Chapter 11
Flexible Budgets and
Overhead Analysis
Static Budgets and
Performance Reports
Static budgets are
prepared for a single,
planned level of
activity.
Performance
evaluation is difficult
when actual activity
differs from the
planned level of
activity.
McGraw-Hill/Irwin
Hmm! Comparing
static budgets with
actual costs is like
comparing apples
and oranges.
Let’s look at CheeseCo.
© The McGraw-Hill Companies, Inc., 2003
Static Budgets and
Performance Reports
CheeseCo
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Static Budgets and
Performance Reports
CheeseCo
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Static Budgets and
Performance Reports
CheeseCo
U = Unfavorable variance
CheeseCo was unable to achieve
the budgeted level of activity.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Static Budgets and
Performance Reports
CheeseCo
F = Favorable variance that occurs when
actual costs are less than budgeted costs.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Static Budgets and
Performance Reports
CheeseCo
Since cost variances are favorable, have
we done a good job controlling costs?
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Static Budgets and
Performance Reports
I don’t think I
can answer the
question using
a static budget.
McGraw-Hill/Irwin
Actual activity is below
budgeted activity.
So, shouldn’t variable costs
be lower if actual activity
is lower?
© The McGraw-Hill Companies, Inc., 2003
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.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
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.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
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.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Preparing a Flexible Budget
To
a budget we need to know that:

Total variable costs change
in direct proportion to
changes in activity.

Total fixed costs remain
unchanged within the
relevant range.
McGraw-Hill/Irwin
Fixed
© The McGraw-Hill Companies, Inc., 2003
Preparing a Flexible Budget
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Preparing a Flexible Budget
CheeseCo
Cost
Formula
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
McGraw-Hill/Irwin
Flexible Budgets
8,000
10,000
Hours
Hours
8,000
$
4.00
3.00
0.50
7.50
12,000
Hours
10,000
12,000
Variable costs are expressed as
$ 32,000 amount per hour.
a constant
24,000
$40,000
4,000÷ 10,000 hours
$ 60,000
$4.00 per hour.
$12,000
2,000
is
Fixed costs are
expressed as a
total amount.
© The McGraw-Hill Companies, Inc., 2003
Preparing a Flexible Budget
CheeseCo
Cost
Formula
Per Hour
Total
Fixed
Cost
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
8,000
$
Fixed costs
Depreciation $4.00
Insurance
Total fixed cost
Total overhead costs
McGraw-Hill/Irwin
Flexible Budgets
8,000
10,000
Hours
Hours
4.00
3.00
0.50
7.50
10,000
12,000
Hours
12,000
$ 32,000
24,000
4,000
$ 60,000
per hour
× 8,000 hours = $32,000
$12,000
2,000
© The McGraw-Hill Companies, Inc., 2003
Preparing a Flexible Budget
CheeseCo
Cost
Formula
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
McGraw-Hill/Irwin
Flexible Budgets
8,000
10,000
Hours
Hours
8,000
$
4.00
3.00
0.50
7.50
10,000
12,000
Hours
12,000
$ 32,000
24,000
4,000
$ 60,000
$12,000
2,000
$ 12,000
2,000
$ 14,000
$ 74,000
?
© The McGraw-Hill Companies, Inc., 2003
Quick Check 
What should be the total overhead costs for the
Flexible Budget at 10,000 hours?
a. $92,500.
b. $74,000.
c. $89,000.
d. $94,000.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Preparing a Flexible Budget
CheeseCo
Cost
Formula
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
McGraw-Hill/Irwin
Flexible Budgets
8,000
10,000
Hours
Hours
8,000
10,000
4.00
$ 32,000
3.00 fixed costs
24,000
Total
0.50not change 4,000
do
in
$ 7.50
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$12,000
2,000
$ 12,000
2,000
$ 14,000
$ 89,000
the relevant range.
$ 12,000
2,000
$ 14,000
$ 74,000
12,000
Hours
12,000
© The McGraw-Hill Companies, Inc., 2003
Quick Check 
What should be the total overhead costs for the
Flexible Budget at 12,000 hours?
a. $92,500.
b. $89,000.
c. $106,800.
d. $104,000.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Preparing a Flexible Budget
CheeseCo
Cost
Formula
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
McGraw-Hill/Irwin
$
4.00
3.00
0.50
7.50
$12,000
2,000
Flexible Budgets
8,000
10,000
Hours
Hours
12,000
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
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
© The McGraw-Hill Companies, Inc., 2003
Flexible Budget
Performance Report
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Flexible Budget
Performance Report
CheeseCo
Flexible budget is
prepared for the Cost
Total
Formula
Fixed
Flexible
same activity level
Per Hour
Costs
Budget
(8,000 hours) as
Machine
hoursachieved.
8,000
actually
Variable costs
Indirect labor
Indirect material
Power
Total variable costs
Fixed Expenses
Depreciation
Insurance
Total fixed costs
Total overhead costs
McGraw-Hill/Irwin
$
$
4.00
3.00
0.50
7.50
Actual
Results
8,000
Variances
0
$ 34,000
25,500
3,800
$ 63,300
$ 12,000
2,000
$ 12,000
2,050
$ 14,050
$ 77,350
© The McGraw-Hill Companies, Inc., 2003
Quick Check 
What is the variance for indirect labor when the
flexible budget for 8,000 hours is compared to
the actual results?
a. $2,000 U
b. $2,000 F
c. $6,000 U
d. $6,000 F
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Flexible Budget
Performance Report
CheeseCo
Cost
Formula
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
McGraw-Hill/Irwin
$
$
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
Variances
0
$ 2,000 U
$ 12,000
2,000
$ 14,000
$ 74,000
© The McGraw-Hill Companies, Inc., 2003
Quick Check 
What is the variance for indirect materials when
the flexible budget for 8,000 hours is compared
to the actual results?
a. $1,500 U
b. $1,500 F
c. $4,500 U
d. $4,500 F
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Flexible Budget
Performance Report
CheeseCo
Cost
Formula
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
McGraw-Hill/Irwin
$
$
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
Variances
0
$ 2,000 U
1,500 U
$ 12,000
2,000
$ 14,000
$ 74,000
© The McGraw-Hill Companies, Inc., 2003
Quick Check 
What is the variance for depreciation when the
flexible budget for 8,000 hours is compared to
the actual results?
a. $0
b. $1,000 F
c. $2,000 U
d. $2,000 F
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Flexible Budget
Performance Report
CheeseCo
Cost
Formula
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
McGraw-Hill/Irwin
$
$
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
2,050
$ 14,050
$ 77,350
0
50 U
50 U
$ 3,350 U
Variances
0
© The McGraw-Hill Companies, Inc., 2003
Flexible Budget
Performance Report
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Static Budgets and Performance
How much of the $11,650 is due to activity
and how much is due to cost control?
Static
Budget
Machine hours
Variable costs
Ind irect labor
Indirect materials
Power
Fixed costs
Depreciation
Insurance
Total overhead costs
McGraw-Hill/Irwin
Actual
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
12,000
2,000
12,000
2,050
0
50 U
$ 89,000
$ 77,350
$11,650 F
© The McGraw-Hill Companies, Inc., 2003
Flexible Budget
Performance Report
Overhead Variance Analysis
Static
Overhead
Budget at
10,000 Hours
$
89,000
Let’s place
the flexible
budget for
8,000 hours
here.
Actual
Overhead
at
8,000 Hours
$
77,350
Difference between original static budget
and actual overhead = $11,650 F.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Flexible Budget
Performance Report
Overhead Variance Analysis
Static
Overhead
Budget at
10,000 Hours
$
89,000
Flexible
Overhead
Budget at
8,000 Hours
$
Activity
This $15,000F variance is
due to lower activity.
McGraw-Hill/Irwin
74,000
Actual
Overhead
at
8,000 Hours
$
77,350
Cost control
This $3,350U flexible
budget variance is due
to poor cost control.
© The McGraw-Hill Companies, Inc., 2003
Flexible Budget
Performance Report
There are two primary
reasons for unfavorable
variable overhead variances:
What causes
the cost
control variance?
McGraw-Hill/Irwin
1. Spending too much for
resources.
2. Using the resources
inefficiently.
© The McGraw-Hill Companies, Inc., 2003