Flexible Budget, Overhead Cost Variances and Management Control Lecture 18 1 Readings Chapter 8,Cost Accounting, Managerial Emphasis, 14 th edition by

Chapter 8Flexible Budget,

Overhead Cost Variances and Management Control

Lecture 18

1

ReadingsChapter 8,Cost Accounting, Managerial Emphasis, 14th edition by HorengrenChapter 11, Managerial Accounting 12th edition by Garrison, Noreen, BrewerChapter 11, Managerial Accounting 6th edition by Weygandt, kimmel, kieso

Learning ObjectivesPrepare a flexible budget and explain the advantages of the

flexible budget approach over the static budget approach.Prepare a performance report for both variable and fixed

overhead costs using the flexible budget approach.Use a flexible budget to prepare a variable overhead

performance report containing onlya spending variance

Use a flexible budget to prepare a variable overhead performance report containing both a spending and an efficiency variance.

Compute the predetermined overhead rate and apply overhead to products in a standard cost system.

Compute and interpret the fixed overhead budget and volume variances.

Planning and OverheadVariable Overhead: as efficiently as possible,

plan only essential activitiesFixed Overhead: as efficiently as possible,

plan only essential activities, especially since fixed costs are predetermined well before the budget period begins

Standard CostingTraces direct costs to output by multiplying

the standard prices or rate by the standard quantities of inputs allowed for actual outputs produced

Allocates overhead costs on the basis of the standard overhead-cost rates time the standard quantities of the allocation bases allowed for the actual outputs produced

A Roadmap: Variable OverheadActual Costs

Incurred:Actual Input

XActual Rate

Flexible Budget:Budgeted Input

Allowed forActual Output

XBudgeted Rate

Actual InputsX

Budgeted Rate

Allocated:Budgeted

Input Allowed forActual Output

XBudgeted Rate

SpendingVariance

EfficiencyVariance

Never aVariance

Never aVariance

Flexible-BudgetVariance

Total Variable Overhead VarianceOver/Under Allocated Variable Overhead

A Roadmap: Fixed OverheadActual Costs

Incurred

Flexible Budget:Same Budgeted Lump Sum (as in

Static Budget)Regardless of Output Level

Same BudgetedLump Sum(as in Static

Budget)Regardless of Output Level

Allocated:Budgeted

Input Allowed forActual Output

XBudgeted Rate

SpendingVariance

Flexible-BudgetVariance

Total Fixed Overhead VarianceOver/Under Allocated Fixed Overhead

Never aVariance

Production-Volume

Variance

Production-Volume

Variance

Overhead VariancesOverhead is the most difficult cost to

manage, and is the least understoodOverhead variances involve taking

differences between equations as the analysis moves back and forth between actual results and budgeted amounts

Developing Budgeted Variable Overhead Cost Rates1. Choose the period to be used for the

budget2. Select the cost-allocation bases to use in

allocating variable overhead costs to output produced

3. Identify the variable overhead costs associated with each cost-allocation base

4. Compute the rate per unit of each cost-allocation base used to allocate variable overhead costs to output produced

The Details: Variable OH VariancesVariable Overhead Flexible-Budget

Variance measures the difference between actual variable overhead costs incurred and flexible-budget variable overhead amounts

Variable Overhead Actual Costs Flexible-budgetflexible-budget variance Incurred amount= -

The Details: Variable OH VariancesVariable Overhead Efficiency Variance is

the difference between actual quantity of the cost-allocation base used and budgeted quantity of the cost per unit of the cost-allocation base

Variable Actual quantity of Budgeted quantity of Budgeted variableOverhead variable overhead variable overhead cost- overhead costEfficiency cost-allocation base allocation based allowed per unit ofVariance used for actual output for actual output cost-allocation base

} X= { -

The Details: Variable OH VariancesVariable Overhead Spending Variance is

the difference between actual and budgeted variable overhead cost per unit of the cost-allocation base, multiplied by actual quantity of variable overhead cost-allocation based used for actual output

Variable Actual variable Budgeted variable Actual quantity ofOverhead overhead cost overhead cost variable overheadSpending per unit of per unit of cost-allocation baseVariance cost-allocation base cost-allocation base used for actual output

{ }- X=

Developing Budgeted Fixed Overhead Cost Rates1. Choose the period to be used for the

budget2. Select the cost-allocation bases to use in

allocating fixed overhead costs to output produced

3. Identify the fixed overhead costs associated with each cost-allocation base

4. Compute the rate per unit of each cost-allocation base used to allocate fixed overhead costs to output produced

The Details: Fixed OH VariancesFixed Overhead Flexible-Budget Variance is

the difference between actual fixed overhead costs and fixed overhead costs in the flexible budget

This is the same amount for the Fixed Overhead Spending Variance

Fixed Overhead Actual Costs Flexible-budgetflexible-budget variance Incurred amount= -

The Details: Fixed OH VariancesProduction-Volume Variance is the difference

between budgeted fixed overhead and fixed overhead allocated on the basis of actual output produced

This variance is also known as the Denominator-Level Variance or the Output-Level Overhead Variance

Production-Volume Budgeted Fixed Overhead allocated usingVariance Fixed Overhead budgeted input allowed for

actual output units produced

= -

Production-Volume VarianceInterpretation of this variance is difficult due to

the nature of the costs involved and how they are budgeted

Fixed costs are by definition somewhat inflexible. While market conditions may cause production to flex up or down, the associated fixed costs remain the same

Fixed costs may be set years in advance, and may be difficult to change quickly

Contradiction: Despite this, examination of the fixed overhead budget formulae reveals that it is budgeted similar to a variable cost

Variable Overhead Variance Analysis Illustrated

Fixed Overhead Variance Analysis Illustrated

Fixed Overhead Behavior

Integrated Variance Analysis Illustrated

20

Static Budgets and Performance Reports

Static budgetsare prepared fora single, plannedlevel of activity.

Performance evaluation is difficult when actual activity

differs from the planned level of

activity.

Hmm! Comparingstatic budgets withactual costs is likecomparing apples

and oranges.

Flexible Budgets

Improve performance evaluation.

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.

Let’s look at CheeseCo.

CheeseCoStatic Actual

Budget Results Variances

Machine hours 10,000

Variable costs Indirect labor 40,000$ Indirect materials 30,000 Power 5,000

Fixed costs Depreciation 12,000 Insurance 2,000

Total overhead costs 89,000$


CheeseCoStatic Actual

Budget Results Variances

Machine hours 10,000 8,000

Variable costs Indirect labor 40,000$ 34,000$ Indirect materials 30,000 25,500 Power 5,000 3,800

Fixed costs Depreciation 12,000 12,000 Insurance 2,000 2,050

Total overhead costs 89,000$ 77,350$


Static ActualBudget Results Variances

Machine hours 10,000 8,000 2,000 U

Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F

Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,050 50 U

Total overhead costs 89,000$ 77,350$ $11,650 F

U = Unfavorable variance CheeseCo was unable to achieve

the budgeted level of activity.

CheeseCo



Machine hours 10,000 8,000 2,000 U




CheeseCo

F = Favorable variance that occurs when actual costs are less than budgeted costs.



Machine hours 10,000 8,000 2,000 U




Since cost variances are favorable, havewe done a good job controlling costs?

CheeseCo


I don’t think Ican answer thequestion usinga static budget.

Actual activity is belowbudgeted activity.

So, shouldn’t variable costsbe lower if actual activity

is lower?


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.

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.


Preparing a Flexible Budget To a budget we need to know that:

Total variable costs changein direct proportion to changes in activity.

Total fixed costs remainunchanged within therelevant range.

FixedVaria

ble

Preparing a Flexible Budget

Let’s prepare budgets for CheeseCo.

Cost Total Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours

Machine hours 8,000 10,000 12,000

Variable costs Indirect labor 4.00$ Indirect material 3.00 Power 0.50 Total variable cost 7.50$

Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs

Flexible Budgets


Fixed costs areexpressed as atotal amount.

Variable costs are expressed as a constant amount per hour.

$40,000 ÷ 10,000 hours is$4.00 per hour.

CheeseCo


Machine hours 8,000 10,000 12,000

Variable costs Indirect labor 4.00$ 32,000$ Indirect material 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$

Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs

Flexible Budgets


$4.00 per hour × 8,000 hours = $32,000

CheeseCo

Preparing a Flexible BudgetCheeseCo


Machine hours 8,000 10,000 12,000


Fixed costs Depreciation 12,000$ 12,000$ Insurance 2,000 2,000 Total fixed cost 14,000$ Total overhead costs 74,000$

Flexible Budgets


Machine hours 8,000 10,000 12,000

Variable costs Indirect labor 4.00$ 32,000$ 40,000$ Indirect material 3.00 24,000 30,000 Power 0.50 4,000 5,000 Total variable cost 7.50$ 60,000$ 75,000$

Fixed costs Depreciation 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ ?

Flexible Budgets


Total fixed costsdo not change in

the relevant range.

CheeseCo

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.




Quick Check

Total overhead cost

= $14,000 + $7.50 per hour 12,000 hours

= $14,000 + $90,000 = $104,000



Machine hours 8,000 10,000 12,000

Variable costs Indirect labor 4.00$ 32,000$ 40,000$ 48,000$ Indirect material 3.00 24,000 30,000 36,000 Power 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$

Flexible Budgets

Let’s prepare a budget performance report for CheeseCo.

Flexible Budget Performance Report

Cost Total Formula Fixed Flexible Actualper Hour Cost Budget Results Variances

Machine hours 8,000 8,000 0



CheeseCoFlexible budget is prepared for the

same activity level (8,000 hours) as

actually achieved.


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 Ub. $2,000 Fc. $6,000 Ud. $6,000 F




Quick Check

Cost Total Formula Fixed Flexible Actualper Hour Cost Budget Results Variances


Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 25,500 Power 0.50 3,800 Total variable cost 7.50$ 63,300$


CheeseCo


Quick Check What is the variance for indirect material

when the flexible budget for 8,000 hours is compared to the actual results?a. $1,500 Ub. $1,500 Fc. $4,500 Ud. $4,500 F

What is the variance for indirect material when the flexible budget for 8,000 hours is compared to the actual results?a. $1,500 Ub. $1,500 Fc. $4,500 Ud. $4,500 F



Quick Check

Cost Total

Formula Fixed Flexible Actualper Hour Cost Budget Results Variances


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 FTotal variable cost 7.50$ 60,000$ 63,300$ $ 3,300 U

Fixed costs Depreciation 12,000$ 12,000$ 12,000$ $ 0 Insurance 2,000 2,000 2,050 50 UTotal fixed cost 14,000$ 14,050$ 50 UTotal overhead costs 74,000$ 77,350$ $ 3,350 U

CheeseCo


47

Remember the question: “How much of the total variance is due to lower activity and how much isdue to cost control?”



Machine hours 10,000 8,000 2,000 U




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?

Difference between original static budgetand actual overhead = $11,650 F.

Overhead Variance Analysis

Static ActualOverhead OverheadBudget at at

10,000 Hours 8,000 Hours

89,000$ 77,350$

Let’s place the flexible budget for

8,000 hours here.


Overhead Variance Analysis

This $15,000F variance is due to lower activity.

Activity

This $3,350Uvariance is due

to poor cost control.

Cost control

Static Flexible ActualOverhead Overhead OverheadBudget at Budget at at

10,000 Hours 8,000 Hours 8,000 Hours

89,000$ 74,000$ 77,350$


The Measure of Activity– A Critical Choice

Three importantfactors in selecting an

activity base for an overheadflexible budget

Activity base andvariable overhead

should becausally related.

Activity base andvariable overhead

should becausally related.

Activity base shouldnot be expressed

in dollars orother currency.

Activity base shouldnot be expressed

in dollars orother currency.

Activity base shouldbe simple and

easily understood.

Activity base shouldbe simple and

easily understood.

End of Lecture 18

Documents

Flexible Budget, Overhead Cost Variances and Management Control Lecture 18 1 Readings Chapter 8,Cost Accounting, Managerial Emphasis, 14 th edition by