17
Flexible Budgets,
Overhead Cost
Management, and
Activity-Based
Budgeting
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Learning Objective 1
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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.
Activity (machine hours)
Budgeted electricity cost
Static
Budget
6,000
$ 1,200
Based on
only one
activity
level.
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$
4,500
900
Flexible
Budget
6,000
$ 1,200
7,500
$ 1,500
Includes several
possible activity
levels.
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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?
Actual
Electricity
Cost
$
1,050
Budgeted
Electricity
Cost
$
1,200
Cost
Variance
$
150 Favorable
After preparing a flexible budget, the manager
obtained the following information about cost control
at 4,500 machine hours.
Actual
Electricity
Cost
$
1,050
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Budgeted
Electricity
Cost
$
900
Cost
Variance
$
150 Unfavorable
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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.
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Formula Flexible Budget
Total budgeted
monthly
=
overhead cost
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Budgeted variable
Total
Budgeted fixed
overhead cost per × activity + overhead cost
activity unit
units
per month
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Learning Objective 2
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Flexible Overhead Budget Illustrated
$2.15 × 6,000 = $12,900
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Flexible Overhead Budget Illustrated
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Flexible Overhead Budget Illustrated
$24,360 + $16,550 = $40,910
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Flexible Overhead Budget Illustrated
Normal costing
Standard costing
Manufacturing Overhead
Manufacturing Overhead
Actual
Overhead
Actual
Overhead
Applied
Overhead
Applied
Overhead
Actual
activity
Standard
allowed activity
×
×
Predetermined
overhead rate
Predetermined
overhead rate
The difference lies in the quantity of hours used
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Learning Objective 3
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Overhead Application in a StandardCosting 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
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Normal costing =
Actual quantity used
* application rate
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Learning Objective 4
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Choice of Activity Measure
1. The activity measure should be one that
varies in a similar pattern to the way that
variable overhead varies.
2. As automation increases, many companies
are using measures such as machine hours
or process time for their flexible overhead
budget.
3. Dollar measures are subject to price-level
changes and fluctuate more than physical
measures.
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Learning Objective 5
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17-17
Overhead Cost Variances
Variable-Overhead Variances
Actual Hours
×
Actual Rate
AH × AR
Actual Hours Standard Hours
×
×
Standard Rate
Standard Rate
AH × SR
Variable-overhead
spending variance
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SH × SR
Variable-overhead
efficiency variance
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17-18
Variable-Overhead Variances
Matrix Inc. has the following variable
manufacturing overhead standard to
manufacture one tent:
1.5 standard hours per tent at $13.00 per
direct labor hour
Last week 1,550 hours were worked to make
1,000 tents, and $20,460 was spent for
variable manufacturing overhead.
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Overhead Cost Variances
Variable-Overhead Variances
Actual Hours
×
Actual Rate
Actual Hours Standard Hours
×
×
Standard Rate
Standard Rate
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-overhead
spending variance
Variable-overhead
efficiency variance
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Overhead Cost Variances
Variable-Overhead Variances
Actual Hours
×
Actual Rate
AH × AR
1,550
×
$13.20
$20,460
Actual Hours Standard Hours
×
×
Standard Rate
Standard Rate
AH × SR
SH × SR
1,550
1,500
×
×
$20,460$13.00
actual overhead costs
$13.00
1,550 actual hours
$20,150
$19,500
$310 Unfavorable
$650 Unfavorable
Variable-overhead
spending variance
Variable-overhead
efficiency variance
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Overhead Cost Variances
Variable-Overhead Variances
Actual Hours
×
Actual Rate
Actual Hours Standard Hours
×
×
Standard Rate
Standard Rate
AH × AR
AH × SR
SH × SR
1,550
×
$13.20
1,000 tents1,550
× 1.5 hours
×
$13.00
1,500
×
$13.00
$20,460
$20,150
$19,500
$310 Unfavorable
$650 Unfavorable
Variable-overhead
spending variance
Variable-overhead
efficiency variance
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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.
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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.
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Fixed-Overhead Variances
Fixed-overhead
Actual fixed- _ Budgeted fixed=
budget variance
overhead
overhead
Fixed-overhead
Budgeted fixed- _ Applied fixed=
volume variance
overhead
overhead
Predetermined fixedStandard hours
×
overhead rate
allowed
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Fixed-Overhead Variances
Matrix, Inc. prepared this flexible budget for overhead:
Machine
Hours
2,000
4,000
Total
Variable
Overhead
Variable
Overhead
Rate
Budgeted
Fixed
Fixed
Overhead
Overhead
Rate
$
$
$
4,000
8,000
2.00
2.00
9,000
9,000
$
4.50
2.25
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.
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17-26
Fixed-Overhead Budget Variance
Fixed-overhead
Actual fixed- _ Budgeted fixed=
budget variance
overhead
overhead
$550 Favorable =
$8,450
_
$9,000
Budget Variance
Results from paying more or less than
expected for overhead items.
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17-27
Fixed-Overhead Variances
Fixed-overhead
Budgeted fixed- _ Applied fixed=
volume variance
overhead
overhead
Volume Variance
Results from operating at an activity
level different from the denominator
activity.
$600 Favorable =
$9,000
3,200 hours
×
$3.00 per hour
=
_
$9,600
$9,000 Budgeted cost ÷ 3,000 Budgeted hours
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Fixed Overhead Variances
Cost
$550
Favorable
Budget
Variance
$9,000 budgeted fixed OH
{ $8,450 actual fixed OH
Volume
3,000 Hours
Expected
Activity
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Fixed Overhead Variances
Cost
$600
Favorable
Volume
Variance
$9,600 applied fixed OH
{ $9,000 budgeted fixed OH
3,000 Hours
Expected
Activity
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Volume
3,200
Standard
Hours
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17-30
Capacity Utilization
Volume
Variance
Results when standard hours
allowed for actual output differs
from the denominator activity.
Unfavorable
when standard hours
< denominator hours
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Favorable
when standard hours
> denominator hours
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17-31
Several Types of Analyses
Variableoverhead
spending
variance
$1,680 U
Fixedoverhead
budget
variance
$2,500 U
Combined
spending
variance
$4,180 U
Variableoverhead
efficiency
variance
$1,800 U
Fixedoverhead
volume
variance
$7,500 U
$1,800 U
$7,500 U
Combined
budget
variance
$5,980 U
$7,500 U
Underapplied overhead
$13,480 U
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17-32
Learning Objective 6
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Overhead Cost Performance Report
= Unfavorable variance
$19,200 - $19,350 = $ 150
$18,000 - $19,200 = $1,200
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Overhead Cost Performance Report
$1,680 + $1,800 + $2,500 = $5,980 unfavorable
$57,000 - $62,980 = $5,980 unfavorable
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17-35
Learning Objective 7
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Standard Costs in Product Costing
In a standard
cost system:
Unfavorable
variances are equivalent
to underapplied overhead.
Favorable
variances are equivalent
to overapplied overhead.
The sum of the overhead variances
equals the under- or overapplied
overhead cost for a period.
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Disposition of Variances
Manufacturing Overhead
Actual
Overhead
Applied
Overhead
$50,000
$44,500
$5,500
$5,500
Cost of Goods Sold
$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.
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Learning Objective 8
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Activity-Based Flexible Budget
$18,000 ÷ 4,500 units = $4.00 per unit
$5,000 ÷ 10 runs = $500 per run
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17-40
How Does ABC Affect Performance
Reporting?
The activity-based flexible budget
provides a more accurate benchmark
against which to compare actual costs.
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17-41
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.
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Learning Objective 9
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


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.
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Learning Objective 10
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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.

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This method is known as backflush costing.
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17-46
Learning Objective 11
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17-47
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.
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End of Chapter 17
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