhead Variance By Ghanendra Fago (C) Ghanendra Fago (M Phil, MBA)

2. Meaning and definitions • A budget prepared at different level of activities is a flexible budget • Flexible budget will furnish the budgeted figures for any level of activity, which a company may actually attain. • It reflects costs, revenues and profits at the various level of budgeted activity. • A flexible budget as a budget designed to change in accordance with the level of activity actually attained. • Also called a variable budget, step budget, sliding-scale budget, expense-formula budget, dynamic budget and expense control budget. (C) Ghanendra Fago (M Phil, MBA)

3. Contd. • Master budget is static or fixed budgets, which forecast revenues and expenses for one level of sales and production. • A flexible budget is a summary of anticipated costs for a range of activity levels, geared to changes in product output. (C) Ghanendra Fago (M Phil, MBA)

4. Characteristics Of Flexible Budget • It covers a range of activity. • It provides a dynamic basis for comparison with the actual results because it is automatically matched to change in activities. • It can be changed according to actual production level. • It facilitates performance measurement and evaluation. • These are based upon adequate knowledge of cost behaviour pattern. (C) Ghanendra Fago (M Phil, MBA)

5. Use of Flexible Budget • Where the level of activity during the year varies from period to period, either due to the seasonal nature of the industry or to variation in demand. • Where the business is a new one and it is difficult to foresee the demand. • The level of activity depends upon the availability of a factor of production such as materials, labor, plant capacity etc. • Where an industry is influenced by changes in fashion. • Where there are general changes in sales. • Where the business units keep or introducing new product or make changes in the design of its products frequently. • Where the industries are engaged in make to order business like ship-building. (C) Ghanendra Fago (M Phil, MBA)

6. Needs of Flexible Budgeting • Helps to obtain detailed information of cost, sales, output and profit at different level of operation, useful for analysis. • Makes possible the comparison of actual performance and budgeted one for actual level of operation in a very easy and understanding way. • Helps to attain the objective of cost reduction and better cost control. • Helps to estimate the profit and cost of the products such as luxury goods, fashionable goods or soft drinks, whose production and sales are uncertain. • Helps to present a monthly report based upon comparative analysis of budgeted and actual cost at given level of operation. • Helps to measure the capacity utilization of plant or labour force, in term of level of activity. • Helps on planning the expenditure of responsible centres, who care responsible for tactical profit plan. • Helps to develop the labour oriented business sector, where labour are scare. • Helps in taking localized decision, identifying the possible factors affection the cost and profit. (C) Ghanendra Fago (M Phil, MBA)

7. Classification Of Costs Fixed Cost: Fixed costs remain constant within the given range of activity in spite of change in volume of production. The unit fixed cost per unit decreases as the level of production increases within the volume. They are the period cost and capacity, should be incurred for a period of time. Variable Cost: Those costs which increase directly and proportionately with the level of activity are called variable costs. Total cost increases or decreases towards the direction of production or sales units. Where as the variable cost per unit will remain constant, if other thing remaining the same. Semi-variable Cost (Mixed Cost): Composition of fixed and variable cost is the mixed cost or semi variable cost. Such costs increase with the level of activity, but by intermittent jumps than continuously. In other words the cost does not change proportionately with the level of output. (C) Ghanendra Fago (M Phil, MBA)

8. Methods for flexible budgeting • Formula Approach • Columnar or Tabular Approach • Graphical Approach (C) Ghanendra Fago (M Phil, MBA)

9. Formula Approach • Fixed cost and the variable cost per unit are found out • BA = FC + (UVC * Q) where, BA= Budget Allowance FC= Fixed Cost UVC= Unit Variable Cost Q = Output level, i.e. labour hour, machine hour, or units produced (C) Ghanendra Fago (M Phil, MBA)

10. Example: Variable Cost = Difference in Cost / Difference in activity level = Rs. (800,000 – 500,000)/(100,000-50,000) = Rs. 300,000/50,000 = Rs.6 Fixed Cost = Total Cost – Variable Cost * Level of activity = Rs. 500,000 – Rs.6 * 50,000 = Rs.(500,000 – 300,000) = Rs. 200,000 (C) Ghanendra Fago (M Phil, MBA)

11. contd… Therefore, the required formula is: BA = 200,000 + 6Q So using the formula the required budget for 60,000 labor hours would be: BA = Rs. 200,000 + (Rs. 6 * 60,000) = Rs. (200,000 + 360,000) = Rs. 560,000 (C) Ghanendra Fago (M Phil, MBA)

12. (C) Ghanendra Fago (M Phil, MBA)

13. Columnar or Tabular Approach • Example: Cost of output levels of 10,000 units in a factory are as follows: (C) Ghanendra Fago (M Phil, MBA)

14. Preparation of Flexible Budget (C) Ghanendra Fago (M Phil, MBA)

15. Manufacturing Overhead Variance The total manufacturing overhead variance is equal to the difference between the actual manufacturing overhead costs incurred and the standard manufacturing overhead costs applied to production (C) Ghanendra Fago (M Phil, MBA)

16. Types Of Overhead Variance • Capacity or volume variance • Spending variance • Efficiency variance (C) Ghanendra Fago (M Phil, MBA)

17. Calculation of Overhead Variance (C) Ghanendra Fago (M Phil, MBA)

18. Variances • Capacity variance (a-b)=Overhead Applied-Budget Allowance for Standard Level of Activities (SLA) • Efficiency variance(b-c)=Budget Allowance for Actual Level of Activities (ALA)- Actual Overhead Incurred • Spending variance (c-d)=Budget Allowance for Standard Level of Activities (SLA)- Budget Allowance for Actual Level of Activities (ALA) (C) Ghanendra Fago (M Phil, MBA)

19. The following are the data relating to overhead expenses of a company: BA = Rs.400,000 + Rs.5 x DLH Normal capacity 100,000DLH Standard time per unit of output 2 DLH Actual output 52,000 units Actual hours worked 98,000 DLH Actual overheads paid Rs.865,500 Required: The three overhead variances (C) Ghanendra Fago (M Phil, MBA)

20. Solution (C) Ghanendra Fago (M Phil, MBA)

21. Variances Capacity Variance (a-b) = Rs.(936,000-920,000) = Rs.16,000(F) Efficiency Variance (b-c) = Rs.(920,000-890,000) = Rs.30,000(F) Spending Variance (s-d) = Rs.(890,000-865,500) = Rs.24,500(F) (C) Ghanendra Fago (M Phil, MBA)