Chapter 11
Flexible Budgeting and
the Management of
Overhead and Support
Activity Costs
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning
Objective
1
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Flexible Budgets
Static budgets are
prepared for a single,
planned level of
activity.
Hmm! Comparing
static budgets
with actual costs
is like comparing
apples and oranges.
Performance
evaluation for
overhead is difficult
when actual activity
differs from the
planned level of
activity.
11-3
Flexible Budgets
Consider
the following
example from
the Cheese
Company . . .
Hmm! Comparing
static budgets
with actual costs
is like comparing
apples and oranges.
11-4
Static Budgets and
Performance Reports
Static
Budget
Machine hours
Variable costs
Indirect labor
Indirect materials
Power
Fixed costs
Depreciation
Insurance
Total overhead costs
10,000
$ 40,000
30,000
5,000
Actual
Results
Variances
8,000
2,000 U
U = Unfavorable variance
Cheese Company was
unable to achieve the
budgeted level of activity.
12,000
2,000
$ 89,000
11-5
Static Budgets and
Performance Reports
F = Favorable variance since actual costs
Static
Actual
are less than budgeted
costs.
Budget
Machine hours
Variable costs
Indirect labor
Indirect materials
Power
Results
Variances
10,000
8,000
2,000 U
$ 40,000
30,000
5,000
$ 34,000
25,500
3,800
$6,000 F
4,500 F
1,200 F
Since cost variances are favorable, have
job controlling
costs?
12,000
12,000
Fixed costs
we
done a good
Depreciation
Insurance
2,000
2,000
Total overhead costs
$ 89,000
$ 77,300
0
0
$11,700 F
11-6
Static Budgets and
Performance Reports
I don’t think I can
answer this question
using a static budget.
I do know that
actual activity is below
budgeted activity which
is unfavorable.
But shouldn’t variable costs
be lower if actual activity
is below budgeted activity?
11-7
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 must
the budget to the
actual level of activity.
11-8
Flexible Budgets
Central Concept
If you can tell me what your activity was
for the period, I will tell you what your costs
and revenue should have been.
11-9
Advantages of Flexible Budgets
Show revenues and expenses
that should have occurred at the
actual 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.
11-10
Learning
Objective
2
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Preparing a Flexible Budget
11-12
Preparing a Flexible Budget
Variable
Cost
Per Hour
Total
Fixed
Cost
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000
$
10,000
12,000
4.00
3.00
0.50
7.50
$12,000
2,000
11-13
Preparing a Flexible Budget
Variable
Cost
Per Hour
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
Total
Fixed
Cost
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
10,000
12,000
Variable8,000
costs are
expressed
as
a constant amount per hour.
$
4.00
3.00
0.50
7.50
$ 32,000
24,000
Fixed
4,000 costs are expressed as a
total amount that does not
$ 60,000
change within the relevant
range of activity.
$12,000
2,000
11-14
Preparing a Flexible Budget
Variable
Cost
Per Hour
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
Total
Fixed
Cost
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000
$
4.00
3.00
0.50
7.50
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$12,000 $ 12,000
2,000
2,000
$ 14,000
$ 74,000
11-15
Preparing a Flexible Budget
Variable
Cost
Per Hour
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
$
4.00
3.00
0.50
7.50
Total
Fixed
Cost
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$ 48,000
36,000
6,000
$ 90,000
$12,000 $ 12,000
2,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
11-16
Preparing a Flexible Budget
Variable
Cost
Per Hour
Machine hours
Variable costs
IndirectThere
labor is no
Note:
material
inIndirect
the fixed
costs.
Power
Total variable cost
$
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
4.00
flex
3.00
0.50
7.50
Total
Fixed
Cost
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$ 48,000
36,000
6,000
$ 90,000
$12,000 $ 12,000
2,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
11-17
Preparing a Flexible Budget
Variable
Cost
Per Hour
Total
Fixed
Cost
Machine hours
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000
10,000
12,000
Total budgeted
Variable costs
overhead cost
Indirect labor
4.00
$ 32,000
Indirect material
3.00
24,000
Power
0.50
Budgeted variable
Total 4,000
Total variable
cost cost
$ per
7.50
$ 60,000
overhead
activity
$ 40,000
30,000
5,000
Budgeted
$ 75,000
$ 48,000
36,000
6,000
fixed
$ 90,000
=
Fixed costsactivity unit
Depreciation
Insurance
Total fixed cost
Total overhead costs
×
units
+
$12,000 $ 12,000
2,000
2,000
$ 14,000
$ 74,000
overhead cost
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
11-18
Flexible Budget
Performance Report
11-19
Flexible Budget
Performance Report
Variable
Cost
Per Hour
Total
Fixed
Costs
Machine hours
Variable costs
Indirect labor
$
Indirect material
Power
Total variable costs $
Fixed Expenses
Depreciation
Insurance
Total fixed costs
Total overhead costs
Flexible
Budget
Actual
Results
8,000
4.00
3.00
0.50
7.50
Variances
0
$ 34,000
25,500
3,800
$ 63,300
$12,000
2,000
$ 12,000
2,000
$ 14,000
$ 77,300
11-20
Flexible Budget
Performance Report
Total
FlexibleVariable
budget
is
Cost
Fixed
prepared
Per for
HourtheCosts
same activity level
Machine hours
(8,000 hours) as
Variable costs
actually$achieved.
Indirect labor
4.00
Indirect material
Power
Total variable costs $
Fixed Expenses
Depreciation
Insurance
Total fixed costs
Total overhead costs
3.00
0.50
7.50
$12,000
2,000
Flexible
Budget
Actual
Results
8,000
8,000
Variances
0
$ 34,000
25,500
3,800
$ 63,300
$ 12,000
2,000
$ 14,000
$ 77,300
11-21
Flexible Budget
Performance Report
Variable
Cost
Per Hour
Total
Fixed
Costs
Machine hours
Variable costs
Indirect labor
$
Indirect material
Power
Total variable costs $
Fixed Expenses
Depreciation
Insurance
Total fixed costs
Total overhead costs
4.00
3.00
0.50
7.50
$12,000
2,000
Flexible
Budget
Actual
Results
8,000
8,000
$ 32,000
24,000
4,000
$ 60,000
$ 34,000
25,500
3,800
$ 63,300
$ 2,000 U
1,500 U
200 F
$ 3,300 U
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 77,300
0
0
0
$ 3,300 U
Variances
0
11-22
Flexible Budget
Performance Report
Variable Total
Cost
Fixed
labor
and Costs
Per Hour
Indirect
indirect
Machine
hours material have
unfavorable variances
Variable costs
because
costs
Indirect
labor actual
$ 4.00
are
more than3.00
the
Indirect
material
Power
flexible budget 0.50
costs.
Total variable costs $
Fixed Expenses
Depreciation
Insurance
Total fixed costs
Total overhead costs
7.50
$12,000
2,000
Flexible
Budget
Actual
Results
8,000
8,000
$ 32,000
24,000
4,000
$ 60,000
$ 34,000
25,500
3,800
$ 63,300
$ 2,000 U
1,500 U
200 F
$ 3,300 U
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 77,300
0
0
0
$ 3,300 U
Variances
0
11-23
Flexible Budget
Performance Report
Variable
Cost
Per Hour
Total
Fixed
Costs
Machine hours
Power has a favorable
Variable costs
variance because
the
Indirect labor
$ 4.00
actualmaterial
cost is less
than
Indirect
3.00
Power
0.50
the flexible budget
cost.
Total variable costs $
Fixed Expenses
Depreciation
Insurance
Total fixed costs
Total overhead costs
7.50
$12,000
2,000
Flexible
Budget
Actual
Results
8,000
8,000
$ 32,000
24,000
4,000
$ 60,000
$ 34,000
25,500
3,800
$ 63,300
$ 2,000 U
1,500 U
200 F
$ 3,300 U
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 77,300
0
0
0
$ 3,300 U
Variances
0
11-24
Learning
Objective
3
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Overhead Application in a
Standard Costing System
Normal Costing
Manufacturing Overhead
Actual
Applied
overhead
overhead:
Work-in-Process Inventory
Applied
overhead:
Actual hours
x
Predetermined
overhead rate
Difference lies in the
quantity of hours used.
Actual hours
x
Predetermined
overhead rate
Standard Costing
Manufacturing Overhead
Actual
Applied
overhead
overhead:
Standard
allowed hours
x
Predetermined
overhead rate
Work-in-Process Inventory
Applied
overhead:
Standard
allowed hours
x
Predetermined
overhead rate
11-26
Overhead Application in a
Standard Costing System
Budgeted
Overhead
Planned
Monthly Activity
Predetermined
Overhead Rate
Variable . . . . . $. . 60,000 * . . . . . . . . . 8,000 machine hours . . . . . . . . .$ 7.50 per process hour
Fixed . . . . . . . . . 14,000 * . . . . . . . . . 8,000 machine hours . . . . . . . . . 1.75 per process hour
Total . . . . . . . .$. 74,000 . . . . . . . . .
8,000 machine hours . . . . . . . . .$ 9.25 per process hour
* From the flexible budget for planned activity of 8,000 machine hours
11-27
Learning
Objective
4
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Choice of Activity Measure

Variable overhead and the activity
measure should vary in a similar
pattern.

Identify variable overhead cost
drivers.


Examples: machine hours, labor
hours, process time.
Dollar measures should be avoided
as they are subject to price-level
changes.
11-29
Learning
Objective
5
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Cost Management Using
Overhead Cost Variances
Let’s turn our attention
to the computation of
overhead cost variances.
We will begin with
variable overhead.
11-31
Variable Overhead Variances
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
Flexible Budget
for Variable
Overhead at
Standard Hours
AH × AR
AH × SVR
SH × SVR
Spending
Variance
AH
AR
SVR
SH
Efficiency
Variance
= Actual Hours of Activity
= Actual Variable Overhead Rate
= Standard Variable Overhead Rate
= Standard Hours Allowed
11-32
Variable Overhead Variances
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
Flexible Budget
for Variable
Overhead at
Standard Hours
AH × AR
AH × SVR
SH × SVR
Spending
Variance
Efficiency
Variance
Spending variance = AH(AR - SVR)
Efficiency variance = SVR(AH - SH)
11-33
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.
Compute the variable overhead spending and
efficiency variances.
11-34
Variable Overhead Variances –
Example
ColaCo prepared this
budget for overhead:
Total budgeted
overhead cost
Budgeted variable
overhead cost per
activity unit
Total budgeted
overhead cost
=
Total
x activity
units
$2.00 per
machine
hour
×
=
+
Budgeted fixed
overhead cost
Total
machine
hours
+
$9,000
11-35
Variable Overhead Variances –
Example
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
3,300 hours
×
$2.00 per hour
Flexible Budget
for Variable
Overhead at
Standard Hours
3,200 hours
×
$2.00 per hour
$6,740
$6,600
$6,400
Spending variance
$140 unfavorable
Efficiency variance
$200 unfavorable
11-36
Variable Overhead Variances –
Example
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
3,300 hours
×
$2.00 per hour
Flexible Budget
for Variable
Overhead at
Standard Hours
3,200 hours
×
$2.00 per hour
$6,740
$6,600
$6,400
The $140 unfavorable spending variance and the $200
unfavorable efficiency variance result in a $340
unfavorable flexible budget variance.
11-37
Variable Overhead Variances – A
Closer Look
Spending Variance
Efficiency Variance
Results from paying more
or less than expected for
overhead items and from
excessive usage of
overhead items.
A function of the
selected cost driver.
It does not reflect
overhead control.
11-38
Fixed Overhead
Now let’s turn
our attention to
fixed overhead.
11-39
Fixed Overhead Variances
Actual Fixed
Overhead
Incurred
Fixed
Overhead
Budget
Fixed
Overhead
Applied
SH × PFOHR
Budget
Variance
Volume
Variance
PFOHR = Predetermined Fixed Overhead Rate
SH = Standard Hours Allowed
11-40
Fixed Overhead
Recall that fixed overhead costs are applied
to products and services using a
predetermined fixed overhead rate
(PFOHR):
Applied Fixed Overhead = PFOHR × Standard Hours
PFOHR
=
Budgeted Fixed Overhead
Planned Activity in Hours
11-41
Fixed Overhead Variances –
Example
ColaCo used the following predetermined
fixed overhead rate:
=
Budgeted Fixed Overhead
Planned Activity in Hours
PFOHR
=
$9,000
3,000 machine hours
PFOHR
=
PFOHR
$3.00 per machine hour
11-42
Fixed Overhead Variances –
Example
ColaCo’s actual production required 3,200
standard machine hours. Actual fixed
overhead was $8,450.
Compute the fixed overhead budget and
volume variances.
11-43
Fixed Overhead Variances –
Example
Actual Fixed
Overhead
Incurred
Fixed
Overhead
Budget
Fixed
Overhead
Applied
3,200 hours
×
$3.00 per hour
$8,450
Budget variance
$550 favorable
$9,000
$9,600
Volume variance
$600 (neither favorable
nor unfavorable)
11-44
Fixed Overhead Variances
Let’s look at a graph
showing fixed
overhead variances.
We will use ColaCo’s
numbers from the
previous example.
11-45
Fixed Overhead Variances –
A Closer Look
Budget Variance
Volume Variance
Results from paying more
or less than expected for
overhead items.
Results from the inability
to operate at the activity
level planned for the period.
Has no significance for
cost control.
11-46
Fixed Overhead Variances
Cost
$600
Volume
Variance
$550
Favorable
Budget
Variance
3,200 machine hours × $3.00 fixed overhead rate
$9,600 applied fixed OH
{ $9,000 budgeted fixed OH
{ $8,450
actual
fixed OH
3,000 Hours
Planned
Activity
Volume
3,200
Standard
Hours
11-47
Learning
Objective
6
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Overhead Cost Performance Report
Variable costs:
Indirect material:
Wax
Plastic wrap
Paper products
Misc. supplies
Indirect labor:
Maintenance
Janitorial
Utilities:
Electricity
Natural gas
Water
Total variable cost
Fixed costs:
Indirect labor:
Inspection
Production supervisor
Set up
Depreciation:
Equipment
Insurance
Property taxes
Total fixed cost
Total overhead cost
11-49
Learning
Objective
7
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Activity-Based Flexible Budget
Variable
Cost
Per Hour
Machine hours
Total
Fixed
Cost
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$ 48,000
36,000
6,000
$ 90,000
Fixed costs
Depreciation
$12,000 $ 12,000
The
Cheese Co. flexible
Insurance
2,000
2,000
budget
is
based
on
a
single
Total fixed cost
$ 14,000
costoverhead
driver,costs
machine hours $ 74,000
Total
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
$
4.00
3.00
0.50
7.50
11-51
Activity-Based Flexible Budget
Variable
Cost
Per Hour
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
$
4.00
3.00
0.50
7.50
Total
Fixed
Cost
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$ 48,000
36,000
6,000
$ 90,000
If costs
different cost drivers are identified for the
Fixed
Depreciation
$ 12,000
$ 12,000
$ 12,000
different
variable costs,$12,000
an activity-based
flexible
Insurance
2,000
2,000
2,000
2,000
budget
should be prepared $with
cost$ 14,000
Total
fixed cost
14,000different
$ 14,000
Total overhead
costs
$ 74,000 drivers.
$ 89,000
$ 104,000
formulas
based on the different
11-52
Learning
Objective
8
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Standard Costs and Product Costing
Standard Costing
Manufacturing Overhead
Actual
Applied
overhead
overhead:
Standard
allowed hours
x
Predetermined
overhead rate
Work-in-Process Inventory
Applied
overhead:
Standard
allowed hours
x
Predetermined
overhead rate
11-54
Standard Costs and Product Costing
Disposition of Variances
Manufacturing Overhead
Cost of Goods Sold
Actual
Applied
Balance (1)
Balance (2)
overhead
overhead:
Actual
Applied
Standard
overhead
overhead
allowed hours
greater than
greater than
x
Applied
Actual
Predetermined
overhead
overhead
overhead rate
Balance (1)
Balance (2)
Balance (2)
Balance (1)
11-55
Learning
Objective
9
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
A General Model for Variance
Analysis
Actual Quantity
×
Actual Price
Actual Quantity
×
Standard Price
Price Variance
Materials
price- SP)
variance
AQ(AP
Labor rate variance
AQ =Variable
Actual overhead
Quantity
AP = spending
Actual Price
variance
Standard Quantity
×
Standard Price
Quantity Variance
Materials
quantity
variance
SP(AQ
- SQ)
Labor efficiency variance
SP
= Standard
Price
Variable
overhead
SQ
= Standard
Quantity
efficiency
variance
11-57
A General Model for Variance
Analysis
Actual Sales Volume
×
Actual Sales Price
Actual Sales Volume
×
Budgeted Sales Price
Sales Price Variance
ASV(ASP - BSP)
ASV = Actual Sales Volume
ASP = Actual Sales Price
Budgeted Sales Volume
×
Budgeted Sales Price
Sales Volume Variance
BSP(ASV - BSV)
BSP = Budgeted Sales Price
BSV = Budgeted Sales Volume
11-58
End of Chapter 11
I’m here to
your
budget. Are you ready to
ante up?
11-59