Flexible Budgets and Overhead Analysis
Chapter
9
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Static Budgets and Performance Reports
Hmm! Comparingstatic budgets withactual costs is likecomparing apples
and oranges.
Let’s look at CheeseCo.
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.
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Static ActualBudget 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 Budgets and Performance Reports
CheeseCo
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Static ActualBudget Results Variances
Machine hours 10,000 8,000 2,000 U
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 Budgets and Performance Reports
U = Unfavorable variance CheeseCo was unable to achieve
the budgeted level of activity.
CheeseCo
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Static ActualBudget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 Power 5,000 3,800
Fixed costs Depreciation 12,000 12,000 Insurance 2,000 2,050
Total overhead costs 89,000$ 77,350$
Static Budgets and Performance Reports
CheeseCo
F = Favorable variance
Actual cost is less than budgeted cost.
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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$ $11,650 F
Static Budgets and Performance Reports
CheeseCo
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Static ActualBudget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs Ind irect labor 40,000$ 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$ $11,650 F
Static Budgets and Performance Reports
Since cost variances are favorable, havewe done a good job controlling costs?
CheeseCo
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Static Budgets and Performance Reports
I don’t think Ican answer thequestion usinga static budget.
Actual activity is belowbudgeted activity.
So, shouldn’t variable costsbe lower if actual activity
is lower?
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The relevant question is . . .
“How much of the favorable cost variance isdue to lower activity, and how much is due to good cost control?”
To answer the question,we mustthe budget to theactual level of activity.
Static Budgets and Performance Reports
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Flexible Budgets
Improve performance evaluation.
May be prepared for any activity level in the relevant range.
Show revenues and expensesthat should have occurred at theactual level of activity.
Reveal variances due to good costcontrol or lack of cost control.
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Flexible Budgets
Central Concept
If you can tell me what your activity wasfor the period, I will tell you what your costs
and revenue should have been.
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Preparing a Flexible Budget
To a budget we need to know that:Total variable costs change
in direct proportion to changes in activity.
Total fixed costs remainunchanged within therelevant range. Fixed
Variable
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Preparing a Flexible Budget
Let’s prepare budgets for CheeseCo.
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Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ 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
Preparing a Flexible Budget
Fixed costs areexpressed as atotal amount.
Variable costs are expressed as a constant amount per hour.
$40,000 ÷ 10,000 hours is$4.00 per hour.
CheeseCo
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Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ 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
Preparing a Flexible Budget
$4.00 per hour × 8,000 hours = $32,000
CheeseCo
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Preparing a Flexible Budget
Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ Indirect material 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$
Fixed costs Depreciation 12,000$ 12,000$ Insurance 2,000 2,000 Total fixed cost 14,000$ Total overhead costs 74,000$ ?
CheeseCo
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Quick Check What should be the total overhead costs for the
Flexible Budget at 10,000 hours?
a. $92,500.
b. $74,000.
c. $89,000.
d. $94,000.
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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. $104,000.
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Let’s prepare a budget performance report for CheeseCo.
Flexible BudgetPerformance Report
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Cost TotalFormula Fixed Flexible ActualPer Hour Costs Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs Indirect labor 4.00$ 34,000$ Indirect material 3.00 25,500 Power 0.50 3,800 Total variable costs 7.50$ 63,300$ Fixed Expenses Depreciation 12,000$ 12,000$ Insurance 2,000 2,050 Total fixed costs 14,050$ Total overhead costs 77,350$
Flexible BudgetPerformance Report
Flexible budget is prepared for the
same activity level (8,000 hours) as
actually achieved.
CheeseCo
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Cost TotalFormula Fixed Flexible ActualPer Hour Costs Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs Indirect labor 4.00$ 34,000$ Indirect material 3.00 25,500 Power 0.50 3,800 Total variable costs 7.50$ 63,300$ Fixed Expenses Depreciation 12,000$ 12,000$ Insurance 2,000 2,050 Total fixed costs 14,050$ Total overhead costs 77,350$
Flexible BudgetPerformance Report
CheeseCo
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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
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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
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Quick Check What is the variance for depreciation when the
flexible budget for 8,000 hours is compared to the actual results?
a. $0
b. $1,000 F
c. $2,000 U
d. $2,000 F
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Remember the question: “How much of the total variance is due to activityand how much is due tocost control?”
Flexible BudgetPerformance Report
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Static ActualBudget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs Ind irect labor 40,000$ 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
Static Budgets and Performance How much of the $11,650 is due to activity
and how much is due to cost control?
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Flexible BudgetPerformance Report
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.
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Flexible BudgetPerformance Report
This $15,000F variance is due to lower activity.
Overhead Variance Analysis
Activity
This $3,350U flexiblebudget variance is dueto poor cost control.
Cost control
Static Flexible ActualOverhead Overhead OverheadBudget at Budget at at
10,000 Hours 8,000 Hours 8,000 Hours
89,000$ 74,000$ 77,350$
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Flexible BudgetPerformance Report
What causesthe cost
control variance?
There are two primaryreasons for unfavorablevariable overhead variances:
1. Spending too much for resources.
2. Using the resources inefficiently.
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Overhead Rates and Overhead Analysis
Overhead from theflexible budget for the
denominator level of activityPOHR =
Recall that overhead costs are assigned to products and services using a
predetermined overhead rate (POHR):
Assigned Overhead = POHR × Standard Activity
Denominator level of activity
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Overhead Rates and Overhead Analysis – Example
Let’s look at overhead
rates in a
budget for ColaCo.
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ColaCo prepared this budget for overhead:
Overhead Rates and Overhead Analysis – Example
Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
2,000 4,000$ ? 9,000$ ?
4,000 8,000 ? 9,000 ?
ColaCo applies overhead basedon machine hour activity.
ColaCo applies overhead basedon machine hour activity.
Let’s calculate overhead rates.
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Overhead Rates and Overhead Analysis – Example
Rate = Total Variable Overhead ÷ Machine Hours
ColaCo prepared this budget for overhead:
This rate is constant at all levels of activity.
Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
2,000 4,000$ 2.00$ 9,000$ ?
4,000 8,000 2.00 9,000 ?
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Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
2,000 4,000$ 2.00$ 9,000$ 4.50$
4,000 8,000 2.00 9,000 2.25
Overhead Rates and Overhead Analysis – Example
Rate = Total Fixed Overhead ÷ Machine Hours
ColaCo prepared this budget for overhead:
This rate decreases when activity increases.
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Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
2,000 4,000$ 2.00$ 9,000$ 4.50$
4,000 8,000 2.00 9,000 2.25
Overhead Rates and Overhead Analysis – Example
The total POHR is the sum ofthe fixed and variable ratesfor a given activity level.
ColaCo prepared this budget for overhead:
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Overhead Variances
Let’s use the overhead rates, to determine variable and fixed overhead
variances.
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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.
Variable Overhead Variances – Example
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Variable Overhead Variances
AH × SR
AH × AR
Spending variance = AH(AR - SR)
Efficiency variance = SR(AH - SH)
SH × SR
Spending Variance
EfficiencyVariance
Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
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3,300 hours 3,200 hours × × $2.00 per hour $2.00 per hour
Variable Overhead Variances – Example
Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
$6,740 $6,600 $6,400
Spending variance$140 unfavorable
Efficiency variance$200 unfavorable
$340 unfavorable flexible budget total variance$340 unfavorable flexible budget total variance
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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
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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. $250 U
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Variable Overhead Variances – A Closer Look
Spending Variance Efficiency Variance
Results from paying moreor less than expected foroverhead items and from
excessive usage ofoverhead items.
Controlled bymanaging the
overhead cost driver.
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Overhead Variances
Now let’s turn our attention
to fixed overhead.
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Overhead Rates and Overhead Analysis – Example
ColaCo prepared this budget for overhead:
What is ColaCo’s fixed overhead rate for an estimated activity of 3,000 machine hours?
Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
2,000 4,000$ 2.00$ 9,000$ 4.50$
4,000 8,000 2.00 9,000 2.25
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Overhead Rates and Overhead Analysis – Example
ColaCo prepared this budget for overhead:
What is ColaCo’s fixed overhead rate for an estimated activity of 3,000 machine hours? Fixed Overhead Rate
FR = $9,000 ÷ 3,000 machine hours FR = $3.00 per machine hour
Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
2,000 4,000$ 2.00$ 9,000$ 4.50$
4,000 8,000 2.00 9,000 2.25
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ColaCo’s actual production required 3,200 standard machine hours. Actual fixed overhead
was $8,450.
Compute the fixed overhead budget and volume variances.
Fixed Overhead Variances – Example
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Fixed Overhead Variances
Budget Variance
VolumeVariance
FR = Standard Fixed Overhead RateSH = Standard Hours Allowed
SH × FR
Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
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3,200 hours × $3.00 per hour
Budget variance$550 favorable
Fixed Overhead Variances – Example
$8,450 $9,000 $9,600
Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
Volume variance$600 favorable
SH × FR
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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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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 volume variance?
a. $250 U
b. $250 F
c. $100 F
d. $100 U
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Fixed Overhead Variances –A Closer Look
Budget Variance Volume Variance
Results from paying moreor less than expected for
overhead items.
Results from operatingat an activity leveldifferent from the
denominator activity.
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Overhead Variances
Let’s look at a graph showing fixed overhead
variances. We will use ColaCo’s
numbers from the previous example.
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Fixed Overhead Variances
Volume
Cost
$9,000 budgeted fixed OH
3,000 Hours ExpectedActivity
Fixed overhead
applied to products
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{
Fixed Overhead Variances
$8,450 actual fixed OH
Volume
Cost
3,000 Hours ExpectedActivity
$9,000 budgeted fixed OH
Fixed overhead
applied to products
$550Favorable
Budget Variance
{ $8,450 actual fixed OH
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{
Fixed Overhead Variances
$8,450 actual fixed OH
3,200 machine hours × $3.00 fixed overhead rate
$600FavorableVolume
Variance
$9,600 applied fixed OH
3,200 Standard
Hours
Volume
Cost
3,000 Hours ExpectedActivity
$9,000 budgeted fixed OH
Fixed overhead
applied to products
{
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{
Fixed Overhead Variances
$8,450 actual fixed OH
3,200 machine hours × $3.00 fixed overhead rate
$600FavorableVolume
Variance
$9,600 applied fixed OH
3,200 Standard
Hours
Volume
Cost
3,000 Hours ExpectedActivity
$9,000 budgeted fixed OH
Fixed overhead
applied to products
{$550
FavorableBudget
Variance
{ $8,450 actual fixed OH
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Results when standard hoursallowed for actual output differsfrom the denominator activity.
Volume Variance – A Closer Look
VolumeVariance
Favorablewhen standard hours> denominator hours
Unfavorablewhen standard hours< denominator hours
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Results when standard hoursallowed for actual output differsfrom the denominator activity.
Volume Variance – A Closer Look
VolumeVariance
Favorablewhen standard hours> denominator hours
Unfavorablewhen standard hours< denominator hours
Does not measure over- or under spending
Occurs only because actualactivity differs from the
denominator activity
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Overhead Variances and Under- or Overapplied Overhead Cost
Favorablevariances are equivalentto overapplied overhead.
Unfavorablevariances are equivalent
to underapplied overhead.
In a standardcost system:
The sum of the overhead variancesequals the under- or overapplied
overhead cost for a period.