Chapter Eleven
Flexible Budgets
and Overhead Analysis
COPYRIGHT © 2012 Nelson Education Ltd.
Learning Objectives
1. Prepare a flexible budget, and use it for
performance reporting
2. Calculate the variable overhead
variances, and explain their meaning
3. Calculate the fixed overhead variances,
and explain their meaning
4. Prepare an activity-based flexible budget
11-2
COPYRIGHT © 2012 Nelson Education Ltd.
OBJECTIVE 1
Prepare a flexible
budget, and use it for
performance reporting
Performance Reports
• Compare actual costs with budgeted costs
• Two ways:
– Compare actual costs with budgeted costs for
the budgeted level of activity
• Based on a static budget
– Compare actual costs with the actual level of
activity
• Based on a flexible budget
11-4
COPYRIGHT © 2012 Nelson Education Ltd.
Static Budget
• Budget for one particular level of activity
• Performance report compares:
– Direct materials, direct labour, and overhead costs
budgeted for the planned level of activity with
– Actual costs for the actual level of activity
• Actual costs and expected costs must be
compared at the same level of activity
11-5
COPYRIGHT © 2012 Nelson Education Ltd.
Example: Cornerstone 11-1
HOW TO Prepare a Performance Report Based on a Static Budget
(Using Budgeted Production)
Information:
From the Master Budget
Production for Quarter 1: 1,060
Materials:
1 plain t-shirt @ $3.00
5 grams of ink @ $0.20
Labour: 0.12 hours @ $10.00
Variable overhead:
Maintenance: 0.12 hour @ $3.75
Power: 0.12 hour @ $1.25
Fixed overhead:
Grounds keeping: $1,200 per qtr
Depreciation: $600 per quarter
Actual Data for Quarter 1
Production: 1,200 units
Materials cost: $4,380
Labour cost: $1,500
Maintenance cost: $535
Power cost: $170
Grounds keeping: $1,050
Depreciation: $600
Required:
Prepare a performance report using a budget based on expected production
11-6
COPYRIGHT © 2012 Nelson Education Ltd.
Performance Report
Example
Budgeted
1,060
Units produced
Direct materials cost
Direct labour cost
$4,240
1,272
The plan is to produce 1,060
units. All budgeted costs will be
based on 1,060 units
($3.00 t-shirt + (5 grams x $0.20)) x 1,060 units
(0.12 hours x $10.00 per
hour) x 1,060 units
11-7
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Performance Report
Example
Budgeted
Units produced
Direct materials cost
Direct labour cost
Variable overhead:
Maintenance
1,060
$4,240
1,272
477
(0.12 hours x $3.75 per hour) x 1,060 units
11-8
COPYRIGHT © 2012 Nelson Education Ltd.
Performance Report
Example
Budgeted
1,060
Units produced
$4,240
Direct materials cost
Direct labour cost
1,272
Variable overhead:
477
Maintenance
(0.12 hours x $1.25
per hour) x 1,060 units
159
Power
Fixed overhead:
Grounds keeping
1,200
Depreciation
600
Grounds
keeping and
depreciation
are both fixed
costs. They
will be $1,200
and $600
regardless of
the number of
units produced
11-9
COPYRIGHT © 2012 Nelson Education Ltd.
Performance Report
Example
Budgeted
Units produced
Direct materials cost
Direct labour cost
Variable overhead:
Maintenance
Power
Fixed overhead:
Grounds keeping
Depreciation
Total
1,060
$4,240
1,272
477
159
1,200
600
$7,948
Total
budgeted
costs for
1,060 units
11-10
COPYRIGHT © 2012 Nelson Education Ltd.
Performance Report
Example
Actual
Units produced
Direct materials cost
Direct labour cost
Variable overhead:
Maintenance
Power
Fixed overhead:
Grounds keeping
Depreciation
Total
Budgeted
1,200
1,060
Variance
140 F
$4,240
1,272
477
159
1,200
600
$7,948
140 more
units were
produced
than
originally
budgeted
11-11
COPYRIGHT © 2012 Nelson Education Ltd.
Performance Report
Example
Actual
Units produced
Direct materials cost
Direct labour cost
Variable overhead:
Maintenance
Power
Fixed overhead:
Grounds keeping
Depreciation
Total
Budgeted
Variance
1,200
1,060
140 F
$4,830
1,500
$4,240
1,272
$590 U
228 U
535
170
477
159
58 U
11 U
1,050
1,200
600
$7,948
(150) F
COPYRIGHT © 2012 Nelson Education Ltd.
Grounds keeping
costs were lower
than predicted…a
favourable
variance!
Performance Report
Example
Units produced
Direct materials cost
Direct labour cost
Actual
Budgeted
Variance
1,200
$4,830
1,500
1,060
$4,240
1,272
140 F
$590 U
228 U
535
170
477
159
58 U
11 U
1,050
1,200
(150) F
600
600
0
$8,685
$7,948
$737 U
Variable overhead:
Maintenance
Power
Fixed overhead:
Grounds keeping
Depreciation
Total
Overall, actual costs exceeded budgeted costs by $737. Budgeted costs
were based on 1,060 units and 1,200 units were actually produced 11-13
COPYRIGHT © 2012 Nelson Education Ltd.
Flexible Budget
• Enables a firm to compete expected costs for a
range of activity levels
Two types:
– Before-the-fact
• Used to generate financial results for a number of
plausible scenarios
– After-the-fact
• Used to compute what costs should have been for the
actual level of activity
• Expected costs are then compared with the actual
costs in order to assess performance
11-14
COPYRIGHT © 2012 Nelson Education Ltd.
Example: Cornerstone 11-2
HOW TO Prepare a Flexible Production Budget
Information:
• Levels of output: 1,000, 1,200 and 1,400
• Materials (1 plain t-shirt @ $3.00 & 5 grams of ink @ $0.20)
• Labour: 0.12 hour @ $10.00 per hour
• Variable overhead:
– Maintenance: 0.12 hours @ $3.75 per hour
– Power: 0.12 hours @ $1.25 per hour
• Fixed overhead:
– Grounds keeping: $1,200 per quarter & Depreciation: $600 per
quarter
Required:
Prepare a budget for 3 levels of unit output: 1,000, 1,200 & 1,400
11-15
COPYRIGHT © 2012 Nelson Education Ltd.
Flexible Budget
Variable cost Range of Production (units)
Production
per unit
1,400
costs
1,200
1,000
Variable:
$4.00
$4,000 $4,800
$5,600
Direct materials
$3.00 t-shirt and $1.00 of ink
$4 x # of units
11-16
COPYRIGHT © 2012 Nelson Education Ltd.
Flexible Budget
Variable cost Range of Production (units)
Production
per unit
1,400
costs
1,200
1,000
Variable:
$4.00
$4,000 $4,800
$5,600
Direct materials
1,200
1,440
1,680
1.20
Direct labour
0.12 hours × $10 per hour
$1.20 × # of units
11-17
COPYRIGHT © 2012 Nelson Education Ltd.
Flexible Budget
Variable cost Range of Production (units)
Production
per unit
1,400
costs
1,200
1,000
Variable:
$4.00
$4,000 $4,800
$5,600
Direct materials
1,200
1,440
1,680
1.20
Direct labour
Variable overhead:
540
630
0.45
450
Maintenance
210
0.15
150
Power
180
0.12 hours × $3.75 per hour
0.12 hours × $1.25 per hour
11-18
COPYRIGHT © 2012 Nelson Education Ltd.
Flexible Budget
Variable cost Range of Production (units)
Production
per unit
1,400
costs
1,200
1,000
Variable:
$4.00
$4,000
$4,800 $5,600
Direct materials
1.20
Direct labour
1,200
1,440
1,680
Variable overhead:
630
540
0.45
450
Maintenance
210
0.15
150
Power
180
$5,800
$6,960 $8,120
$5.80
Total variable costs
Fixed overhead:
1,200
1,200
1,200
Grounds keeping
Depreciation
600
600
600
Fixed costs do not change when levels of output change
COPYRIGHT © 2012 Nelson Education Ltd.
11-19
Flexible Budget continued
Variable cost Range of Production (units)
Production
per unit
1,400
costs
1,200
1,000
Fixed overhead:
Grounds keeping
1,200
1,200
1,200
Depreciation
600
600
600
Total fixed costs
$1,800 $1,800
$1,800
Total production costs
$7,600 $8,760
$9,920
11-20
COPYRIGHT © 2012 Nelson Education Ltd.
Example: Cornerstone 11-3
HOW TO Prepare a Performance Report using a Flexible Budget
Information:
Budgeted Costs
Direct Materials: $4 per unit
Direct Labour: $1.20 per unit
Variable overhead:
Maintenance: $0.45 per unit
Power: $0.15 per unit
Fixed overhead:
Grounds keeping: $1,200 per qtr
Depreciation: $600 per quarter
Actual Costs @ 1200 units
Direct Materials: $4,830
Direct Labour: $1,500
Maintenance cost: $535
Power cost: $170
Grounds keeping: $1,050
Depreciation: $600
Required:
Prepare a performance report using budgeted costs for the
actual level of activity
11-21
COPYRIGHT © 2012 Nelson Education Ltd.
Performance Report
Example
Actual
Units produced
Budgeted
1,200
Variance
1,200
Budgeted costs are based
on actual units produced
11-22
COPYRIGHT © 2012 Nelson Education Ltd.
Performance Report
Example
Actual
Units produced
Direct materials
Budgeted
1,200
1,200
$4,830
$4,800
Variance
$
30 U
Direct materials costs to produce 1,200
units were $30 higher than expected
11-23
COPYRIGHT © 2012 Nelson Education Ltd.
Performance Report
Example
Actual
Units produced
Direct materials cost
Direct labour cost
Variable overhead:
Maintenance
Power
Total variable costs
Fixed overhead:
Grounds keeping
Depreciation
Total fixed costs
Total production costs
Budgeted
Variance
1,200
1,200
$4,830
1,500
$4,800
1,440
$30 U
60 U
535
170
$7,035
540
180
$6,960
(5) U
(10) U
$ 75 U
$1,050
600
$1,650
$1,200
600
$1,800
$8,685
$8,760
$(150) F
0
$(150) F
$ (75) F
COPYRIGHT © 2012 Nelson Education Ltd.
OBJECTIVE 2
Calculate the variable
overhead variances and
explain their meaning
Variance Overhead Anaylsis
• Difference between applied and actual overhead
• Broken down into:
– Total Variable Overhead Variance
• Broken further into:
– Variable Overhead Spending Variance
– Variable Overhead Efficiency Variance
– Total Fixed Overhead Variance
• Broken further into:
– Fixed Overhead Spending Variance
– Fixed Overhead Volume Variance
11-26
COPYRIGHT © 2012 Nelson Education Ltd.
Example: Cornerstone 11-4
HOW TO Calculate the Total Variable Overhead Variance
Information:
• Standard variable overhead rate (SVOR) $5.00 per
direct labour hour
• Actual variable overhead costs
– Actual direct labour hours (AH) = 150 hours
– Actual Variable Overhead Rate (AVOR) $4.70 per
hour
• Standard hours (SH) allowed per unit 0.12 hour
• Actual production 1,200 units
Required:
Calculate the total variable overhead variance
11-27
COPYRIGHT © 2012 Nelson Education Ltd.
Total Variable Overhead
Variance
Actual Costs
– Applied Costs = Total Variance
(AH × AVOR)
$705
Actual Hours × Actual Variable Overhead Rate
150 hours × $4.70
11-28
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Total Variable Overhead
Variance
Actual Costs
– Applied Costs = Total Variance
(AH × AVOR) – (SH × SVOR)
$705
–
$720
144 hours × $5.00
Hours allowed for production (SH) ×
Standard Variable Overhead Rate
(SVOR)
11-29
COPYRIGHT © 2012 Nelson Education Ltd.
Total Variable Overhead
Variance
Actual Costs
– Applied Costs = Total Variance
(AH × AVOR) – (SH × SVOR)
$705
–
$720
=
($15)
This is a favourable variance since actual costs
were less than expected
11-30
COPYRIGHT © 2012 Nelson Education Ltd.
Variable Overhead
Spending Variance
• Measures the aggregate effect of the differences
between
– Actual variable overhead (AVOR)
– Standard variable overhead rate (SVOR)
• Two ways to calculate:
– Three-pronged columnar approach
– Formula approach
• (AVOR – SVOR) AH
11-31
COPYRIGHT © 2012 Nelson Education Ltd.
Variable Overhead
Efficiency Variance
• Measures the change in variable overhead
consumption that occurs because of efficient (or
inefficient) use of direct labour
• Two ways to calculate:
– Three-pronged columnar approach
– Formula approach
• (AH – SH) SVOR
11-32
COPYRIGHT © 2012 Nelson Education Ltd.
Example: Cornerstone 11-5
HOW TO Calculate Variable Overhead Variances:
Columnar and Formula Approaches
Information:
• Standard variable overhead rate (SVOR) $5.00 per
direct labour hour
• Actual variable overhead rate (AVOR) $4.70
• Actual hours worked (AH) 150 hours
• Number of tee shirts produced 1,200 units
• Hours allowed for production (SH) 144 hours
Required:
Calculate the variable overhead spending and efficiency
variances
11-33
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Columnar Approach
1. AH × AVOR
150 × $4.70
$705
2. AH ×
SVOR
150 × $5.00
$750
3. SH × SVOR
144 × $5.00
$720
Spending
Variance
(1 – 2)
$45 F
This is a favourable variance since the actual variable
overhead rate was less than the expected rate
11-34
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Columnar Approach
2. AH × SVOR
150 × $5.00
$750
1. AH × AVOR
150 × $4.70
$705
Spending
Variance
(1 – 2)
$45 F
3. SH × SVOR
144 × $5.00
$720
Efficiency
Variance
(2 – 3)
$30 U
This is an unfavourable variance since the
actual hours exceeded budgeted hours
11-35
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Columnar Approach
1. AH × AVOR
150 × $4.70
$705
2. AH x SVOR
150 x $5.00
$750
Spending
Variance
(1 – 2)
$45 F
3. SH x SVOR
144 x $5.00
$720
Efficiency
Variance
(2 – 3)
$30 U
Variable Overhead
(1 – 3)
$15 F
COPYRIGHT © 2012 Nelson Education Ltd.
11-36
Example
Formula Approach
VOH spending variance
(AVOR
–
SVOR) AH
($4.70 - $5.00) 150
$45 favourable
11-37
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Formula Approach
VOH efficiency variance
(AH - SH) SVOR
(150 - 144) $5.00
$30 Unfavourable
11-38
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Example: Cornerstone 11-6
HOW TO Performance Report for Variable Overhead Variances
Information:
• Standard variable overhead rate (SVOR) $5.00 per
direct labour hour
• Actual costs: Maintenance $535 & Power $170
• Actual hours worked (AH) 150 hours
• Number of t-shirts produced 1,200 units
• Hours allowed for production (SH) 144 hours
• Variable overhead: Maintenance 0.12 hour @ $3.75
& Power 0.12 hour @ $1.25
Required:
Prepare a performance report that shows the variances on an
item-by-item basis
11-39
COPYRIGHT © 2012 Nelson Education Ltd.
Performance Report
For the Quarter Ended March 31, 2011
Cost
Maintenance
Cost
Formula
Actual
Costs
$3.75
$535
150 hours × $3.75
Budget for
Actual
Spending
Hours
Variance
$562.50
$27.50 F
$535 - $562.50
11-40
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Performance Report (continued)
For the Quarter Ended March 31, 2011
Cost
Budget for
Actual
Spending
Hours
Variance
Maintenance $562.50
Budget for
Standard Efficiency
Hours
Variance
$540
$27.50 F
144 × $3.75
$22.50 U
$562.50 - $540
11-41
COPYRIGHT © 2012 Nelson Education Ltd.
Performance Report
For the Quarter Ended March 31, 2011
Cost
Maintenance
Power
Budget for
Actual
Spending
Hours
Variance
Cost
Formula
Actual
Costs
$3.75
$535
$562.50
$27.50 F
1.25
170
187.50
17.50 F
$1.25 × 150
$170 - $187.50
11-42
COPYRIGHT © 2012 Nelson Education Ltd.
Performance Report (continued)
For the Quarter Ended March 31, 2011
Cost
Budget for
Actual
Spending
Hours
Variance
Maintenance $562.50
Power
187.50
$27.50 F
17.50 F
Budget for
Standard Efficiency
Hours
Variance
$540
$22.50 U
180
7.50 U
11-43
COPYRIGHT © 2012 Nelson Education Ltd.
Performance Report
For the Quarter Ended March 31, 2011
Budget for
Actual
Spending
Hours
Variance
Cost
Formula
Actual
Costs
Maintenance
$3.75
$535
$562.50
$27.50 F
Power
1.25
$5.00
170
$705
187.50
$750.00
17.50 F
Cost
Total
$45.00 F
11-44
COPYRIGHT © 2012 Nelson Education Ltd.
Performance Report (continued)
For the Quarter Ended March 31, 2011
Cost
Budget for
Actual
Spending
Hours
Variance
Budget for
Standard Efficiency
Hours
Variance
Maintenance $562.50
$27.50 F
$540
$22.50 U
Power
17.50 F
$45.00 F
180
$720
7.50 U
Total
187.50
$750.00
$30.00 U
11-45
COPYRIGHT © 2012 Nelson Education Ltd.
OBJECTIVE 3
Calculate the fixed
overhead variances, and
explain their meaning
Total Fixed Overhead
Variance
• Difference between actual and applied
fixed overhead
– When applied overhead = standard fixed
overhead rate × standard hours allowed for
the actual output
• Broken down into:
– Fixed Overhead Spending Variance
– Fixed Overhead Volume Variance
11-47
COPYRIGHT © 2012 Nelson Education Ltd.
Example: Cornerstone 11-7
HOW TO Calculate the Total Fixed Overhead Variance
Information:
• Standard fixed overhead rate (SFOR) $10.00 per
direct labour hour
• Actual fixed overhead costs $1,650
• Standard hours allowed per unit 0.12 hours
• Actual production 1,200 units
Required:
Calculate the total fixed overhead variance
11-48
COPYRIGHT © 2012 Nelson Education Ltd.
Total Fixed Overhead
Variance
Actual Costs
AFOH
$1605
– Applied Costs = Total Variance
– (SH X SFOR)
–
$1,440
=
$210 U
This is an unfavourable variance since
actual costs exceeded applied costs
11-49
COPYRIGHT © 2012 Nelson Education Ltd.
Fixed Overhead Spending
Variance
• Difference between
– Actual fixed overhead rate (AFOH)
– Budgeted fixed overhead rate (BFOH)
• Two ways to calculate:
– Three-pronged columnar approach
– Formula approach
• AFOH – SFOH
11-50
COPYRIGHT © 2012 Nelson Education Ltd.
Fixed Overhead Volume
Variance
• Difference between
– Budgeted fixed overhead (BFOH)
– Applied fixed overhead (ApFOH)
• Two ways to calculate:
– Three-pronged columnar approach
– Formula approach
• (SHp – SH) SFOR
11-51
COPYRIGHT © 2012 Nelson Education Ltd.
Example: Cornerstone 11-8
HOW TO Calculate Fixed Overhead Variances:
Columnar and Formula Approaches
Information:
• Standard fixed overhead rate (SFOR) $10.00 per
direct labour hour
• Budgeted fixed overhead (BFOH) $1,800
• Number of t-shirts produced 1,200 units
• Hours allowed for production (SH) 144 hours
Required:
Calculate the fixed overhead spending and volume variances
11-52
COPYRIGHT © 2012 Nelson Education Ltd.
Fixed Overhead Variances
Columnar Approach
2. SH × SFOR
180 × $10
$1,800
1. Actual Fixed
Overhead
$1,650
Spending
Variance
(1 – 2)
$150 F
3. SHp × SFOR
144 × $10
$1,440
Volume
Variance
(2 – 3)
$360 U
Fixed Overhead
(1 – 3)
$210 U
COPYRIGHT © 2012 Nelson Education Ltd.
11-53
Example
Formula Approach
Fixed Overhead (FOH)
Volume Variance
AFOH –
BFOH
$1,650 - $1,800
$150 Favourable
11-54
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Formula Approach
Fixed Overhead (FOH)
Efficiency Variance
(SHp – SH) SFOR
(180 – 144) $10.00
$360 Unfavourable
11-55
COPYRIGHT © 2012 Nelson Education Ltd.
OBJECTIVE 4
Prepare an activity-based
flexible budget
Activity-Based Budgeting
• A powerful planning and control tool
• Can be used to emphasize cost reduction
through the elimination of wasteful
activities and improving efficiency of
necessary activities
• Two types:
– Static activity budgets
– Activity-based flexible budget
11-57
COPYRIGHT © 2012 Nelson Education Ltd.
Example: Cornerstone 11-9
HOW TO Prepare Static Budget for an Activity
Information:
• Demand for purchase orders based on materials
requirements: 15,000 purchase orders
• Resources needed:
– Five purchasing agents, each capable of processing
3,000 orders per year, salary, $40,000 each
– Supplies projected to cost $1.00 per purchase order
– Desks and computers: depreciation, $5,000 per year
– Office space, rent, and utilities, $6,000
Required:
Prepare a budget for the purchasing activity
11-58
COPYRIGHT © 2012 Nelson Education Ltd.
Purchasing Budget
Salaries
$200,000
Depreciation
Supplies
5,000
15,000
6,000
Occupancy
Total
$226,000
5 agents × $40,000
per agent per year
$1.00 per purchase order ×
15,000 purchase orders
COPYRIGHT © 2012 Nelson Education Ltd.
Example: Cornerstone 11-10
HOW TO Prepare an Activity Flexible Budget
Information:
• The individual activities, drivers, their cost formulas,
and the output levels are the inputs needed to prepare
the budget
• For example:
– Activity: Maintenance
– Driver: Machine hours
– Fixed activity cost: $20,000
– Variable activity rate: $5.50 per machine hour
Required:
Prepare an activity-based flexible budget
11-60
COPYRIGHT © 2012 Nelson Education Ltd.
Activity-Based Flexible
Budget
Formula
Fixed Variable
Driver: Direct Labour Hours
Direct materials
$ ---
Direct labour
Subtotal
--$ 0
$ 10
8
$ 18
Fixed
Variable
$20,000
15,000
$35,000
$ 5.50
2.00
$ 7.50
Level of Activity
20,000
10,000
$100,000 $200,000
80,000 160,000
$180,000 $360,000
Driver: Machine Hours
Maintenance
Machining
Subtotal
8,000
16,000
$64,000 $108,000
31,000
47,000
$95,000 $155,000
11-61
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Activity-Based Flexible
Budget continued
Formula
Level of Activity
Driver: Number of Setups
Fixed
Setups
Variable
$ ---$ 1,800
2,100
80,000
$80,000 $3,900
Inspections
Subtotal
25
30
$ 45,000 $ 54,000
132,500 143,000
$177,500 $197,000
Driver: Number of Orders
Fixed
Purchasing
$211,000
Variable
$
1
15,000
30,000
$226,000 $236,000
11-62
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Example: Cornerstone 11-11
HOW TO Prepare an Activity-Based Performance Report
Information:
Direct materials
Direct labour
Maintenance
Machining
Inspections
Setups
Purchasing
Actual Costs
$101,000
$80,000
$55,000
$29,000
$125,500
$46,500
$220,000
Actual Activity
Level
10,000
10,000
8,000
8,000
25
25
15,000
Required:
Prepare an activity-based performance report
(use budgeted costs from Cornerstone 11-10)
COPYRIGHT © 2012 Nelson Education Ltd.
11-63
Activity-Based
Performance Report
Actual
Costs
Budgeted
Costs
Budget
Variance
$ 1,000 U
---9,000 F
2,000 F
7,000 F
1,500 U
6,000 F
Direct materials
Direct labour
Maintenance
Machining
Inspections
Setups
Purchasing
$101,000
80,000
55,000
29,000
125,500
46,500
220,000
$100,000
80,000
64,000
31,000
132,500
45,000
226,000
Total
$657,000
$678,500
$21,500 F
11-64
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