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Flexible Budgets and Overhead Analysis

Flexible Budgets and Overhead Analysis. Chapter Eleven. Hmm! Comparing static budgets with actual costs is like comparing apples and oranges. Static Budgets and Performance Reports. Static budgets are prepared for a single, planned level of activity.

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Flexible Budgets and Overhead Analysis

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  1. Flexible Budgets and Overhead Analysis Chapter Eleven

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

  3. May be prepared for any activity level in 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. Let’s look at CheeseCo. Flexible Budgets

  4. Static Budgets and Performance Reports CheeseCo

  5. Static Budgets and Performance Reports CheeseCo

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

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

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

  9. 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? Static Budgets and Performance Reports

  10. 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.

  11. Preparing a Flexible Budget Let’s prepare budgets for CheeseCo.

  12. 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. Preparing a Flexible Budget CheeseCo

  13. $4.00 per hour × 8,000 hours = $32,000 Preparing a Flexible Budget CheeseCo

  14. Preparing a Flexible Budget CheeseCo

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

  16. Preparing a Flexible Budget

  17. Flexible Budget Performance Report Let’s prepare abudget performance report for CheeseCo.

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

  19. Flexible Budget Performance Report CheeseCo

  20. Flexible Budget Performance Report CheeseCo

  21. Flexible Budget Performance Report Remember the question: “How much of the total variance is due to lower activity and how much isdue to cost control?”

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

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

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

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

  26. 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 overheadefficiency variance.

  27. 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)

  28. 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= $140 unfavorable

  29. Spending Variance Variable Overhead Variances –A Closer Look 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.

  30. 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)

  31. 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

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

  33. 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

  34. 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 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

  35. 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

  36. 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

  37. 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

  38. Overhead Rates and Overhead Analysis Recall that overhead costs are assigned to products and services using apredetermined overhead rate (POHR): Assigned Overhead = POHR × Standard Activity Overhead from theflexible budget for thedenominator level of activity POHR = Denominator level of activity

  39. Overhead Rates and Overhead Analysis The predetermined overhead ratecan be broken down into fixedand variable components. The variablecomponent is usefulfor preparing and analyzingvariable overheadvariances. The fixedcomponent is usefulfor preparing and analyzingfixed overheadvariances.

  40. In a standard costsystem, overhead isapplied to work inprocess based onthe standard hoursallowed for the outputof the period. Normal versus Standard Cost Systems In a normal costsystem, overhead isapplied to work inprocess based onthe actual numberof hours workedin the period.

  41. Fixed Overhead Variances Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied DH × FR SH × FR Budget Variance VolumeVariance FR = Standard Fixed Overhead RateSH = Standard Hours AllowedDH = Denominator Hours

  42. Overhead Rates and OverheadAnalysis – Example ColaCo prepared this budget for overhead: Let’s calculate overhead rates. ColaCo applies overhead basedon machine-hour activity.

  43. The total POHR is the sum ofthe fixed and variable ratesfor a given activity level. Overhead Rates and OverheadAnalysis – Example ColaCo prepared this budget for overhead:

  44. Fixed Overhead Variances – Example ColaCo’s actual production required 3,200standard machine hours. Actual fixed overhead was $8,450. The predetermined overhead rate is based on 3,000 machine hours.

  45. Overhead Variances Now let’s turn our attention to calculatingfixed overhead variances.

  46. Fixed Overhead Variances – Example Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied $8,450 $9,000 Budget variance$550 favorable

  47. Budget Variance Fixed Overhead Variances –A Closer Look Results from spendingmore or less thanexpected for fixedoverhead items. Now, let’s use the standard hours allowed to compute the fixed overhead volume variance.

  48. Fixed Overhead Variances – Example Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied SH × FR 3,200 hours × $3.00 per hour $8,450 $9,000 $9,600 Budget variance$550 favorable Volume variance$600 favorable

  49. VolumeVariance Results when standard hoursallowed for actual output differsfrom the denominator activity. Unfavorablewhen standard hours< denominator hours Favorablewhen standard hours> denominator hours Volume Variance – A Closer Look

  50. Quick Check  Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the budget variance? a. $350 U b. $350 F c. $100 F d. $100 U

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