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11. Chapter Eleven. Flexible Budgeting and the Management of Overhead and Support Activity Costs. Flexible Budgets. Hmm! Comparing static budgets with actual costs is like comparing apples and oranges. Static budgets are prepared for a single, planned level of activity.

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flexible budgeting and the management of overhead and support activity costs

11

Chapter

Eleven

Flexible Budgeting and the Management of Overhead and Support Activity Costs

flexible budgets
Flexible Budgets

Hmm! Comparingstatic budgetswith actual costsis like comparingapples and oranges.

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.

flexible budgets3
Flexible Budgets

Hmm! Comparingstatic budgetswith actual costsis like comparingapples and oranges.

Considerthe following example from the Cheese Company . . .

static budgets and performance reports6
Static Budgets andPerformance Reports

F = Favorable variance since actual costs are less than budgeted costs.

static budgets and performance reports7
Static Budgets andPerformance Reports

Since cost variances are favorable, havewe done a good job controlling costs?

static budgets and performance reports8

I do know thatactual activity is belowbudgeted activity which is unfavorable.

But shouldn’t variable costsbe lower if actual activityis below budgeted activity?

Static Budgets andPerformance Reports

I don’t think I can answer this question using a static budget.

static budgets and performance reports9
Static Budgets andPerformance 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 mustthe budget to theactual level of activity.
flexible budgets10
Flexible Budgets

Central Concept

If you can tell me what your activity wasfor the period, I will tell you what your costs and revenue should have been.

preparing a flexible budget

Variable

Fixed

Preparing a Flexible Budget

To a budget for different activity levels, we must know how costs behave with changes in activity levels.

  • Total variable costs changein direct proportion to changes in activity.
  • Total fixed costs remainunchanged within therelevant range.
advantages of flexible budgets
Advantages of Flexible Budgets

Show revenues and expensesthat should have occurred at theactual 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.

preparing a flexible budget13
Preparing a Flexible Budget

Let’s prepare budgets for the Cheese Company.

preparing a flexible budget15
Preparing a Flexible Budget

Using an input activity measureas units of output may not be meaningful in a multiproduct firm.

preparing a flexible budget16
Preparing a Flexible Budget

Variable costs are expressed as a constant amount per hour.

In the original static budget, indirect labor was $40,000 for 10,000 hours resulting in a rate of $4.00 per hour.

preparing a flexible budget17
Preparing a Flexible Budget

Fixed costs are expressed as a total amount that does not change within the relevant range of activity.

preparing a flexible budget20
Preparing a Flexible Budget

Note: There is no flexin the fixed costs.

preparing a flexible budget21

Total budgetedoverhead cost

=

Budgeted variable Total overhead cost per activity activity unit units

Budgeted fixedoverhead cost

×

+

Preparing a Flexible Budget
flexible budget performance report27

Indirect labor and indirect material have unfavorable variances because actual costs are more than the flexible budget costs.

Flexible BudgetPerformance Report
choice of activity measure

Variable overhead and the activity measure should vary in a similar pattern.

  • Identify variable overhead cost drivers.
    • Examples: machine hours, labor hours, process time.
  • Dollar measures should be avoided as they are subject to price-level changes.
Choice of Activity Measure
slide31

Variable Overhead Variances

Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours

AH × AR

AH × SVR

SH × SVR

Spending Variance

EfficiencyVariance

AH = Actual Hours of Activity AR = Actual Variable Overhead RateSVR = Standard Variable Overhead RateSH = Standard Hours Allowed

slide32

Variable Overhead Variances

Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours

AH × AR

AH × SVR

SH × SVR

Spending Variance

EfficiencyVariance

Spending variance = AH(AR - SVR)

Efficiency variance = SVR(AH - SH)

variable overhead variances example
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.

variable overhead variances example34

Total budgetedoverhead cost

=

Budgeted variable Total overhead cost per activity activity unit units

Budgeted fixedoverhead cost

×

+

$2.00 permachine hour

Totalmachine hours

Total budgetedoverhead cost

=

×

+

$9,000

Variable Overhead Variances – Example

ColaCo prepared this budget for overhead:

variable overhead variances example35

Spending variance$140 unfavorable

Efficiency variance$200 unfavorable

Variable Overhead Variances – Example

Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours

3,300 hours 3,200 hours × × $2.00 per hour $2.00 per hour

$6,740

$6,600

$6,400

variable overhead variances example36
Variable Overhead Variances – Example

Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours

3,300 hours 3,200 hours × × $2.00 per hour $2.00 per hour

$6,740

$6,600

$6,400

The $140 unfavorable spending variance and the $200 unfavorable efficiency variance result in a $340 unfavorable flexible budget variance.

variable overhead variances a closer look
Spending Variance

Efficiency Variance

Variable Overhead Variances – A Closer Look

Results from paying moreor less than expected foroverhead items and from excessive usage ofoverhead items.

A function of the selected cost driver.

It does not reflectoverhead control.

fixed overhead
Fixed Overhead

Now let’s turn our attention to fixed overhead.

slide39

Fixed Overhead Variances

Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied

SH × PFOHR

Budget Variance

VolumeVariance

PFOHR = Predetermined Fixed Overhead Rate SH = Standard Hours Allowed

fixed overhead40

Budgeted Fixed OverheadPlanned Activity in Hours

Fixed Overhead

Recall that fixed overhead costs are applied to products and services using a predetermined fixed overhead rate (PFOHR):

Applied Fixed Overhead = PFOHR × Standard Hours

PFOHR =

fixed overhead variances example

Budgeted Fixed OverheadPlanned Activity in Hours

PFOHR =

$9,0003,000 machine hours

PFOHR =

PFOHR = $3.00 per machine hour

Fixed Overhead Variances – Example

ColaCo used the following predeterminedfixed overhead rate:

fixed overhead variances example42
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.

fixed overhead variances example43

Budget variance$550 favorable

Volume variance$600 (neither favorable nor unfavorable)

Fixed Overhead Variances – Example

Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied

3,200 hours × $3.00 per hour

$8,450

$9,000

$9,600

fixed overhead variances a closer look
Budget Variance

Volume Variance

Fixed Overhead Variances –A Closer Look

Results from paying moreor less than expected foroverhead items.

Results from the inabilityto operate at the activitylevel planned for the period.

Has no significance for cost control.

fixed overhead variances
Fixed Overhead Variances

Let’s look at a graph showing fixed overhead variances. We will use ColaCo’s numbers from the previous example.

fixed overhead variances46

3,200 machine hours × $3.00 fixed overhead rate

$9,600 applied fixed OH

$600Volume Variance

{

$9,000 budgeted fixed OH

{

$550FavorableBudget Variance

$8,450 actual fixed OH

Fixed Overhead Variances

Cost

Fixed overhead

applied to products

Volume

3,000 Hours PlannedActivity

3,200 StandardHours

activity based flexible budget48
Activity-Based Flexible Budget

If different cost drivers are identified for the different variable costs, an activity-based flexible budget should be prepared with different costformulas based on the different drivers.

end of chapter 11
End of Chapter 11

I’m here to your budget. Are you ready to ante up?

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