Flexible Budgets, Overhead Cost Management, and Activity-Based Budgeting

1. 17 Flexible Budgets,Overhead Cost Management, andActivity-Based Budgeting

2. Learning Objective 1

3. Based ononly oneactivitylevel. Includes severalpossible activitylevels. Flexible Overhead Budget A flexible budget is a budget that is valid for a relevant range of activity. It is not based on only one level of activity as we have seen with the static budget.

4. After preparing a flexible budget, the manager obtained the following information about cost control at 4,500 machine hours. Advantages of Flexible Budgets A manager is faced with the following information from the static budget for June when the level of activity was 4,500 machine hours. Was there good control of electric costs?

5. Activity Measure: Based on Input or Output? The number of units of output usually is not a meaningful measure in a multiproduct firm because it requires the addition of numbers of dissimilar products. Output should be measured in terms of the standard input allowed given actual output.

6. Total budgetedmonthly overhead cost Budgeted variableoverhead cost peractivity unit Totalactivityunits Budgeted fixedoverhead costper month = × + Formula Flexible Budget

7. Learning Objective 2

8. $2.15 × 6,000 = $12,900 Flexible Overhead Budget Illustrated

9. Flexible Overhead Budget Illustrated

10. Flexible Overhead Budget Illustrated $24,360 + $16,550 = $40,910

11. The difference lies in the quantity of hours used Flexible Overhead Budget Illustrated Normal costing Standard costing Manufacturing Overhead Manufacturing Overhead ActualOverhead AppliedOverhead ActualOverhead AppliedOverhead Actualactivity Standardallowed activity × × Predeterminedoverhead rate Predeterminedoverhead rate

12. Learning Objective 3

13. Overhead Application in a Standard-Costing System • In a normal-costing system, overhead is applied based on the actual amount of resources used (e.g., labor hours, machine hours). • In a standard-costing system, the standard amount of resources forms the basis of application. • Since the application rate would be the same in both cases, the difference between them lies in the quantity of resources that is recorded. Standard costing = Standard quantity * application rate Normal costing = Actual quantity used * application rate

14. Learning Objective 4

15. Choice of Activity Measure • The activity measure should be one that varies in a similar pattern to the way that variable overhead varies. • As automation increases, many companies are using measures such as machine hours or process time for their flexible overhead budget. • Dollar measures are subject to price-level changes and fluctuate more than physical measures.

16. Learning Objective 5

17. Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate Overhead Cost Variances Variable-Overhead Variances AH × AR AH × SR SH × SR Variable-overheadspending variance Variable-overheadefficiency variance

18. Variable-Overhead Variances Matrix Inc. has the following variable manufacturing overhead standard tomanufacture one tent: 1.5 standard hours per tent at $13.00 perdirect labor hour Last week 1,550 hours were worked to make 1,000 tents, and $20,460 was spent forvariable manufacturing overhead.

19. Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,550×$13.20 1,550×$13.00 1,500×$13.00 $20,460 $20,150 $19,500 $310 Unfavorable $650 Unfavorable Variable-overheadspending variance Variable-overheadefficiency variance Overhead Cost Variances Variable-Overhead Variances AH × AR AH × SR SH × SR

20. Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate $20,460 actual overhead costs1,550 actual hours Overhead Cost Variances Variable-Overhead Variances AH × AR AH × SR SH × SR 1,550×$13.20 1,550×$13.00 1,500×$13.00 $20,460 $20,150 $19,500 $310 Unfavorable $650 Unfavorable Variable-overheadspending variance Variable-overheadefficiency variance

21. Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,000 tents × 1.5 hours Overhead Cost Variances Variable-Overhead Variances AH × AR AH × SR SH × SR 1,550×$13.20 1,550×$13.00 1,500×$13.00 $20,460 $20,150 $19,500 $310 Unfavorable $650 Unfavorable Variable-overheadspending variance Variable-overheadefficiency variance

22. What Does the Efficiency Variance Reveal? Variable-overhead efficiency variance did not result from using more of the variable-overhead items than the standard allowed amount.

23. What Does the Spending Variance Reveal? An unfavorable spending variance simply means that the total actual cost of variable overhead is higher than expected after adjusting for the actual quantity of activity used.

24. Fixed-overheadbudget variance Actual fixed-overhead _ Budgeted fixed-overhead = Fixed-overheadvolume variance Budgeted fixed-overhead _ Applied fixed-overhead = Predetermined fixed-overhead rate Standard hoursallowed × Fixed-Overhead Variances

25. Matrix, Inc. prepared this flexible budget for overhead: Total Variable Budgeted Fixed Machine 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 Fixed-Overhead Variances The company’s actual fixed overhead for the period was $8,450, and it operated at a standard 3,200 machine hours. Matrix budgeted 3,000 machine hours during the period.

26. Fixed-overheadbudget variance Actual fixed-overhead _ Budgeted fixed-overhead = Fixed-Overhead Budget Variance _ $550 Favorable $8,450 $9,000 = Budget Variance Results from paying more or less than expected for overhead items.

27. Fixed-overheadvolume variance Budgeted fixed-overhead _ Applied fixed-overhead = $9,000 Budgeted cost ÷ 3,000 Budgeted hours Fixed-Overhead Variances 3,200 hours×$3.00 per hour=$9,600 Volume VarianceResults from operating at an activity level different from the denominator activity. _ $9,000 $600 Favorable=

28. Fixed Overhead Variances Cost $9,000 budgeted fixed OH $550FavorableBudget Variance { $8,450 actual fixed OH Fixed overhead applied to products Volume 3,000 Hours ExpectedActivity

29. Fixed Overhead Variances Cost $9,600 applied fixed OH $600FavorableVolume Variance { $9,000 budgeted fixed OH Fixed overhead applied to products Volume 3,000 Hours ExpectedActivity 3,200 StandardHours

30. VolumeVariance Capacity Utilization Results when standard hoursallowed for actual output differsfrom the denominator activity. Unfavorablewhen standard hours< denominator hours Favorablewhen standard hours> denominator hours

31. Variable-overheadspendingvariance Fixed-overheadbudgetvariance Variable-overheadefficiencyvariance Fixed-overheadvolumevariance $1,680 U $2,500 U $1,800 U $7,500 U Combinedspendingvariance $4,180 U $1,800 U $7,500 U Combinedbudgetvariance $5,980 U $7,500 U Underapplied overhead $13,480 U Several Types of Analyses

32. Learning Objective 6

33. = Unfavorable variance $19,200 - $19,350 = $ 150$18,000 - $19,200 = $1,200 Overhead Cost Performance Report

34. Overhead Cost Performance Report $1,680 + $1,800 + $2,500 = $5,980 unfavorable$57,000 - $62,980 = $5,980 unfavorable

35. Learning Objective 7

36. Standard Costs in Product Costing In a standardcost system: Unfavorablevariances are equivalentto underapplied overhead. Favorablevariances are equivalentto overapplied overhead. The sum of the overhead variancesequals the under- or overappliedoverhead cost for a period.

37. $5,500 $5,500 Disposition of Variances Manufacturing Overhead Cost of Goods Sold ActualOverhead AppliedOverhead $50,000 $44,500 $5,500 An alternative accounting treatment is to prorate underapplied or overapplied overhead among Work-in-Process Inventory, Finished-Goods Inventory, and Cost of Goods Sold.

38. Learning Objective 8

39. $18,000 ÷ 4,500 units = $4.00 per unit $5,000 ÷ 10 runs = $500 per run Activity-Based Flexible Budget

40. How Does ABC Affect Performance Reporting? The activity-based flexible budget provides a more accurate benchmark against which to compare actual costs.

41. Standard Costing in A JIT Environment A just-in-time manufacturing setting minimizes inventories. Some companies have simplified their accounting system by charging all manufacturing costs directly to Cost of Goods Sold.

42. Learning Objective 9

43. Proration of Cost Variances • Generally, variances for direct and indirect costs are closed at the end of each period to the Cost of goods sold account. • Logically, though, those variances are also related to the ending inventories of Materials, Work-in-process and Finished goods. • The Cost Accounting Standards Board, which publishes rules for government contractors, requires that part of any cost variance be assigned to the related inventories. Example: The company purchased $5,000 of direct materials, of which 30% remained in inventory. If there is an unfavorable materials price variance of $250, we add $75 to Materials inventory.

44. Learning Objective 10

45. Standard Costing in a Just-in-Time Environment • Businesses with a JIT management philosophy try to minimize their inventories. • They simplify their accounting by charging purchases immediately to Cost of goods sold. • Then, if any inventory exists at the end of the period, its cost is recorded and part of the Cost of goods sold is reduced. • This method is known as backflush costing. JIT Backflush costing

46. Learning Objective 11

47. Sales Variance Analysis • Sales are also subject to deviation from plans. • The two most common types of analysis focus on (1) sales revenue and (2) contribution margin. • Once again the variance measures the difference between budgeted and actual amounts. But now a variance is favorable if actual exceeds budget. • Sales variances can be further divided into (1) sales-price and (2) revenue sales-volume variances. • Additional analyses can be carried out on (1) revenue sales-mix, (2) revenue sales-quantity, (3) revenue market-size and (4) revenue market-share variances.

48. End of Chapter 17