Flexible Budgets and Overhead Analysis

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Flexible Budgets and Overhead Analysis
Chapter 11
2
Static Budgets and Performance Reports

• 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 Budgets and Performance Reports
CheeseCo
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Static Budgets and Performance Reports
CheeseCo
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Static Budgets and Performance Reports
CheeseCo
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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
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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.

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Flexible Budgets
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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
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Preparing a Flexible Budget
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
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


?


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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 10,000 hours?
• a. 92,500.
• b. 74,000.
• c. 89,000.
• d. 94,000.

Total overhead cost 14,000
7.50 per hour ? 10,000 hours
14,000 75,000 89,000
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Preparing a Flexible Budget
CheeseCo
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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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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
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Preparing a Flexible Budget
CheeseCo
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Flexible BudgetPerformance Report
Lets prepare a budget
performance report for CheeseCo.
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Flexible BudgetPerformance Report
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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 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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Flexible BudgetPerformance Report
CheeseCo
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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 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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Flexible BudgetPerformance Report
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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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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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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.
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Flexible BudgetPerformance Report
Overhead Variance Analysis
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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

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

This rate decreases when activity increases.
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Overhead Rates and Overhead Analysis Example

• ColaCo prepared this budget for
  overhead

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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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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 ?
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

• 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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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

Efficiency variance SR (AH - SH) 5
per hour (2,050 hours - 2,100 hours)
250 F
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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
2,050 hours
2,100 hours
5 per hour
5 per hour
10,950
10,500
10,250
Spending variance700 unfavorable
Efficiency variance250 favorable
450 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

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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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 ?
Budget variance Actual fixed overhead -
Budgeted fixed overhead 14,800 -
14,450 350 U

• 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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Quick Check ?
Volume variance Budgeted fixed overhead
- SH ? FR 14,450 - 2,100 hours ? 7 per
hour 14,450 - 14,700 250 F

• 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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Quick Check ?
Actual
Fixed Fixed
Fixed Overhead
Overhead Overhead
Incurred
Budget Applied
SH FR

2,100 hours

7.00 per hour
14,800
14,450
14,700
Budget variance350 unfavorable
Volume variance250 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
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Fixed Overhead Variances

8,450 actual fixed OH
8,450 actual fixed OH
550FavorableBudget Variance
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Fixed Overhead Variances
3,200 machine hours 3.00 fixed overhead rate
600FavorableVolume Variance
9,600 applied fixed OH



8,450 actual fixed OH
8,450 actual fixed OH
550FavorableBudget Variance
3,200 StandardHours
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Volume Variance A Closer Look
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Volume Variance A Closer Look
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Overhead Variances and Under- or Overapplied
Overhead Cost
In a standardcost system
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End of Chapter 11