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1. Overhead Budgets • Most companies use flexible budgets to control overhead costs. • A flexible budget is not based on only one level of activity but is valid for the firm’s relevant range of activity. • The flexible budget provides the correct basis for comparison between actual and expected costs. • The flexible overhead budget is based on a standard input measure (e.g. machine hours)

2. Flexible Budget Formula • The relationship between activity and total budgeted overhead is given by: Budgeted variable-overhead cost per activity unit Budgeted fixed-overhead cost per month Total budgeted monthly overhead cost Total activity units + = *

3. Standard Costing System • In a standard costing system, overhead application is based on standard hours allowed, given actual output. • The Manufacturing Overhead account is credited and the Work-In-Process Inventory is debited by the following amount: • Standard allowed hours X Predetermined (Standard) rate

4. Variable-Overhead Spending Variance • Variable-overhead spending variance = • Actual variable overhead - (AH x SVR) or • (AH x AVR) - (AH x SVR) • AH x (AVR - SVR) Notation: AH = actual machine hours AVR = actual variable-overhead rate = actual variable overhead AH SVR = standard variable-overhead rate

5. Variable-Overhead Efficiency Variance • Variable-Overhead Efficiency Variance = • (AH x SVR) - (SH x SVR) • SVR x (AH - SH) Notation: AH = actual machine hours SH = standard machine hours SVR = standard variable-overhead rate

6. Variance Analysis for Managerial ControlVariable Overhead Actual Costs Incurred (a) Flexible Budget based on Actual Output (b) Expected Costs based on Actual Output (c) AQ * AR AQ * SR SQA * SR Variable-Overhead Spending Variance (b-a) Variable-Overhead Efficiency Variance (c-b) AQ(SR - AR) SR(SQA - AQ) Variable-Overhead Budget Variance (c-a) (SQA * SR) - (AQ * AR)

7. Interpreting Variable Variance • The variable-overhead efficiency variance simply reflects an adjustment in the managerial accountant’s expectation about variable overhead cost. • It does not indicate inefficient use of variable-overhead. • An unfavorable variable-overhead spending variance simply means that the total actual cost of variable overhead is greater than expected. • The spending variance is the real control variance for variable overhead. The spending variance can alert managers if variable overhead costs are exceeding expectations.