Flexible Budgets, Variances, and Management Control: II

1. Flexible Budgets, Variances,and Management Control: II Chapter 8 March 21, 2005

2. Overhead Costs • Overhead costs can range from 10% to 50% or more of a firm’s total product cost • High OH results from increased automation, product complexity, product diversity, etc. • Variable OH costs include energy, maintenance, engineering support, indirect material and labor, • Fixed OH costs include primarily capacity costs such as depreciation, rent, property taxes, insurance, plant admin., etc.

3. Planning of Variable andFixed Overhead Costs Effective planning of variable overhead costs involves undertaking only those variable overhead activities that add value for customers using the product or service. The key challenge with planning fixed overhead is choosing the appropriate level of capacity or investment that will benefit the company. Can be too much or too little.

4. Learning Objective 2 Developing Variable Manufacturing Overhead Allocation Rates.

5. Developing Budgeted VariableOverhead Allocation Rates Step 1: Choose the time period used to compute the budget. Pasadena Co. uses a twelve-month budget period. Step 2: Select the cost-allocation base. Pasadena budgets 26,000 labor-hours for a budgeted output of 13,000 suits in year 2004.

6. Developing Budgeted VariableOverhead Allocation Rates Step 3: Identify the variable overhead costs. Pasadena’s budgeted variable manufacturing costs for 2004 are $312,000. Step 4: Compute the rate per unit of each cost-allocation base. $312,000 ÷ 26,000 hours = $12/hour

7. Developing Budgeted VariableOverhead Allocation Rates What is the budgeted variable overhead cost rate per output unit (dress suit)? 2.00 hours allowed per output unit × $12 budgeted variable overhead cost rate per input unit = $24 per suit (output unit)

8. Learning Objective 3 Compute the variable overhead efficiency variance and the variable overhead spending variance.

9. Variable OverheadCost Variances The following data are for 2004 when Pasadena produced and sold 10,000 suits: Output units: 10,000 Labor-hours: Actual results: 21,500 Flexible-budget (2 x 10,000) 20,000

10. Variable OverheadCost Variances Variable manufacturing overhead costs: Actual results: $244,775 Flexible-budget: ($12 x 20,000) $240,000 Underallocated by $ 4,775

11. Variable OverheadCost Variances Variable manufacturing overhead cost per labor-hour: Actual results: $244,775 ÷ 21,500 = $11.3849 Flexible-budget amount: $240,000 ÷ 20,000 = $12.00

12. Flexible-Budget Analysis The variable overhead flexible-budget variance measures the difference between the actual variable overhead costs and the flexible-budget variable overhead costs. Actual results: $244,775 – Flexible-budget amount $240,000 = $4,775 U

13. Flexible-Budget Analysis 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

14. Flexible-Budget Analysis Actual Quantity of Inputs at Budgeted Rate 21,500 × $12.00 = $258,000 Budgeted Inputs Allowed for Actual Outputs at Budgeted Rate 20,000 × $12.00 = $240,000 $18,000 U Variable overhead efficiency variance

15. Flexible-Budget Analysis 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

16. Variable Overhead Variances Flexible-budget variance $4,775 U Efficiency variance $18,000 U (Too many hours) Spending variance $13,225 F (Lower rate per unit)

17. Learning Objective 4 Discuss and explain efficiency variance causes and remedies for a variable indirect-cost item

18. Efficiency Variance In the Pasadena Co.’s example, the 21,500 actual direct manufacturing labor-hours are 7.5% greater than the flexible-budget amount of 20,000 direct manufacturing labor-hours. (21,500 – 20,000) ÷ 20,000 = 7.5% Therefore, since the actual hours are higher than the flexible budget amount, more variable overhead will be allocated to the product

19. Efficiency Variance Causes and Remedies (same as labor rate variance) Less skilled workers Inefficient production schedule or a rush job Poor machine maintenance Poor standard Improve hiring, training practices Improve production planning, scheduling Assure regular maintenance is performed Evaluate standards regularly; change as needed

20. Learning Objective 5 Compute a budgeted fixed overhead cost rate.

21. Developing Budgeted FixedOverhead Allocation Rates Step 1: Choose the time period used to compute the budget. The budget period is typically twelve months. Step 2: Select the cost-allocation base. Pasadena budgets 26,000 labor-hours for a budgeted output of 13,000 suits in year 2004.

22. Developing Budgeted FixedOverhead Allocation Rates Step 3: Identify the fixed overhead costs. Pasadena’s fixed manufacturing budget for 2004 is $286,000. (This is based on capacity of 13,000 units) Step 4: Compute the rate per unit of each cost-allocation base. $286,000 ÷ 26,000 hours = $11

23. Developing Budgeted FixedOverhead Allocation Rates 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)

24. Flexible-Budget Variance Actual Costs Incurred $300,000 Flexible Budget: Budgeted Fixed Overhead $286,000 – $14,000 U Fixed overhead flexible-budget variance

25. Production-Volume Variance Flexible Budget: Budgeted Fixed Overhead $286,000 Fixed Overhead Allocated Using Budgeted Input Allowed for Actual Output Units Produced $220,000* – $66,000 U Production-volume variance *10,000 × 2.00 × $11 = $220,000

26. Fixed Overhead Variances Fixed overhead variance $80,000 U Volume variance $66,000 U Spending variance $14,000 U

27. Learning Objective 6 Explain two concerns when interpreting the production-volume variance as a measure of the economic cost of unused capacity.

28. Interpreting the Production-Volume Variance Management may have maintained some extra capacity. Management may have made a strategic mistake • Demand turned out less than expected. • Management planning for business upsurge • Cost of overcapacity identified for all to see

29. Interpreting the Production-Volume Variance Had Pasadena manufactured 13,000 suits instead of 10,000, allocated fixed overhead would have been = $286,000 (13,000 × 2.00 × $11). No production-volume variance would have occurred.

30. Learning Objective 7 Show how the 4-variance analysis approach reconciles the actual overhead incurred with the overhead amounts allocated during the period.

31. Integrated Analysis A 4-variance analysis presents spending and efficiency variances for variable overhead costs and spending and production-volume variances for fixed overhead costs. Managers can reconcile the actual overhead costs with the overhead amounts allocated during the period.

32. Integrated Analysis (Lazy E) Actual variable overhead costs incurred $244,775 Flexible budget: budgeted inputs allowed × budgeted rate $240,000 – Flexible-budget variance $4,775 U Underallocated variable overhead

33. Integrated Analysis Actual variable overhead costs incurred $244,775 Actual inputs × budgeted rate $258,000 – Variable overhead spending variance $13,225 F

34. Integrated Analysis Actual inputs × budgeted rate $258,000 Flexible budget: budgeted inputs allowed × budgeted rate $240,000 – Variable overhead efficiency variance $18,000 U

35. Integrated Analysis – Fixed Overhead Actual fixed overhead costs incurred $300,000 Budgeted fixed overhead costs $286,000 – Fixed overhead spending variance $14,000 U

36. Integrated Analysis Budgeted fixed overhead costs $286,000 Budgeted inputs allowed × budgeted rate $220,000 – Volume variance $66,000 U

37. 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 Integrated Analysis

38. 4-Variance Analysis: Variable manufacturing overhead: Spending variance $13,225 F Efficiency variance 18,000 U Fixed manufacturing overhead: Spending variance 14,000 U Volume variance 66,000 U Total $84,775 U Integrated Analysis

39. Different Purposes of Overhead Cost Analysis • Planning and control purposes • Various levels of output • Capacity planning • 2. Inventory costing for financial reporting

40. Different Purposes of Overhead Cost Analysis Every output unit that Pasadena manufactures will increase the fixed overhead allocated to products by $22. Reduces unused capacity. Managers should not use this unitization of fixed manufacturing overhead costs for planning and control. Masks the capacity issue. Management needs to identify the production volume variance representing unused fixed manufacturing capacity

41. Financial and Nonfinancial Performance Overhead variances are examples of financial performance measures. What are examples of nonfinancial measures? Actual labor time relative to budgeted time Actual indirect materials usage relative to budgeted indirect materials usage

42. End of Chapter 8