Flexible Budgets and Overhead Analysis

1. Flexible Budgets and Overhead Analysis Chapter Eleven

2. Learning Objectives After studying this chapter, you should be able to: 1. Prepare a flexible budget and explain the need for the flexible budget approach. • Prepare a performance report for both variable and fixed overhead costs using the flexible budget approach. • Prepare a variable overhead performance report.

3. Learning Objectives After studying this chapter, you should be able to: • Explain the significance of the denominator activity figure in determining the standard cost of a unit of product. • Apply overhead cost to units of product in a standard cost system. • Compute and interpret the fixed overhead budget and volume variances.

4. 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.

5. 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

6. Static Budgets and Performance Reports CheeseCo

7. Static Budgets and Performance Reports CheeseCo

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

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

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

11. 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

12. 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.

13. Preparing a Flexible Budget To a budget we need to know that: • Total variablecosts changein direct proportion to changes in activity. • Total fixedcosts remainunchanged within therelevant range. Variable Fixed

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

15. 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

16. $4.00 per hour × 8,000 hours = $32,000 Preparing a Flexible Budget CheeseCo

17. Preparing a Flexible Budget CheeseCo

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

19. 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.

20. 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. Total overhead cost = $14,000 + $7.50 per hour  12,000 hours = $14,000 + $90,000 = $104,000

21. Preparing a Flexible Budget

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

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

24. Quick Check  What is the variance for indirect labour 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

25. Quick Check  What is the variance for indirect labour 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

26. Flexible Budget Performance Report CheeseCo

27. 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 U b. $1,500 F c. $4,500 U d. $4,500 F

28. 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 U b. $1,500 F c. $4,500 U d. $4,500 F

29. Flexible Budget Performance Report CheeseCo

30. 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?”

31. 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

32. 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.

33. 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

34. Activity base andvariable overheadshould becausally related. Activity base shouldbe simple andeasily understood. Activity base shouldnot be expressedin dollars orother currency. The Measure of Activity– A Critical Choice Three importantfactors in selecting anactivity base for an overheadflexible budget

35. 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

36. 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.

37. 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)

38. 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

39. 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.

40. 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)

41. 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

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

43. Quick Check  Yoder Enterprises’ actual production for the period required 2,100 standard direct labour hours. Actual variable overhead for the period was $10,950. Actual direct labour hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labour hour. What was the spending variance? a. $450 U b. $450 F c. $700 F d. $700 U

44. Quick Check  Yoder Enterprises’ actual production for the period required 2,100 standard direct labour hours. Actual variable overhead for the period was $10,950. Actual direct labour hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labour 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

45. Quick Check  Yoder Enterprises’ actual production for the period required 2,100 standard direct labour hours. Actual variable overhead for the period was $10,950. Actual direct labour hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labour hour. What was the efficiency variance? a. $450 U b. $450 F c. $250 F d. $250 U

46. Quick Check  Yoder Enterprises’ actual production for the period required 2,100 standard direct labour hours. Actual variable overhead for the period was $10,950. Actual direct labour hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labour 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

47. 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

48. Activity-based Costingand the Flexible Budget It is unlikely that allvariable overhead will bedriven by a single activity. Activity-based costingcan be used when multipleactivity bases drivevariable overhead costs.

49. 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

50. 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.