Chapter
7
Flexible Budgets and
Overhead Analysis
Static Budgets and Performance
Reports
Hmm! Comparing
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.
Irwin/McGraw-Hill
static budgets with
actual costs is like
comparing apples
and oranges.
Let’s look at CheeseCo.
© The McGraw-Hill Companies, Inc., 2000
Static Budgets and Performance
Reports
CheeseCo
Static
Budget
Machine hours
Variable costs
Ind irect labor
Indirect materials
Power
Fixed costs
Depreciation
Insurance
Total overhead costs
Irwin/McGraw-Hill
Actual
Results
10,000
8,000
$ 40,000
30,000
5,000
$ 34,000
25,500
3,800
12,000
2,000
12,000
2,050
$ 89,000
$ 77,350
Variances
© The McGraw-Hill Companies, Inc., 2000
Static Budgets and Performance
Reports
CheeseCo
Static
Budget
Machine hours
10,000
Actual
Results
Variances
8,000
2,000 U
Variable costs
U = Unfavorable
variance
Ind irect labor
$ 40,000
$ 34,000
was30,000
unable to achieve
Indirect CheeseCo
materials
25,500
the budgeted 5,000
level of activity.
Power
3,800
Fixed costs
Depreciation
Insurance
Total overhead costs
Irwin/McGraw-Hill
$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., 2000
Static Budgets and Performance
Reports
CheeseCo
Static
Budget
Machine hours
Variable costs
Ind irect labor
Indirect materials
Power
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
F = Favorable variance that occurs when
Fixed costs
actual
costs are less than
budgeted12,000
costs.
Depreciation
12,000
Insurance
2,000
2,050
Total overhead costs
Irwin/McGraw-Hill
$ 89,000
$ 77,350
0
50 U
$11,650 F
© The McGraw-Hill Companies, Inc., 2000
Static Budgets and Performance
Reports
CheeseCo
Static
Budget
Machine hours
Variable costs
Ind irect labor
Indirect materials
Power
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
Since cost variances are favorable, have
Fixed costs
we
done a good job controlling
costs?
Depreciation
12,000
12,000
Insurance
2,000
2,050
Total overhead costs
Irwin/McGraw-Hill
$ 89,000
$ 77,350
0
50 U
$11,650 F
© The McGraw-Hill Companies, Inc., 2000
Static Budgets and Performance
Reports
I don’t think I
can answer the
question using
a static budget.
Irwin/McGraw-Hill
Actual activity is below
budgeted activity which
is unfavorable.
So, shouldn’t variable costs
be lower if actual activity
is lower?
© The McGraw-Hill Companies, Inc., 2000
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.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
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.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
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.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
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.
Irwin/McGraw-Hill
Fixed
© The McGraw-Hill Companies, Inc., 2000
Preparing a Flexible Budget
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Preparing a Flexible Budget
CheeseCo
Cost
Formula
Per Hour
Total
Fixed
Cost
Flexible Budgets
8,000
10,000
Hours
Hours
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
Irwin/McGraw-Hill
8,000
$
4.00
3.00
0.50
7.50
10,000
12,000
Hours
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., 2000
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
Irwin/McGraw-Hill
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., 2000
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
Irwin/McGraw-Hill
$
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., 2000
Preparing a Flexible Budget
CheeseCo
Cost
Formula
Per Hour
Total
Fixed
Cost
Machine hours
Variable costs
Indirect
labor fixed costs
4.00
Total
Indirect material
3.00
do
not
change
in
Power
0.50
the relevant
Total variable
cost
$ range.
7.50
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
Irwin/McGraw-Hill
$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., 2000
Flexible Budget
Performance Report
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Flexible Budget
Performance Report
CheeseCo
Cost
Total
FlexibleFormula
budget
is
Fixed
prepared
for theCosts
Per Hour
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
Irwin/McGraw-Hill
$
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
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,050
$ 14,050
$ 77,350
Variances
0
© The McGraw-Hill Companies, Inc., 2000
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
Irwin/McGraw-Hill
$
$
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., 2000
Flexible Budget
Performance Report
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
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
Irwin/McGraw-Hill
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., 2000
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.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
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.
Irwin/McGraw-Hill
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., 2000
Flexible Budget
Performance Report
There are two primary
reasons for unfavorable
variable overhead variances:
What causes
the cost
control variance?
Irwin/McGraw-Hill
1. Spending too much for
resources.
2. Using the resources
inefficiently.
© The McGraw-Hill Companies, Inc., 2000
Overhead Rates and Overhead
Analysis
Recall that overhead costs are assigned to
products and services using a
predetermined overhead rate (POHR):
Assigned Overhead = POHR × Standard Activity
POHR
Irwin/McGraw-Hill
=
Overhead from the
flexible budget for the
denominator level of activity
Denominator level of activity
© The McGraw-Hill Companies, Inc., 2000
Overhead Rates and Overhead
Analysis – Example
Let’s look at overhead
rates in a
budget for ColaCo.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Overhead Rates and Overhead
Analysis – Example
ColaCo prepared this
Machine
Hours
2,000
4,000
Total
Variable
Overhead
$
budget for overhead:
Variable
Overhead
Rate
4,000
?
8,000
?
Total
Fixed
Overhead
$
Fixed
Overhead
Rate
9,000
?
9,000
?
Let’s calculate overhead rates.
ColaCo applies overhead based
on machine hour activity.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Overhead Rates and Overhead
Analysis – Example
ColaCo prepared this
Machine
Hours
2,000
4,000
budget for overhead:
Total
Variable
Overhead
Variable
Overhead
Rate
Total
Fixed
Overhead
$
$
$
4,000
8,000
2.00
2.00
Fixed
Overhead
Rate
9,000
?
9,000
?
Rate = Total Variable Overhead ÷ Machine Hours
This rate is constant at all levels of activity.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Overhead Rates and Overhead
Analysis – Example
ColaCo prepared this
Machine
Hours
2,000
4,000
budget for overhead:
Total
Variable
Overhead
Variable
Overhead
Rate
Total
Fixed
Overhead
Fixed
Overhead
Rate
$
$
$
$
4,000
8,000
2.00
2.00
9,000
9,000
4.50
2.25
Rate = Total Fixed Overhead ÷ Machine Hours
This rate decreases when activity increases.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Overhead Rates and Overhead
Analysis – Example
ColaCo prepared this
Machine
Hours
2,000
4,000
budget for overhead:
Total
Variable
Overhead
Variable
Overhead
Rate
Total
Fixed
Overhead
Fixed
Overhead
Rate
$
$
$
$
4,000
8,000
2.00
2.00
9,000
9,000
4.50
2.25
The total POHR is the sum of
the fixed and variable rates
for a given activity level.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Overhead Variances
Let’s use the
overhead rates, to
determine variable
and fixed overhead
variances.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
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.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Variable Overhead Variances
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
AH × AR
Spending
Variance
AH ×
SR
Flexible Budget
for Variable
Overhead at
Standard Hours
SH ×
SR
Efficiency
Variance
Spending variance = AH(AR - SR)
Efficiency variance = SR(AH - SH)
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Variable Overhead Variances –
Example
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
3,300 hours
×
$2.00 per hour
$6,740
Spending variance
$140 unfavorable
$6,600
Flexible Budget
for Variable
Overhead at
Standard Hours
3,200 hours
×
$2.00 per hour
$6,400
Efficiency variance
$200 unfavorable
$340 unfavorable flexible budget total variance
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Variable Overhead Variances – A
Closer Look
Spending Variance
Results from paying more
or less than expected for
overhead items and from
excessive usage of
overhead items.
Irwin/McGraw-Hill
Efficiency Variance
Controlled by
managing the
overhead cost driver.
© The McGraw-Hill Companies, Inc., 2000
Overhead Variances
Now let’s turn
our attention
to fixed
overhead.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Overhead Rates and Overhead
Analysis – Example
ColaCo prepared this
Machine
Hours
2,000
4,000
budget for overhead:
Total
Variable
Overhead
Variable
Overhead
Rate
Total
Fixed
Overhead
Fixed
Overhead
Rate
$
$
$
$
4,000
8,000
2.00
2.00
9,000
9,000
4.50
2.25
What is ColaCo’s fixed overhead rate for an
estimated activity of 3,000 machine hours?
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Overhead Rates and Overhead
Analysis – Example
ColaCo prepared this
Machine
Hours
2,000
4,000
budget for overhead:
Total
Variable
Overhead
Variable
Overhead
Rate
Total
Fixed
Overhead
Fixed
Overhead
Rate
$
$
$
$
4,000
8,000
2.00
9,000
2.00
9,000
4.50
2.25
What is ColaCo’s
overhead
Fixedfixed
Overhead
Rate rate for an
estimated
activity÷of3,000
3,000
machine
hours?
FR = $9,000
machine
hours
FR = $3.00 per machine hour
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
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.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Fixed Overhead Variances
Actual Fixed
Overhead
Incurred
Budget
Variance
Fixed
Overhead
Budget
Fixed
Overhead
Applied
SH × FR
Volume
Variance
FR = Standard Fixed Overhead Rate
SH = Standard Hours Allowed
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Fixed Overhead Variances –
Example
Actual Fixed
Overhead
Incurred
Fixed
Overhead
Budget
Fixed
Overhead
Applied
SH × FR
3,200 hours
×
$3.00 per hour
$8,450
$9,000
$9,600
Budget variance
$550 favorable
Irwin/McGraw-Hill
Volume variance
$600 favorable
© The McGraw-Hill Companies, Inc., 2000
Fixed Overhead Variances –
A Closer Look
Budget Variance
Volume Variance
Results from paying more
or less than expected for
overhead items.
Results from operating
at an activity level
different from the
denominator activity.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Overhead Variances
Let’s look at a
graph showing
fixed overhead
variances. We will
use ColaCo’s
numbers from the
previous example.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Fixed Overhead Variances
Cost
3,000 Hours
Expected
Activity
Irwin/McGraw-Hill
Volume
3,200
Standard
Hours
© The McGraw-Hill Companies, Inc., 2000
Fixed Overhead Variances
Cost
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
Expected
Activity
Irwin/McGraw-Hill
Volume
3,200
Standard
Hours
© The McGraw-Hill Companies, Inc., 2000
Fixed Overhead Variances
Cost
$600
Favorable
Volume
Variance
{
$550 {
Favorable
3,200 machine hours × $3.00 fixed overhead rate
$9,600 applied fixed OH
$9,000 budgeted fixed OH
$8,450 actual fixed OH
Budget
Variance
3,000 Hours
Expected
Activity
Irwin/McGraw-Hill
Volume
3,200
Standard
Hours
© The McGraw-Hill Companies, Inc., 2000
Volume Variance – A Closer Look
Volume
Variance
Results when standard hours
allowed for actual output differs
from the denominator activity.
Unfavorable
when standard hours
< denominator hours
Irwin/McGraw-Hill
Favorable
when standard hours
> denominator hours
© The McGraw-Hill Companies, Inc., 2000
Volume Variance – A Closer Look
Volume
Variance
Does not measure overor under spending
Results when standard hours
allowed
for actual output
differs
Explainable
by
and
from the denominator activity.
controllable only through
activity
Unfavorable
when standard hours
< denominator hours
Irwin/McGraw-Hill
Favorable
when standard hours
> denominator hours
© The McGraw-Hill Companies, Inc., 2000
Overhead Variances and Under- or
Overapplied Overhead Cost
In a standard
cost system:
Unfavorable
variances are equivalent
to underapplied overhead.
Favorable
variances are equivalent
to overapplied overhead.
The sum of the overhead variances
equals the under- or overapplied
overhead cost for a period.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
End of Chapter 11
I’m here to
your
budget. Are you ready to
ante up?
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000