Flexible Budgeting and
overhead Variance
By Ghanendra Fago
(C) Ghanendra Fago (M Phil,
MBA)
1
Meaning and definitions
A budget prepared at different level of activities is a
flexible budget
Flexible budget will furnish the budgeted figures for any
level of activity, which a company may actually attain.
It reflects costs, revenues and profits at the various level of
budgeted activity.
A flexible budget as a budget designed to change in
accordance with the level of activity actually attained.
Also called a variable budget, step budget, sliding-scale
budget, expense-formula budget, dynamic budget and
expense control budget.
(C) Ghanendra Fago (M Phil,
MBA)
2
Contd.
Master budget is static or fixed budgets,
which forecast revenues and expenses for
one level of sales and production.
A flexible budget is a summary of
anticipated costs for a range of activity
levels, geared to changes in product output.
(C) Ghanendra Fago (M Phil,
MBA)
3
Characteristics Of Flexible Budget
It covers a range of activity.
It provides a dynamic basis for comparison with the actual
results because it is automatically matched to change in
activities.
It can be changed according to actual production level.
It facilitates performance measurement and evaluation.
These are based upon adequate knowledge of cost behaviour
pattern.
(C) Ghanendra Fago (M Phil,
MBA)
4
Use of Flexible Budget
Where the level of activity during the year varies from
period to period, either due to the seasonal nature of the
industry or to variation in demand.
Where the business is a new one and it is difficult to foresee
the demand.
The level of activity depends upon the availability of a factor
of production such as materials, labor, plant capacity etc.
Where an industry is influenced by changes in fashion.
Where there are general changes in sales.
Where the business units keep or introducing new product or
make changes in the design of its products frequently.
Where the industries are engaged in make to order business
like ship-building.
(C) Ghanendra Fago (M Phil,
MBA)
5
Needs of Flexible Budgeting
Helps to obtain detailed information of cost, sales, output and profit at
different level of operation, useful for analysis.
Makes possible the comparison of actual performance and budgeted one for
actual level of operation in a very easy and understanding way.
Helps to attain the objective of cost reduction and better cost control.
Helps to estimate the profit and cost of the products such as luxury goods,
fashionable goods or soft drinks, whose production and sales are uncertain.
Helps to present a monthly report based upon comparative analysis of
budgeted and actual cost at given level of operation.
Helps to measure the capacity utilization of plant or labour force, in term of
level of activity.
Helps on planning the expenditure of responsible centres, who care
responsible for tactical profit plan.
Helps to develop the labour oriented business sector, where labour are scare.
Helps in taking localized decision, identifying the possible factors affection
the cost and profit.
(C) Ghanendra Fago (M Phil,
MBA)
6
Classification Of Costs
Fixed Cost: Fixed costs remain constant within the given range of activity in spite of
change in volume of production. The unit fixed cost per unit decreases as the level of
production increases within the volume. They are the period cost and capacity,
should be incurred for a period of time.
Variable Cost: Those costs which increase directly and proportionately with the
level of activity are called variable costs. Total cost increases or decreases towards
the direction of production or sales units. Where as the variable cost per unit will
remain constant, if other thing remaining the same.
Semi-variable Cost (Mixed Cost): Composition of fixed and variable cost is the
mixed cost or semi variable cost. Such costs increase with the level of activity, but by
intermittent jumps than continuously. In other words the cost does not change
proportionately with the level of output.
(C) Ghanendra Fago (M Phil,
MBA)
7
Methods for flexible budgeting
Formula Approach
Columnar or Tabular Approach
Graphical Approach
(C) Ghanendra Fago (M Phil,
MBA)
8
Formula Approach
Fixed cost and the variable cost per unit are
found out
BA = FC + (UVC * Q)
where,
BA= Budget Allowance
FC= Fixed Cost
UVC= Unit Variable Cost
Q = Output level, i.e. labour hour, machine
hour, or units produced
(C) Ghanendra Fago (M Phil,
MBA)
9
Example:
Level of activity
50,000 hours
100,000 hours
Total Cost
Rs. 500,000
Rs. 800,000
Variable Cost = Difference in Cost / Difference in activity level
= Rs. (800,000 – 500,000)/(100,000-50,000)
= Rs. 300,000/50,000
= Rs.6
Fixed Cost = Total Cost – Variable Cost * Level of activity
= Rs. 500,000 – Rs.6 * 50,000
= Rs.(500,000 – 300,000)
= Rs. 200,000
(C) Ghanendra Fago (M Phil,
MBA)
10
contd…
Therefore, the required formula is:
BA = 200,000 + 6Q
So using the formula the required budget for 60,000
labor hours would be:
BA = Rs. 200,000 + (Rs. 6 * 60,000)
= Rs. (200,000 + 360,000)
= Rs. 560,000
(C) Ghanendra Fago (M Phil,
MBA)
11
Activity level in units
Flexible
Formula
A. Variable Costs:
Direct material
Direct labor
Variable expenses
Selling expenses (90%)
Distribution expenses (80%)
Total Variable Cost
B. Fixed Costs:
Fixed Overheads
Administrative Expenses
Selling Expenses 10% of 6.5 *
10,000
Distribution Expenses 20% of
3.5 * 10,000
Total Fixed Cost
C. Total Costs (A + B)
6,000
units
8,000 units
Rs. 35
Rs. 12.5
Rs. 10
Rs. 5.85
Rs. 2.8
210,000
75,000
60,000
35,100
16,800
396,900
280,000
100,000
80,000
46,800
22,400
529,200
50,000
25,000
6,500
7,000
88,500
50,000
25,000
6,500
7,000
88,500
50,000
25,000
6,500
7,000
88,500
485,400
617,700
(C) Ghanendra Fago (M Phil,
MBA)
12
Columnar or Tabular Approach
Example:
Cost of output levels of 10,000 units in a factory are as
follows:
Details
Cost per unit
Direct Material
Direct Labor
Variable Overheads
Fixed Overheads Rs.50,000
Selling expenses (10% fixed)]
Administrative expenses (100% fixed)
Distribution expenses (20% fixed)
Total Costs
Rs. 35
2.5
10
5
6.5
2.5
3.5
75
(C) Ghanendra Fago (M Phil,
MBA)
13
Preparation of Flexible Budget
Activity level in units
6,000 units
A. Variable Costs:
Direct material @ Rs. 35
Direct labor @ Rs. 12.5
Variable expenses @ Rs. 10
Selling expenses (90%) @ Rs. 5.85
Distribution expenses (80%) @ Rs. 2.8)
Total Variable Cost
B. Fixed Costs:
Fixed Overheads
Administrative Expenses
Selling Expenses 10% of 6.5 * 10,000
Distribution Expenses 20% of 3.5 * 10,000
Total Fixed Cost
C. Total Costs (A + B)
(C) Ghanendra Fago (M Phil,
MBA)
8,000 units
210,000
75,000
60,000
35,100
16,800
396,900
280,000
100,000
80,000
46,800
22,400
529,200
50,000
25,000
6,500
7,000
88,500
50,000
25,000
6,500
7,000
88,500
485,400
617,700
14
Manufacturing Overhead Variance
The total manufacturing overhead variance is equal to
the difference between the actual manufacturing
overhead costs incurred and the standard manufacturing
overhead costs applied to production
(C) Ghanendra Fago (M Phil,
MBA)
15
Types Of Overhead Variance
Capacity or volume variance
Spending variance
Efficiency variance
(C) Ghanendra Fago (M Phil,
MBA)
16
Calculation of Overhead Variance
Analytical Table
d.
Overhead Applied
xxx
(SOR x SLA)
SOR=FOR+VOR, FOR=FO/NC
c.
b.
a.
Budget Allowance for Standard Level of Activities(SLA)
(Fixed Overhead + VOR x SLA)
xxx
Budget Allowance for Actual Level of Activities (ALA)
(Fixed Overhead + VOR x Actual of Activities (hrs))
(FO + VOR x ALA)
xxx
Actual Overhead Incurred
(Actual Fixed Overhead + Actual Variable Overhead)
(C) Ghanendra Fago (M Phil,
MBA)
xxx
17
Variances

Capacity variance (a-b)=Overhead Applied-Budget
Allowance for Standard Level of Activities (SLA)

Efficiency variance(b-c)=Budget Allowance for Actual
Level of Activities (ALA)- Actual Overhead Incurred

Spending variance (c-d)=Budget Allowance for Standard
Level of Activities (SLA)- Budget Allowance for Actual
Level of Activities (ALA)
(C) Ghanendra Fago (M Phil,
MBA)
18
The following are the data relating to
overhead expenses of a company:
BA = Rs.400,000 + Rs.5 x DLH
Normal capacity 100,000DLH
Standard time per unit of output 2 DLH
Actual output 52,000 units
Actual hours worked 98,000 DLH
Actual overheads paid Rs.865,500
Required: The three overhead variances
(C) Ghanendra Fago (M Phil,
MBA)
19
Solution
Analytical Table
a. Overhead Applied (SOR x SLA)
(Rs.9x2x52,000) FOR=FO/NC=400,000/100,000=4
SOR=FOR+VOR=4+5=9
936,000
b. Budget Allowance for Standard Level of Activities(SLA)
(400,000+Rs.5x2x52,000)
920,000
c. Budget Allowance for Actual Level of Activities (ALA)
(400,000+Rs.5x98,000)
890,000
d. Actual Overhead Paid
865,500
(C) Ghanendra Fago (M Phil,
MBA)
20
Variances
Capacity Variance (a-b)
= Rs.(936,000-920,000)
= Rs.16,000(F)
Efficiency Variance (b-c)
= Rs.(920,000-890,000)
= Rs.30,000(F)
Spending Variance (s-d)
= Rs.(890,000-865,500)
= Rs.24,500(F)
(C) Ghanendra Fago (M Phil,
MBA)
21