TM 11-1
AGENDA: FLEXIBLE BUDGETS AND OVERHEAD ANALYSIS
A.
Flexible budgets and performance reports
1. Static budgets
2. Flexible budgets
3. Flexible budget overhead performance report
B.
Further analysis of variable overhead
1. The choice of activity measure
2. Variable overhead spending variance
3. Variable overhead efficiency variance
C.
Overhead application in a standard cost system
1. Predetermined overhead rate
2. Applying overhead
D. Fixed overhead variances
1. Budget variance
2. Volume variance
E.
Overhead under- and overapplied and standard cost variances
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TM 11-2
STATIC BUDGETS
The budgets in Chapter 9 were “static.” A static budget is created at the
beginning of the budgeting period and is valid only for the budgeted level
of activity.
EXAMPLE: Larch Company, which makes a single product, bases its
budgets for manufacturing overhead on the following data:
Variable overhead cost category
Maintenance ...............................
Indirect materials........................
Utilities .......................................
Total variable overhead cost ........
Fixed overhead cost category
Depreciation ...............................
Supervision.................................
Insurance ...................................
Total fixed overhead cost ............
Standard
Cost Per Unit
$0.60
1.40
1.00
$3.00
Budgeted
Annual Cost
$ 40,000
50,000
10,000
$100,000
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TM 11-3
STATIC BUDGETS (continued)
Larch Company originally planned to produce and sell 10,000 units
during the year, but actual activity was only 8,000 units. A report based on
the static (i.e., original) budget from the beginning of the year follows:
Larch Company
Comparison of Actual Overhead Costs
to Budgeted Overhead Costs
Units produced and sold .....
Actual
8,000
Original
Budget
10,000
Variance
2,000 U
Variable overhead costs:
Maintenance ....................
Indirect materials.............
Utilities............................
Total variable overhead ......
$ 4,500
12,000
9,500
26,000
Fixed overhead costs:
Depreciation ....................
Supervision .....................
Insurance ........................
Total fixed overhead ...........
40,000
49,000
10,000
99,000
40,000
50,000
10,000
100,000
0
1,000 F
0
1,000 F
Total overhead cost ............
$125,000
$130,000
$5,000 F
$
6,000
14,000
10,000
30,000
$1,500
2,000
500
4,000
F
F
F
F
Does the above report, which is based on the original static budget,
indicate whether overhead spending was under control?
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TM 11-4
FLEXIBLE BUDGETS
• A flexible budget is geared toward all levels of activity within a relevant
range, rather than toward only one level of activity.
• A flexible budget is dynamic rather than static; it can be tailored for any
level of activity within the relevant range.
EXAMPLE: Refer to the data for Larch Company. A flexible budget for
manufacturing overhead is provided below for three different levels of
activity ranging from 5,000 to 15,000 units.
Larch Company
Flexible Budget for Overhead
Cost
Formula
Per Unit
Variable overhead costs:
Maintenance ..................
Indirect materials...........
Utilities..........................
Total variable overhead ....
Fixed overhead costs:
Depreciation ..................
Supervision ...................
Insurance ......................
Total fixed overhead .........
Total overhead cost ..........
$0.60
1.40
1.00
$3.00
5,000
Units
10,000
15,000
$ 3,000
7,000
5,000
15,000
$ 6,000
14,000
10,000
30,000
$ 9,000
21,000
15,000
45,000
40,000
50,000
10,000
100,000
40,000
50,000
10,000
100,000
40,000
50,000
10,000
100,000
$115,000 $130,000 $145,000
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TM 11-5
OVERHEAD PERFORMANCE REPORT
In a performance report focused on cost control, actual costs should be
compared to the flexible budget for the actual level of activity—not the
budget for the planned level of activity.
EXAMPLE: Because Larch Company produced and sold only 8,000 units
instead of the 10,000 units that had been planned, we would expect
spending on variable overhead items to be less than had been planned.
Larch Company
Overhead Performance Report
Cost
Formula
Per Unit
Variable overhead costs:
Maintenance .................
Indirect materials ..........
Utilities .........................
Total variable overhead....
Fixed overhead costs:
Depreciation .................
Supervision ...................
Insurance .....................
Total fixed overhead ........
Total overhead cost .........
$0.60
1.40
1.00
$3.00
Actual
Costs
Incurred
8,000
Units
$
Flexible
Budget
Based on Spending
8,000
& Budget
Units
Variances
4,500 $ 4,800
12,000
11,200
9,500
8,000
26,000
24,000
40,000
49,000
10,000
99,000
$ 300
800
1,500
2,000
40,000
50,000
10,000
100,000
0
1,000
0
1,000
$125,000 $124,000
$1,000
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TM 11-6
THE MEASURE OF ACTIVITY
• Most companies use a measure of activity such as labor-hours or
machine-hours as the activity base for manufacturing overhead. This is
particularly true in multi-product companies where hours often serve as
a common denominator for diverse products.
• Should actual hours or standard hours allowed for the actual output be
used in constructing budget allowances for the performance report?
There are two approaches:
1. The budget allowance is based solely on the actual hours. Then
only a spending variance for variable overhead is computed. (See
Exhibit 11-6 in the text for an example.)
2. Budget allowances are based on both the actual hours and the
standard hours allowed for the actual output. Then both spending
and efficiency variances are computed for variable overhead. (See
Exhibit 11-7 in the text for an example.)
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TM 11-7
Variable Overhead Performance Report:
Budget Allowances Based on Actual Hours
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TM 11-8
Variable Overhead Performance Report:
Budget Allowances Based on Actual Hours
and Standard Hours Allowed
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TM 11-9
OVERHEAD VARIANCE ANALYSIS
The flexible budget for manufacturing overhead provides information
to:
• Compute predetermined overhead rates.
• Complete the standard cost card.
• Apply overhead cost to products.
• Prepare overhead variance reports.
EXAMPLE: Swift Company manufactures a single product. Standard
cost data for the product follow:
Direct materials ....
Direct labor ..........
(1)
Standard
Quantity
or Hours
3.5 feet
2.0 hours
(2)
Standard
Price
or Rate
$12 per foot
$16 per hour
Standard
Cost
(1) × (2)
$42
$32
Overhead is assigned to the product on the basis of standard direct
labor-hours. Swift Company’s flexible budget for overhead (in
condensed form) is given below:
Variable costs .
Fixed costs .....
Total cost .......
Cost
Per DLH
$5
Direct Labor-Hours
10,000
15,000
20,000
$ 50,000
300,000
$350,000
$ 75,000 $100,000
300,000 300,000
$375,000 $400,000
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TM 11-10
PREDETERMINED OVERHEAD RATE
In a standard cost system, the predetermined overhead rate is
computed as follows:
Overhead from the flexible budget
at
the denominator level of activity
Predetermined =
overhead rate
Denominator level of activity
EXAMPLE: The predetermined overhead rate at Swift Company is
computed below for two levels of activity:
Denominator activity: 10,000 DLHs
Variable element: ($50,000 ÷ 10,000 DLHs) ..
Fixed element: ($300,000 ÷ 10,000 DLHs) ....
Predetermined overhead rate .......................
$ 5 per DLH
30 per DLH
$35 per DLH
Denominator activity: 15,000 DLHs
Variable element: ($75,000 ÷ 15,000 DLHs) ..
Fixed element: ($300,000 ÷ 15,000 DLHs) ....
Predetermined overhead rate .......................
$ 5 per DLH
20 per DLH
$25 per DLH
Note that the difference between the predetermined overhead rates
at the two levels of activity is entirely due to fixed overhead being
spread over different amounts of activity.
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TM 11-11
APPLYING OVERHEAD IN A STANDARD COST SYSTEM
Assume that the denominator level of activity at Swift Company is
15,000 DLHs. The following data apply to the current year’s
operations.
Denominator level of activity ................
Number of units completed ..................
Actual direct labor-hours ......................
Actual manufacturing overhead cost:
Variable ............................................
Fixed ................................................
Total ...................................................
15,000 DLHs
8,000 units
18,000 DLHs
$ 81,000
305,000
$386,000
In a standard cost system, overhead is applied on the basis of the
standard hours allowed for the actual output rather than on the basis
of the actual hours. This results in a simpler system in which the
overhead applied to units is always the same. In this example, the
overhead cost is always $50 per unit (2.0 DLHs per unit × $25 per
DLH)
Using the above data, the company’s manufacturing overhead
account would appear as follows:
Actual overhead cost
Manufacturing Overhead
386,000 Applied overhead cost
Overapplied overhead
400,000*
14,000
* 8,000 units × 2.0 DLHs per unit = 16,000 DLHs;
16,000 DLHs × $25 per DLH = $400,000.
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TM 11-12
VARIABLE OVERHEAD VARIANCES
Swift Company’s $14,000 overapplied overhead can be explained
by four variances: the variable overhead spending and efficiency
variances and the fixed overhead budget and volume variances. The
variable overhead variances are computed below:
Actual Hours of
Input, at the
Actual Rate
(AH × AR)
Actual Hours of
Input, at the
Standard Rate
(AH × SR)
18,000 DLHs ×
$5 per DLH
= $90,000
Standard Hours
Allowed for Output,
at the Standard Rate
(SH × SR)
16,000 DLHs ×
$5 per DLH
= $80,000
$81,000



Spending Variance,
Efficiency Variance,
$9,000 F
$10,000 U
Spending variance: The variable overhead spending variance
contains differences between actual and standard prices and between
actual and standard quantities.
Efficiency variance: The variable overhead efficiency variance is
not a measure of how efficiently overhead resources were used. It is
a measure of the efficiency with which the base underlying the
flexible budget was used.
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TM 11-13
FIXED OVERHEAD VARIANCES
Data concerning Swift Company are presented below:
Denominator activity (direct labor-hours) ...............
Actual direct labor-hours worked ...........................
Standard direct labor-hours allowed for output ......
Number of units produced ....................................
Budgeted fixed overhead cost ...............................
Actual fixed overhead cost incurred .......................
Fixed element of the predetermined overhead rate
15,000
18,000
16,000
8,000
$300,000
$305,000
$20
DLHs
DLHs
DLHs
units
Using these data, an analysis of the company’s fixed overhead
variances follows:
Actual Fixed
Overhead Cost
Budgeted Fixed
Overhead Cost
Fixed Overhead Cost
Applied to
Work in Process
16,000 DLHs ×
$20 per DLH
= $320,000
$300,000
$305,000


Budget Variance,
Volume Variance,
$5,000 U
$20,000 F

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TM 11-14
FIXED OVERHEAD VARIANCES (continued)
The fixed overhead variances can also be computed as follows:
Budget = Actual fixed - Budgeted fixed
variance
overhead cost
overhead cost
= $305,000 - $300,000
= $5,000 U
Fixed component of
Volume = the predetermined
variance
overhead rate
æ
ö
ççDenominator Standard÷
÷
- hours ÷
çç
÷
hours
çè
allowed ÷
ø
= $20 per DLH × (15,000 DLHs - 16,000 DLHs)
= $20,000 F
• The volume variance is not a measure of spending; it is affected
only by the level of activity.
Standard hours allowed for the actual activity >
Denominator level of activity
Favorable
Standard hours allowed for the actual activity <
Denominator level of activity
Unfavorable
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TM 11-15
GRAPHIC ANALYSIS OF VOLUME VARIANCE
Applied
fixed
overhead
320,000
300,000
Fixed overhead cost
applied at $20 per
standard hour
Volume variance
20,000 F
Budgeted
fixed
overhead
Denominator
hours
Standard
hours
allowed
13 14 15 16 17 18
Standard direct labor hours (000)
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TM 11-16
SUMMARY OF VARIANCES
• In a standard costing system, under or overapplied overhead
equals the sum of:
• Variable overhead spending variance
• Variable overhead efficiency variance
• Fixed overhead budget variance
• Fixed overhead volume variance
• Underapplied overhead is equivalent to a net unfavorable variance.
• Overapplied overhead is equivalent to a net favorable variance.
Thus, Swift Company’s $14,000 overapplied overhead can be
explained as follows:
Variable overhead:
Spending variance ................. $ 9,000
Efficiency variance ................. 10,000
Fixed overhead:
Budget variance ....................
5,000
Volume variance.................... 20,000
Overapplied overhead .............. $14,000
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