Flexible Budgets, Variances, and
Management Control: II
Cost Accounting
Horngreen, Datar, Foster
1
Planning of Variable and
Fixed Overhead Costs
ƒ Rockville Co. manufactures dress suits that are then sold to
distributors.
ƒ Variable overhead costs include:
–
–
–
–
Energy
Machine maintenance
Indirect materials
Indirect labor
ƒ Fixed manufacturing overhead costs include:
– Plant leasing costs
– Some administrative costs (plant manager’s salary)
– Depreciation
Cost Accounting
Horngreen, Datar, Foster
2
Planning of Variable and
Fixed Overhead Costs
ƒ Effective planning of variable overhead costs involves
undertaking only those variable overhead activities that add
value for customers using the product or service.
• Rockville’s customers perceive sewing to be an essential
activity, therefore, maintenance activities for sewing
machines included in variable overhead costs are also
essential.
ƒ Effective planning of fixed overhead costs involves planning
to undertake only essential activities and then planning to be
efficient in that undertaking.
Cost Accounting
Horngreen, Datar, Foster
3
Planning of Variable and
Fixed Overhead Costs
ƒ The key challenge with planning fixed overhead is choosing
the appropriate level of capacity or investment that will
benefit the company over an extended time period.
ƒ Most of the key decisions that determine the level of fixed
overhead costs to be incurred are made at the start of a
budget period.
ƒ Day-to-day, ongoing operating decisions play a large role in
determining the level of variable overhead costs incurred in
the budget period.
Cost Accounting
Horngreen, Datar, Foster
4
Standard Costing
ƒ Remember: With standard costing direct costs are traced
to a cost object by multiplying the standard price(s) or
rate(s) times the standard inputs allowed for actual outputs
produced.
ƒ Costs of every product or service planned to be worked on
during the period can be computed at the start of that
period.
ƒ Once standards have been set, the costs of operating a
standard costing system can be low relative to an actual or
normal costing system.
Cost Accounting
Horngreen, Datar, Foster
5
Developing Budgeted Variable Overhead
Allocation Rates
ƒ Variable overhead cost allocation rates can be developed
with a four step approach.
ƒ Step 1: Choose the time period used to compute the budget.
• Rockville uses a twelve-month budget period.
Cost Accounting
Horngreen, Datar, Foster
6
Developing Budgeted Variable Overhead
Allocation Rates
ƒ Variable overhead cost allocation rates can be developed
with a four step approach.
ƒ Step 1: Choose the time period used to compute the budget.
ƒ Step 2: Select the cost-allocation bases to use in allocating
variable overhead-costs to the cost object(s).
• Rockville selects standard labor-hours as the cost allocation base.
• Rockville budgets 26,000 labor hours for a budgeted output of 13,000
suits in year 2012.
Cost Accounting
Horngreen, Datar, Foster
7
Developing Budgeted Variable Overhead
Allocation Rates
ƒ Variable overhead cost allocation rates can be developed
with a four step approach.
ƒ Step 1: Choose the time period used to compute the budget.
ƒ Step 2: Select the cost-allocation bases to use in allocating
variable overhead-costs to the cost object(s).
ƒ Step 3: Identify the variable overhead costs associated with
each cost-allocation base.
• Rockville groups all its variable manufacturing overhead costs
(energy, machine maintenance, engineering support, indirect
materials, indirect labor) into a single cost pool.
• Rockville’s budgeted variable manufacturing costs for 2012 are
$312,000.
Cost Accounting
Horngreen, Datar, Foster
8
Developing Budgeted Variable Overhead
Allocation Rates
ƒ Variable overhead cost allocation rates can be developed
with a four step approach.
ƒ Step 1: Choose the time period used to compute the budget.
ƒ Step 2: Select the cost-allocation bases to use in allocating
variable overhead-costs to the cost object(s).
ƒ Step 3: Identify the variable overhead costs associated with
each cost-allocation base.
ƒ Step 4: Compute the rate per unit of each cost-allocation base
used to allocate variable overhead costs to the cost object(s).
• Rockville estimates a rate of $12/labor hour for its variable
manufacturing overhead costs.
– $312,000 ÷ 26,000 hours = $12/hour
Cost Accounting
Horngreen, Datar, Foster
9
Developing Budgeted Variable Overhead
Allocation Rates
ƒ What is the budgeted variable overhead cost rate per output
unit (dress suit)?
ƒ 2.00 hours allowed per output unit
× $12 budgeted variable overhead cost rate per input unit
= $24 per suit (output unit)
Cost Accounting
Horngreen, Datar, Foster
10
Variable Overhead Cost Variances
ƒ The following data are for 2012 when Rockville Co. produced and
sold 10,000 suits:
1 Output units: 10,000
2 Labor-hours: Actual results: 21,500
Flexible-budget amount: 20,000
3 Labor-hours/output unit: Actual results: 21,500 ÷ 10,000 = 2.15
Flexible-budget amount: 20,000 ÷ 10,000 = 2.00
4 Variable manufacturing overhead costs: Actual results: $244,775
Flexible-budget amount:
$240,000
5 Variable manufacturing overhead cost per labor hour:
Actual results: $244,775 ÷ 21,500 = $11.3849
Flexible-budget amount: $240,000 ÷ 20,000 = $12.00
6 Variable manufacturing overhead cost per output unit:
Actual results:
$244,775 ÷ 10,000 = $24.4775
Flexible-budget amount: $240,000 ÷ 10,000 = $24.00
Cost Accounting
Horngreen, Datar, Foster
11
Flexible-Budget Analysis
ƒ The variable overhead flexible-budget variance measures
the difference between the actual variable overhead costs
and the flexible-budget variable overhead costs.
Actual
Costs
Incurred
21,500 × $11.3849
= $244,775
Budgeted Inputs
Allowed for Actual
Outputs at Budgeted Rate
20,000 × $12.00
= $240,000
$4,775 U
Flexible-budget variance
Cost Accounting
Horngreen, Datar, Foster
12
Variable Overhead Efficiency Variance
ƒ The variable overhead efficiency variance measures the
efficiency with which the cost-allocation base is used.
• (Actual units of variable overhead cost-allocation base used for actual
output − Budgeted units of variable overhead cost-allocation base
allowed for actual output) x Budgeted variable overhead rate =
(21,500 – 20,000) × $12 = $18,000 U
• This unfavorable variance means that actual labor-hours were higher
than the budgeted labor-hours allowed.
Actual Quantity of Inputs at
Budgeted Inputs Allowed for Actual
Budgeted Rate
Outputs at Budgeted Rate
21,500 × $12.00
20,000 × $12.00
= $258,000
= $240,000
$18,000 U
Variable overhead efficiency variance
Cost Accounting
Horngreen, Datar, Foster
13
Variable Overhead Spending Variance
ƒ The variable overhead spending variance is the difference
between the actual amount of variable overhead incurred
and the budgeted amount allowed for the actual quantity of
the variable overhead allocation base used for the actual
output units produced.
Actual
Costs
Incurred
21,500 × $11.3849
= $244,775
Actual Quantity
of Inputs at
Budgeted Rate
21,500 × $12.00
= $258,000
$13,225 F
Variable overhead spending variance
Cost Accounting
Horngreen, Datar, Foster
14
Variable Overhead Variances
Flexible-budget variance
$4,775 U
Efficiency variance
$18,000 U
Cost Accounting
Spending variance
$13,225 F
Horngreen, Datar, Foster
15
Developing Budgeted Fixed Overhead
Allocation Rates
ƒ Fixed overhead costs are a lump sum that remains
unchanged in total for a given time period despite wide
changes in the related total activity or output level.
ƒ While total fixed costs are frequently included in flexible
budgets, they remain the same total amount within the
relevant range regardless of the output level chosen.
Cost Accounting
Horngreen, Datar, Foster
16
Developing Budgeted Fixed Overhead
Allocation Rates
ƒ 4 steps in developing the budgeted fixed overhead rate:
ƒ Step 1: Choose the time period used to compute the budget.
• The budget period is typically twelve months.
Cost Accounting
Horngreen, Datar, Foster
17
Developing Budgeted Fixed Overhead
Allocation Rates
ƒ 4 steps in developing the budgeted fixed overhead rate:
ƒ Step 1: Choose the time period used to compute the budget.
ƒ Step 2: Select the cost-allocation base to use in allocating
fixed overhead costs to the cost object(s).
• Rockville uses standard labor hours as the cost allocation base for
fixed manufacturing overhead costs.
• In year 2012, Rockville budgets 26,000 labor hours for a budgeted
output of 13,000 suits.
Cost Accounting
Horngreen, Datar, Foster
18
Developing Budgeted Fixed Overhead
Allocation Rates
ƒ 4 steps in developing the budgeted fixed overhead rate:
ƒ Step 1: Choose the time period used to compute the budget.
ƒ Step 2: Select the cost-allocation base to use in allocating
fixed overhead costs to the cost object(s).
ƒ Step 3: Identify the fixed overhead costs associated with
each cost-allocation base.
• Rockville groups all its fixed manufacturing overhead costs
(depreciation, leasing costs, plant manager’s salary) in a single
cost pool.
• Rockville’s fixed manufacturing budget for 2012 is $286,000.
Cost Accounting
Horngreen, Datar, Foster
19
Developing Budgeted Fixed Overhead
Allocation Rates
ƒ 4 steps in developing the budgeted fixed overhead rate:
ƒ Step 1: Choose the time period used to compute the budget.
ƒ Step 2: Select the cost-allocation base to use in allocating
fixed overhead costs to the cost object(s).
ƒ Step 3: Identify the fixed overhead costs associated with
each cost-allocation base.
ƒ Step 4: Compute the rate per unit of each cost-allocation
base used to allocate fixed overhead costs to the cost
object(s).
• Rockville estimates a rate of $11/labor-hour for its fixed
manufacturing overhead costs.
• $286,000 ÷ 26,000 = $11
Cost Accounting
Horngreen, Datar, Foster
20
Developing Budgeted Fixed Overhead
Allocation Rates
ƒ What is the budgeted fixed overhead cost rate per output
unit (dress suit)?
2.00 hours allowed per output unit
× $11 budgeted fixed overhead
cost rate per input unit
= $22 per suit (output unit)
Cost Accounting
Horngreen, Datar, Foster
21
Fixed Overhead Cost Variances
ƒ The flexible budget amount for a fixed cost item is the
amount included in the static budget prepared at the start of
the period.
ƒ No adjustment is required for differences between the actual
output and the budgeted output for fixed costs.
ƒ Fixed costs are unaffected by changes in the level of output.
Cost Accounting
Horngreen, Datar, Foster
22
Flexible-Budget Variance
ƒ The fixed overhead flexible-budget variance (spending
variance) is the difference between actual fixed overhead
costs and the fixed overhead costs in the flexible budget.
• Assume that Rockville’s actual total fixed overhead is $300,000.
• Actual costs incurred $300,000
– Flexible-budget amount $286,000 = $14,000 U
ƒ The variable overhead flexible-budget variance was
subdivided into a spending variance and an efficiency
variance.
• For fixed overhead there is not an efficiency variance. Why?
• Because a lump sum of fixed costs will be unaffected by the degree of
operating efficiency in a given budget period.
Cost Accounting
Horngreen, Datar, Foster
23
Production-Volume Variance
ƒ The production-volume variance is the difference between budgeted
fixed overhead and the fixed overhead allocated on the basis of the
budgeted quantity of the fixed overhead allocation base allowed for the
actual output produced.
Flexible Budget:
Budgeted
Fixed Overhead
Fixed Overhead
Allocated Using Budgeted Input
Allowed for Actual
Output Units Produced
$286,000
$220,000
$66,000 U
Production-volume variance
10,000 × 2.00 × $11 = $220,000
Cost Accounting
Horngreen, Datar, Foster
24
Fixed Overhead Variances
Fixed overhead variance
$80,000 U
Volume variance
$66,000 U
Cost Accounting
Spending variance
$14,000 U
Horngreen, Datar, Foster
25
Fixed overhead variances
Actual Cost Function
Cost
Budgeted Cost Function
300
14 286
66
Labor hours
20
Cost Accounting
26
Horngreen, Datar, Foster
26
Interpreting the Production-Volume
Variance
ƒ Caution is appropriate before interpreting the productionvolume variance as a measure of the economic cost of
unused capacity.
• One caveat is that management may have maintained
some extra capacity to meet uncertain demand surges
that are important to satisfy customer demands.
• A second caveat is that the production-volume variance
focuses only on costs.
It does not take into account any price changes
necessary to spur extra demand that would in turn make
use of any idle capacity.
Cost Accounting
Horngreen, Datar, Foster
27
Interpreting the Production-Volume
Variance
ƒ Lump-sum fixed costs represent resources sacrificed in
acquiring capacity.
• Plant
• Equipment leases
ƒ These costs cannot be decreased if the resources
needed are less than the resources acquired.
Cost Accounting
Horngreen, Datar, Foster
28
Interpreting the Production-Volume
Variance
ƒ The unfavorable $66,000 production-volume variance
measures the amount of extra fixed costs that Rockville
incurred for manufacturing capacity it planned to use but
did not.
ƒ Had Rockville manufactured 13,000
suits instead of 10,000, allocated fixed
overhead would have been
13,000 × 2.00 × $11 = $286,000.
ƒ No production-volume variance
would have occurred.
Cost Accounting
Horngreen, Datar, Foster
29
Integrated Analysis
ƒ A 4-Variance Analysis presents
• spending and
• efficiency variances for variable overhead costs
• and spending and
• production-volume variances for fixed overhead costs.
ƒ Managers can reconcile the actual overhead costs with the
overhead amounts allocated during the period.
Cost Accounting
Horngreen, Datar, Foster
30
Integrated Analysis
Actual manufacturing overhead incurred:
Variable manufacturing overhead
$244,775
Fixed manufacturing overhead
300,000
Total
$544,775
Overhead allocated:
Variable manufacturing overhead
$240,000
Fixed manufacturing overhead
220,000
Total
$460,000
Amount underallocated
$ 84,775
Cost Accounting
Horngreen, Datar, Foster
31
Integrated Analysis
4-Variance Analysis
Variable manufacturing overhead:
Spending variance
Efficiency variance
Fixed manufacturing overhead:
Spending variance
Volume variance
Total
Cost Accounting
Horngreen, Datar, Foster
$13,225 F
18,000 U
14,000 U
66,000 U
$84,775 U
32
Integrated Analysis
3-Variance Analysis
Variable and fixed manufacturing overhead:
Spending variance
$13,225 F + $14,000 U =
$ 775 U
Variable manufacturing overhead:
Efficiency variance
18,000 U
Fixed manufacturing overhead:
Volume variance
66,000 U
Total
$84,775 U
Cost Accounting
Horngreen, Datar, Foster
33
Integrated Analysis
2-Variance Analysis
Variable and fixed manufacturing overhead:
Spending variance
$ 775 U
Variable manufacturing overhead:
Efficiency variance
18,000 U
Flexible-budget variance:
$18,775 U
Fixed manufacturing overhead
Volume variance:
66,000 U
Total
$84,775 U
Cost Accounting
Horngreen, Datar, Foster
34
Different Purposes of
Overhead Cost Analysis
ƒ Variable manufacturing overhead costs are variable with
respect to output units (suits) for both planning and
control purposes and inventory costing purpose.
ƒ The greater the number of output units manufactured,
the higher the budgeted total variable manufacturing
overhead costs and the higher the total variable
manufacturing overhead costs allocated to output units
Cost Accounting
Horngreen, Datar, Foster
35
Different Purposes of
Overhead Cost Analysis
ƒ Fixed overhead costs do not change within the relevant
range.
ƒ Management can do little to change the lump-sum fixed
cost.
ƒ Under generally accepted accounting principles, fixed
manufacturing costs are allocated as an inventoriable
cost based on the level of output units produced.
Cost Accounting
Horngreen, Datar, Foster
36
Different Purposes of
Overhead Cost Analysis
ƒ Every output unit that Rockville manufactures will
increase the fixed overhead allocated to products by
$22.
ƒ Managers should not use this unitization of fixed
manufacturing overhead costs for planning and control.
Cost Accounting
Horngreen, Datar, Foster
37
Financial and Nonfinancial Performance
ƒ Overhead variances are examples of financial
performance measures.
ƒ Managers also find that nonfinancial measures provide
useful information. Examples are:
1 actual labor time per suit, relative to budgeted labor time per suit,
and...
2 actual indirect materials usage per labor-hour, relative to
budgeted indirect materials usage per labor-hour.
ƒ Nonfinancial performance measures are best viewed as
attention directors, not as problem solvers.
Cost Accounting
Horngreen, Datar, Foster
38
True or False ???
ƒ
Effective planning of variable overhead costs for a product or service means that
a company does involve a variable overhead activity, even if it does not add
value.
ƒ
The variable overhead efficiency variance is based on the efficiency with which
the cost-allocation base is used.
ƒ
Fixed costs for the period are by definition a lump sum of costs that remain
unchanged and therefore the fixed overhead spending variance is always zero.
ƒ
An unfavorable production-volume variance always infers that management
made a bad planning decision regarding the plant capacity.
Cost Accounting
Horngreen, Datar, Foster
39
Pick your Chioce I:
ƒ SJH has the following information with respect to variable manufacturing
overhead for the month of April. The budget calls for 11,000 units to be
produced using a total of 4,400 machine-hours. The variable overhead
costs for the period are budgeted to be $132,000. During April, the
actual output was 10,000 units. The total variable overhead costs were
$132,250, and 4,600 machine-hours were actually used. What is the
standard machine-hours allowed per unit of output?
•
•
•
•
0.40
0.42
0.44
0.46
Cost Accounting
Horngreen, Datar, Foster
40
Pick your Chioce II:
ƒ CFH, Inc., which uses a standard costing system, has the following
information for the current year. The budgeted fixed costs are $240,000.
The budgeted activity level of machine-hours, the allocation base, is
48,000. The firm budgets at a level of 36,000 units of product HJS.
During the year, the firm actually produced 35,800 units of HJS. CFH
used 48,200 machine-hours during the period and incurred costs totaling
$239,500. What is the budgeted fixed overhead cost per output unit?
• $3.75
• $5.00
• $6.67
• $7.50
Cost Accounting
Horngreen, Datar, Foster
41