Flexible Budgets and Overhead Analysis

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Flexible Budgets and Overhead Analysis
2
Static Budgets and Performance Reports
Hmm! Comparingstatic budgets withactual costs
is likecomparing applesand oranges.

• 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.

Lets look at CheeseCo.
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Static Budgets and Performance Reports
CheeseCo
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Static Budgets and Performance Reports
CheeseCo
U Unfavorable variance CheeseCo was unable to
achieve the budgeted level of activity.
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Static Budgets and Performance Reports
CheeseCo
F Favorable variance that occurs when actual
costs are less than budgeted costs.
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Static Budgets and Performance Reports
CheeseCo
Since cost variances are favorable, havewe done
a good job controlling costs?
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Static Budgets and Performance Reports
I dont think Ican answer thequestion usinga
static budget.
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Static Budgets and Performance Reports

• 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.

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Flexible Budgets
Show revenues and expensesthat should have
occurred at theactual level of activity.
May be prepared for any activity level in the
relevant range.
Reveal variances due to good cost control or lack
of cost control.
Improve performance evaluation.
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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 changein direct proportion
  to changes in activity.
• Total fixed costs remainunchanged within
  therelevant range.

Variable
Fixed
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Preparing a Flexible Budget
Lets prepare budgets
for CheeseCo.
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Preparing a Flexible Budget
CheeseCo
Cost
Total
Flexible Budgets
Formula
Fixed
8,000
10,000
12,000
Per Hour
Cost
Hours
Hours
Hours
Machine hours
8,000


10,000


12,000


Variable costs are expressed as a constant amount
per hour. 40,000 10,000 hours is4.00 per
hour.
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
Fixed costs areexpressed as atotal amount.
Depreciation
12,000


Insurance
2,000


Total fixed cost
Total overhead costs
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Preparing a Flexible Budget
CheeseCo
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Preparing a Flexible Budget
CheeseCo
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Preparing a Flexible Budget
CheeseCo
Total fixed costsdo not change inthe relevant
range.
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Flexible BudgetPerformance Report
Lets prepare a budget
performance report for CheeseCo.
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Flexible BudgetPerformance Report
CheeseCo
Cost
Total
Flexible budget is prepared for thesame activity
level (8,000 hours) as actually achieved.
Formula
Fixed
Flexible
Actual
Per Hour
Costs
Budget
Results
Variances
Machine hours
8,000


8,000


0
Variable costs
Indirect labor
4.00


32,000


34,000


Indirect material
3.00


24,000


25,500


Power
0.50


4,000


3,800


Total variable costs
7.50


60,000


63,300


Fixed Expenses
Depreciation
12,000


12,000


12,000


Insurance
2,000


2,000


2,050


Total fixed costs
14,000


14,050


Total overhead costs
74,000


77,350


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Flexible BudgetPerformance Report
CheeseCo
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Flexible BudgetPerformance Report
Remember the question How much of the total
variance is due to activityand how much is due
tocost control?
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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
Overhead Variance Analysis
Lets place the flexible budget for 8,000 hours
here.
Difference between original static budgetand
actual overhead 11,650 F.
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Flexible BudgetPerformance Report
Overhead Variance Analysis
Activity
Cost control
This 15,000F variance is due to lower activity.
This 3,350U flexiblebudget variance is dueto
poor cost control.
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Flexible BudgetPerformance Report
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Overhead Rates and Overhead Analysis

• Recall that overhead costs are assigned to
  products and services using a predetermined
  overhead rate (POHR)

Assigned Overhead POHR Standard Activity
Overhead from theflexible budget for
thedenominator level of activity
POHR
Denominator level of activity
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Overhead Rates and Overhead Analysis Example
Lets look at overhead rates in a budget for
ColaCo.
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Overhead Rates and Overhead Analysis Example

• ColaCo prepared this budget for
  overhead

Total
Variable
Total
Fixed
Machine
Variable
Overhead
Fixed
Overhead
Hours
Overhead
Rate
Overhead
Rate
2,000


4,000


?
9,000


?
4,000


8,000


?
9,000


?
Lets calculate overhead rates.
ColaCo applies overhead basedon machine hour
activity.
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Overhead Rates and Overhead Analysis Example

• ColaCo prepared this budget for
  overhead

Rate Total Variable Overhead Machine Hours
This rate is constant at all levels of activity.
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Overhead Rates and Overhead Analysis Example

• ColaCo prepared this budget for
  overhead

Rate Total Fixed Overhead Machine Hours
This rate decreases when activity increases.
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Overhead Rates and Overhead Analysis Example

• ColaCo prepared this budget for
  overhead

The total POHR is the sum ofthe fixed and
variable ratesfor a given activity level.
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Overhead Variances
Lets use the overhead rates, to determine
variable and fixed overhead variances.
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Variable Overhead Variances Example

• ColaCos 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.

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Variable Overhead Variances
Actual Flexible Budget
Flexible Budget Variable
for Variable for Variable
Overhead Overhead at
Overhead at Incurred
Actual Hours
Standard Hours
AH SR
AH AR
SH SR
Spending Variance
EfficiencyVariance
Spending variance AH(AR - SR) Efficiency
variance SR(AH - SH)
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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 variance140 unfavorable
Efficiency variance200 unfavorable
340 unfavorable flexible budget total variance
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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 theoverhead cost driver.
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Overhead Variances
Now lets turn our attention to fixed overhead.
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Overhead Rates and Overhead Analysis Example

• ColaCo prepared this budget for
  overhead

What is ColaCos fixed overhead rate for an
estimated activity of 3,000 machine hours?
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Overhead Rates and Overhead Analysis Example

• ColaCo prepared this budget for
  overhead

What is ColaCos 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
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Fixed Overhead Variances Example

• ColaCos actual production required 3,200
  standard machine hours. Actual fixed overhead
  was 8,450.
• Compute the fixed overhead budget and volume
  variances.

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Fixed Overhead Variances
Actual
Fixed Fixed
Fixed Overhead
Overhead Overhead
Incurred
Budget Applied
SH FR
Budget Variance
VolumeVariance
FR Standard Fixed Overhead RateSH Standard
Hours Allowed
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Fixed Overhead Variances Example
Actual
Fixed Fixed
Fixed Overhead
Overhead Overhead
Incurred
Budget Applied
SH FR

3,200 hours

3.00 per hour
8,450
9,000
9,600
Budget variance550 favorable
Volume variance600 favorable
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Fixed Overhead Variances A Closer Look

• Budget Variance

• Volume Variance

Results from paying moreor less than expected
foroverhead items.
Results from operatingat an activity
leveldifferent from thedenominator activity.
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Overhead Variances
Lets look at a graph showing fixed overhead
variances. We will use ColaCos numbers from
the previous example.
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Fixed Overhead Variances
Cost
Fixed overhead applied to products
Volume
3,200 StandardHours
3,000 Hours ExpectedActivity
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Fixed Overhead Variances
3,200 machine hours 3.00 fixed overhead rate
Cost
9,600 applied fixed OH
9,000 budgeted fixed OH
8,450 actual fixed OH
Fixed overhead applied to products
Volume
3,200 StandardHours
3,000 Hours ExpectedActivity
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Fixed Overhead Variances
3,200 machine hours 3.00 fixed overhead rate
Cost
600FavorableVolume Variance
9,600 applied fixed OH


9,000 budgeted fixed OH

8,450 actual fixed OH
8,450 actual fixed OH
550FavorableBudget Variance
Fixed overhead applied to products
Volume
3,200 StandardHours
3,000 Hours ExpectedActivity
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Volume Variance A Closer Look
Results when standard hoursallowed for actual
output differsfrom the denominator activity.
Favorablewhen standard hoursgt denominator hours
Unfavorablewhen standard hourslt denominator
hours
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Volume Variance A Closer Look
Results when standard hoursallowed for actual
output differsfrom the denominator activity.
Favorablewhen standard hoursgt denominator hours
Unfavorablewhen standard hourslt denominator
hours
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Overhead Variances and Under- or Overapplied
Overhead Cost
In a standardcost system
Favorablevariances are equivalentto overapplied
overhead.
Unfavorablevariances are equivalentto
underapplied overhead.
The sum of the overhead variancesequals the
under- or overappliedoverhead cost for a period.
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End of Chapter 11
Im here to your budget. Are you
ready to ante up?