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# Flexible budgets & overhead costs

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### Flexible budgets & overhead costs

1. 1. Hilton • Maher • Selto
3. 3. What Are Flexible Overhead Budgets? 17- A flexible budget is valid for a range of activity A static budget is based on a particular planned level of activity This range of activity is the relevant range A flexible overhead budget is defined as a detailed plan for controlling overhead cost valid in the firm’s relevant range of activity
4. 4. Static Budget Versus Flexible Budget 17- Based on planned June production of 4,000 tents, at 1.5 machine hours per tent. We cannot tell from this budget what it would cost to make 3,000 tents. Based on only ONE anticipated activity level Includes several possible activity levels Exh. 17-1
5. 5. Advantages Of Flexible Budgets 17- Actual Electricity Cost Budgeted Electricity Cost (static budget) \$1,050 \$1,200 The manager is comparing the electricity cost incurred at the ACTUAL activity level (3,000 tents) with the budgeted electricity cost at the PLANNED activity level (4,000 tents). These activity levels are different, therefore we would expect the electricity cost to be different Cost Variance \$150 Favorable
6. 6. Advantages Of Flexible Budgets 17- Actual Electricity Cost Budgeted Electricity Cost (flexible budget) Cost Variance \$1,050 \$900 \$150 Unfavorable The manager is comparing the electricity cost incurred at the ACTUAL activity level, 3,000 tents with the budgeted electricity cost at the ACTUAL activity level, (3,000 tents x 1.5 machine hours) = 4,500 machine hours Electrical cost was greater than it should have been, given the actual level of output
7. 7. Activity Measure: Based On Input Or Output 17- Output measures require different inputs Output measures can be used if you only make one product Flexible budget must be based on outputs that can be compared
8. 8. Flexible Budgets: Inputs Versus Outputs 17- 1.5 standard allowed machine hours per tent Usually not a meaningful measure in a multi-product firm because it would require us to add numbers of unlike products Output is measured in terms of the standard allowed input, given actual output
9. 9. Formula Flexible Budget 17- If you recall, this is similar to the Predetermined Cost-Driver Rate discussed in Chapter 4. EXAMPLE Assume that the company needs flexible budget numbers for three activity levels: 4,500 hours, 6,000 hours, and 7,500 hours. Also, assume that the Predetermined Budgeted Variable-Overhead Cost per Activity Unit is \$6 per hour. Budgeted Fixed-Overhead Cost for the month is \$30,000. Flexible Budget? .
10. 10. Formula Flexible Budget 17- The flexed total budgeted monthly overhead for each activity level can now be used effectively in planning and variance analysis.
11. 11. Overhead Application - Normal Costing 17- Manufacturing Overhead Work-in-Process Inventory Actual overhead Applied overhead Actual hours Predetermined overhead rate X Applied overhead Actual hours Predetermined overhead rate X The Difference between Normal Costing and Standard Costing lies in the quantity of hours used Exh. 17-4
12. 12. Overhead Application - Standard Costing 17- Manufacturing Overhead Work-in-Process Inventory Actual overhead Applied overhead Standard allowed hours Predetermined or standard overhead rate X Applied overhead Standard allowed hours Predetermined or standard overhead rate X The Difference between Normal Costing and Standard Costing lies in the quantity of hours used Exh. 17-4
13. 13. Predetermined Overhead Rates 17- Both normal-costing and standard-costing systems use an overhead rate computed at the beginning of the accounting period (predetermined overhead rate) Computed annually Exh. 17-5
14. 14. Choice Of Activity Measure <ul><li>How should the cost manager select the activity measure for the flexible budget? </li></ul>17- The variable overhead cost and the activity measure should move together Direct labor time has traditionally been the most popular activity measure in manufacturing firms As automation increases, more firms are switching to machine hours or process time Dollar measures, such as direct-labor or material costs can be misleading because they are subject to price-level changes and other fluctuations
15. 15. Overhead Cost Variances 17- Koala manufactured 3,000 tree line tents X 1.5 machine hours per tent = standard allowed 4,500 machine hours Actual machine hours for June = 4,800 The total variable overhead variance for June = Actual variable overhead \$30,480 Budget variable overhead \$27,000 \$ 3,480 F For standard allowed 4,500 machine hours the budget overhead (from Exhibit 17-3) for June = Variable overhead \$27,000 Fixed overhead \$30,000 From the cost accounting records, the actual overhead for June = Variable overhead \$30,480 Fixed overhead \$32,500 \$62,980
16. 16. Variable Overhead Variances 17- The VARIABLE-OVERHEAD SPENDING VARIANCE is the difference between the actual variable overhead cost and the product of the standard variable -overhead rate and the actual hours of an activity base (or cost driver) Exh. 17-6 Actual variable overhead Actual machine hours (AH) Actual rate (AVR) Actual machine hours (AH) Standard rate (SVR) Actual machine hours × the standard rate ? ? ? ? 4,800 machine hours \$6.35 per machine hour 4,800 machine hours \$6.00 per machine hour \$30,480 \$28,800 \$1,680 Unfavorable Variable-overhead spending variance
17. 17. Variable Overhead Variances 17- The VARIABLE-OVERHEAD EFFICIENCY VARIANCE is the difference between the actual and the standard hours of an activity base (or cost driver) multiplied by the standard variable overhead rate Flexible budget: variable overhead Standard allowed machine hours (SH) Standard rate (SVR) Actual machine hours (AH) Standard rate (SVR) Actual machine hours times the standard rate Exh. 17-6 \$27,000 \$28,800 ? ? ? ? 4,500 machine hours \$6.00 per machine hour 4,800 machine hours \$6.00 per machine hour \$1,800 Unfavorable Variable-overhead efficiency variance
18. 18. Variable Overhead Variances 17- The flexible budget amount for variable overhead \$27,000 is the amount that will be applied to Work-in-Process for product-costing purposes Flexible budget: variable overhead Standard allowed machine hours (SH) Standard rate (SVR) Variable overhead applied to work in process Standard allowed machine hours (SH) Standard rate (SVR) Exh. 17-6 ? ? ? ? \$27,000 4,500 machine hours \$6.00 per machine hour 4,500 machine hours \$6.00 per machine hour No difference \$27,000
19. 19. How To Interpret The Variable Overhead Variances 17- ? The unfavorable variance resulting from using more machine hours than the standard quantity, given actual output The actual labor rate per hour differs from the standard rate Efficiency variance Spending variance The variable overhead efficiency variance has nothing to do with efficient or inefficient use of variable overhead items An unfavorable variance means that the total actual cost of variable overhead is > expected, after adjusting for the actual quantity of machine hours used The spending variance is the real control variance for variable overhead
20. 20. Fixed Overhead Budget Variance 17- The FIXED-OVERHEAD BUDGET VARIANCE is the difference between actual fixed overhead and budgeted fixed overhead Unfavorable variance of \$2,500, because we spent more than budgeted Fixed-overhead budget variance Actual Fixed overhead Budgeted fixed overhead = - Fixed-overhead budget variance Actual Fixed overhead = \$32,500 Budgeted fixed overhead = \$30,000 = -