11 th  Edition Chapter 11
Flexible Budgets and Overhead Analysis Chapter Eleven
Static Budgets and Performance Reports <ul><li>Static budgets are prepared for a single,  planned level   of activity.  </...
Flexible Budgets Improve performance evaluation. May be prepared for any activity  level in the relevant range. Show costs...
Static Budgets and Performance Reports CheeseCo
Static Budgets and Performance Reports CheeseCo
Static Budgets and Performance Reports CheeseCo U = Unfavorable variance  CheeseCo was unable to achieve the budgeted leve...
Static Budgets and Performance Reports CheeseCo F = Favorable variance  that occurs when actual costs are less than budget...
Static Budgets and Performance Reports Since cost variances are favorable, have we done a good job controlling costs? Chee...
Static Budgets and Performance Reports I don’t think I can answer the question using a static budget. Actual activity is b...
<ul><li>The relevant question is . . . </li></ul><ul><ul><li>“ How much of the favorable cost variance is due to lower act...
Preparing a Flexible Budget <ul><li>To  a budget we need to know that: </li></ul><ul><ul><li>Total variable   costs  chang...
Preparing a Flexible Budget Let’s prepare   budgets   for CheeseCo.
Preparing a Flexible Budget CheeseCo Fixed costs are expressed as a total amount. Variable costs are expressed as a consta...
Preparing a Flexible Budget CheeseCo $4.00 per hour × 8,000 hours = $32,000
Preparing a Flexible Budget CheeseCo
Preparing a Flexible Budget CheeseCo Total fixed costs do not change in the relevant range.
Quick Check   <ul><li>What should be the total overhead costs for the Flexible Budget at 12,000 hours? </li></ul><ul><ul>...
<ul><li>What should be the total overhead costs for the Flexible Budget at 12,000 hours? </li></ul><ul><ul><li>a. $92,500....
Preparing a Flexible Budget
Flexible Budget Performance Report Let’s prepare a     budget performance report   for CheeseCo.
Flexible Budget Performance Report CheeseCo Flexible budget is prepared for the same activity level (8,000 hours) as  actu...
Quick Check   <ul><li>What is the variance for indirect labor when the flexible budget for 8,000 hours is compared to the...
<ul><li>What is the variance for indirect labor when the flexible budget for 8,000 hours is compared to the actual results...
Flexible Budget Performance Report CheeseCo
Quick Check   <ul><li>What is the variance for indirect material when the flexible budget for 8,000 hours is compared to ...
<ul><li>What is the variance for indirect material when the flexible budget for 8,000 hours is compared to the actual resu...
CheeseCo Flexible Budget Performance Report
Flexible Budget Performance Report Remember the question:   “How much of the total variance is due to lower activity and h...
Static Budgets and Performance How much of the $11,650 favorable variance is due to lower activity and how much is due to ...
Flexible Budget Performance Report Overhead Variance Analysis Let’s place the flexible budget for 8,000 hours here. Differ...
Flexible Budget Performance Report Overhead Variance Analysis This $15,000 F  variance is due to lower activity.  Activity...
The Measure of Activity – A Critical Choice Three important factors in selecting an activity base for an overhead flexible...
Variable Overhead Variances  – A Closer Look If flexible budget is based on actual  hours If flexible budget is based on s...
<ul><li>ColaCo’s actual production for the period required 3,200 standard machine hours.  Actual variable overhead incurre...
Variable Overhead Variances Actual  Flexible Budget    Variable  for Variable     Overhead  Overhead at    Incurred  Actua...
Variable Overhead Variances – Example Actual  Flexible Budget    Variable  for Variable     Overhead  Overhead at    Incur...
Variable Overhead Variances – A Closer Look <ul><li>Spending Variance </li></ul>Results from paying more or less than expe...
Variable Overhead Variances AH × SR  AH × AR Spending variance = AH(AR - SR) Efficiency variance = SR(AH -  SH) SH × SR  S...
Variable Overhead Variances – Example   3,300 hours  3,200 hours     ×  ×     $2.00 per hour  $2.00 per hour  $6,740 $6,60...
Variable Overhead Variances – A Closer Look <ul><li>Efficiency Variance </li></ul>Controlled by managing the overhead cost...
Quick Check   <ul><li>  Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. A...
<ul><li>  Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable ...
Quick Check   <ul><li>  Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. A...
<ul><li>  Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable ...
Quick Check Summary   2,050 hours  2,100 hours     ×  ×     $5 per hour  $5 per hour  Actual  Flexible Budget  Flexible Bu...
Activity-based Costing and the Flexible Budget It is unlikely that all variable overhead will be driven by a single activi...
Overhead Rates and Overhead Analysis <ul><li>Recall that overhead costs are assigned to products and services using a   pr...
Overhead Rates and Overhead Analysis The predetermined overhead rate can be broken down into fixed and variable components...
Normal versus Standard Cost Systems In a  normal cost system, overhead is applied to work in process based on the actual n...
Budget Variance Volume Variance FR = Standard Fixed Overhead Rate SH = Standard Hours Allowed DH = Denominator Hours SH × ...
<ul><li>ColaCo prepared this  budget for overhead: </li></ul>Overhead Rates and Overhead Analysis – Example Total Variable...
<ul><li>ColaCo prepared this  budget for overhead: </li></ul>Overhead Rates and Overhead Analysis – Example This rate is c...
<ul><li>ColaCo prepared this  budget for overhead: </li></ul>Overhead Rates and Overhead Analysis – Example This rate decr...
<ul><li>ColaCo prepared this  budget for overhead: </li></ul>Overhead Rates and Overhead Analysis – Example Total Variable...
<ul><li>ColaCo’s actual production required 3,200   standard  machine hours.  Actual fixed overhead was $8,450.  The prede...
Overhead Variances Now let’s turn our attention to calculating   fixed overhead variances .
Fixed Overhead Variances – Example Budget variance $550 favorable $8,450 $9,000     Actual Fixed  Fixed  Fixed   Overhead ...
Fixed Overhead Variances – A Closer Look <ul><li>Budget Variance </li></ul>Results from spending more or less than expecte...
Fixed Overhead Variances – Example   3,200 hours     ×     $3.00 per hour  Budget variance $550 favorable $8,450 $9,000 $9...
Volume Variance – A Closer Look Volume Variance Results when standard hours allowed for actual output differs from the den...
Volume Variance – A Closer Look Volume Variance Results when standard hours allowed for actual output differs from the den...
Quick Check   <ul><li> Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Ac...
<ul><li> Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed over...
Quick Check   <ul><li> Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Ac...
<ul><li> Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed over...
Quick Check Summary   2,100 hours     ×     $7.00 per hour  Budget variance $350 unfavorable $14,800 $14,450 $14,700     A...
Overhead Variances Let’s look at a graph showing fixed overhead variances.  We will use ColaCo’s  numbers from the previou...
Fixed Overhead Variances Activity Cost 3,000 Hours Expected Activity $9,000 budgeted fixed OH Fixed overhead applied to pr...
Fixed Overhead Variances $8,450 actual fixed OH $8,450 actual fixed OH $550 Favorable Budget Variance { Activity Cost 3,00...
Fixed Overhead Variances { $8,450 actual fixed OH 3,200 machine hours × $3.00 fixed overhead rate $600 Favorable Volume Va...
Overhead Variances and Under- or Overapplied Overhead Cost In a standard cost system: Unfavorable variances are equivalent...
End of Chapter 11
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Managerial Accounting by G. Norren Chap011

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  • This chapter expands the study of overhead variances that was started in Chapter Ten. It also explains how flexible budgets can be used to analyze and control variable and fixed manufacturing overhead cost variances.
  • A static budget is prepared at the beginning of the budgeting period and is valid only for the planned level of activity It is suitable for planning, but it is inadequate for evaluating how well costs are controlled because the actual level of activity is unlikely to equal the planned level of activity. Comparing static budgets prepared at one with level of activity with actual costs at another level of activity is like comparing apples and oranges.
  • Flexible budgets provide estimates of what costs should be for any level of activity in the relevant range. When used for performance evaluation, actual costs are compared to the costs that should have been incurred at the actual level of activity, thereby enabling “apples to apples” cost comparisons.
  • CheeseCo has prepared the static budget shown on your screen for variable and fixed manufacturing overhead. The budget is based on an activity level of ten thousand machine hours.
  • Now we add CheeseCo’s actual results for the period. CheeseCo worked only eight thousand machine hours. Comparing the static budget costs at ten thousand machine hours to actual costs at eight thousand machine hours results in an “apples-to-oranges” comparison.
  • The machine-hour variance is two thousand hours unfavorable. It is unfavorable because CheeseCo was unable to achieve the budgeted level of activity.
  • All of the variable manufacturing overhead variances are favorable because the actual costs are less than the budgeted costs. The total overhead variance is eleven thousand six hundred fifty dollars favorable.
  • The variable manufacturing overhead cost variances are favorable, but are the favorable cost variances an indication the CheeseCo has done a good job of controlling costs?
  • Evaluating cost control is difficult if not impossible when comparing static budget costs at one level of activity to actual costs at another level of activity. Actual activity (eight thousand machine hours) is below budgeted activity (ten thousand machine hours), so, shouldn’t variable costs be lower if actual activity is lower?
  • Comparing static budget costs at one level of activity to actual costs at another level of activity raises an additional question: 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 flex the budget to the actual level of activity.
  • Flexing a budget to the actual level of activity is an application of cost behavior patterns that we studied in Chapter Five. Recall that: Total variable costs change in direct proportion to changes in activity. Total fixed costs remain unchanged within the relevant range.
  • Let’s continue the CheeseCo example by preparing flexible budgets at several different levels of activity.
  • The key to preparing flexible budgets is to specify the amount of each variable cost per unit of activity. For CheeseCo, indirect labor is four dollars per machine hour, material is three dollars per machine hour, and power is fifty cents per machine hour. We compute these per machine hour amounts by dividing the total cost according to the static budget by the static budget activity level. For example, the computation for indirect labor is forty thousand dollars divided by ten thousand machine hours, or four dollars per machine hour. Note that fixed costs are expressed as a total amount.
  • We can prepare a flexible budget for eight thousand machine hours of activity by multiplying the cost per hour times the activity level as follows: For indirect labor, we multiply four dollars per machine hour times eight thousand machine hours to get thirty-two thousand dollars. For indirect material, we multiply three dollars per machine hour times eight thousand machine hours to get twenty-four thousand dollars. For power, we multiply fifty cents per machine hour times eight thousand machine hours to get four thousand dollars.
  • The two fixed costs remain unchanged. When they are included, the total overhead budget is seventy-four thousand dollars at an activity level of eight thousand machine hours.
  • The flexible budget for ten thousand machine hours totals eighty-nine thousand dollars. Note that the dollar amounts for ten thousand machine hours are the same as the static budget since the static budget was also prepared for ten thousand machine hours. The fifteen thousand dollar difference in total overhead for the two levels of activity is due entirely to flexing the variable costs. The fixed costs are unchanged. Can you prepare a flexible budget for twelve thousand machine hours? The question on the following screen will ask you to do that.
  • Here’s the question. You can compute the total overhead amount directly, or you can flex the budget to twelve thousand hours and sum the amounts to get the total overhead costs for twelve thousand hours.
  • Total overhead is the sum of the fourteen thousand dollars total fixed overhead plus the ninety thousand dollars total variable overhead . The total variable overhead is computed by multiplying the seven dollars and fifty cents total variable overhead rate per machine hour times twelve thousand machine hours.
  • If you chose to flex the budget in the previous question, you can check your answers here. The answer to the Quick Check question is one hundred four thousand dollars as shown in the lower right corner of the spread sheet.
  • Now that we can prepare flexible budgets, let’s see how we can use them to develop performance reports. We will again use the CheeseCo data.
  • Recall from earlier in our example that CheeseCo’s actual level of activity was eight thousand machine hours. The actual costs shown are the same as in our earlier CheeseCo example. To enable an “apples to apples” comparison, a flexible budget is prepared for the same activity level (eight thousand machine hours) as actually achieved. Note that the machine hour variance is now zero. Now let’s look at some questions that will require us to compute cost variances.
  • Here’s your first question.
  • Flexing the budget for for indirect labor, we multiply four dollars per machine hour times eight thousand machine hours to get thirty-two thousand dollars. When we compare the flexed budget amount of thirty-two thousand dollars with the actual cost of thirty-four thousand dollars, we see that the indirect labor cost variance is two thousand dollars unfavorable.
  • On your screen, we have entered the flexed budget amount for indirect labor and the amount of the two thousand dollar unfavorable cost variance for indirect labor.
  • Here’s your second question.
  • Flexing the budget for indirect material, we multiply three dollars per machine hour times eight thousand machine hours to get twenty-four thousand dollars. When we compare the flexed budget amount of twenty-four thousand dollars with the actual cost of twenty-five thousand five hundred dollars, we see that the indirect material cost variance is one thousand five hundred dollars unfavorable.
  • On your screen, we have now completed the flexible budget performance report and entered all of the cost variances.
  • The flexible budget that we just prepared enables us to answer the previously posed question: How much of the the total variance is due to lower activity and how much is due to cost control?
  • On your screen you can see our original “apples to oranges” comparison comparing static budget costs at ten thousand machine hours with actual costs at eight thousand machine hours. So the question becomes: How much of the the eleven thousand six hundred fifty dollar favorable total variance is due to lower activity and how much is due to cost control?
  • If we insert the flexible budget at eight thousand machine hours in between the static budget at ten thousand machine hours and the actual results at eight thousand machine hours, we will be able to compute the overhead variances that will answer our question.
  • This fifteen thousand dollar favorable variance resulting from the difference between eighty-nine thousand dollars and seventy-four thousand dollars of the static and flexible budgets is due to lower activity. The three thousand three hundred fifty dollars unfavorable variance resulting from the difference between the seventy-four thousand dollars flexible budget and the seventy-seven thousand three hundred fifty dollar actual overhead is due to poor cost control. The fifteen thousand dollars favorable variance and the three thousand three hundred fifty dollars unfavorable variance net to the eleven thousand six hundred fifty dollars favorable total variance.
  • At least three factors are important in selecting an activity base for an overhead flexible budget: The activity base and variable overhead should be causally related. The activity base should not be expressed in dollars or other currency. The activity base should be simple and easily understood.
  • When the flexible budget is based on hours of activity, the quantity of hours chosen can be based on actual hours or standard hours allowed for the actual output. If actual hours are used, only a spending variance can be computed. Since the efficiency variance is based on the difference between actual hours and standard hours allowed, if actual and standard hours are used, both a spending and efficiency variance can be computed.
  • We will illustrate the computation of variable overhead spending and efficiency variances with an example. ColaCo’s actual production for the period required three thousand two hundred standard machine hours. Actual variable overhead incurred for the period was six thousand seven hundred forty dollars. Actual machine hours worked were three thousand three hundred. The standard variable overhead cost per machine hour is two dollars. First we will compute the variable overhead spending variance using actual hours. Then, we will use standard hours allowed with actual hours to compute the variable overhead efficiency variance.
  • The overhead spending variance is the difference between actual variable overhead and the flexible budget at actual hours for variable overhead. We can express this in a formula: The spending variance is equal to actual hours times the difference between the actual variable overhead rate and the standard variable overhead rate.
  • We compute the variable overhead variance by taking the difference between the six thousand seven forty dollars actual cost and the six thousand six hundred dollar flexible budget. For ColaCo, the variable overhead spending variance is one hundred forty dollars unfavorable.
  • The variable overhead spending variance may contain both price and quantity components. ColaCo’s unfavorable spending variance may be due to variable overhead resources costing more to purchase than standards allow, or it may be caused by using more of the variable overhead resources than standards allow.
  • The general model for computing both variable overhead variances is now shown on your screen. Note that the efficiency variance is based on the difference between actual hours and standard hours.
  • Here we see the computation of the efficiency variance in addition to the spending variance that we computed earlier. The total variable overhead variance is the combination of the spending variance and the efficiency variance, three hundred forty dollars unfavorable.
  • The efficiency variance estimates the indirect effect on variable overhead of the inefficiency in the use of the activity base. Those who control the activity base are responsible for the efficiency variance. Next, we will look at two questions that will require us to compute variable overhead spending and efficiency variances.
  • Here’s the first question asking us to compute a spending variance.
  • The spending variance is the difference between the actual variable overhead incurred and the flexible budget at the actual hours. Actual variable overhead is ten thousand nine hundred fifty dollars. The flexible budget amount is obtained by multiplying the standard rate of five dollars per hour times two thousand fifty actual hours.
  • Here’s the second question asking us to compute an efficiency variance.
  • The variable overhead efficiency variance is found by multiplying the standard variable overhead rate of five dollars per hour times the difference between two thousand fifty actual hours and two thousand one hundred standard hours. Since actual hours are less than standard hours, the efficiency variance is favorable.
  • Here we see a summary of our computations from the previous two questions in a convenient three-column format. The total variable overhead variance is the combination of the spending variance and the efficiency variance, four hundred fifty dollars unfavorable.
  • It is unlikely that all variable overhead costs within a company are driven by a single factor such as the number of units produced, labor hours, or machine hours. Activity-based costing offers a way to recognize the presence of more than one activity base within a company to evaluate overhead spending for each activity cost pool that has its own respective activity measure.
  • Overhead costs are assigned to products by multiplying the predetermined overhead rate times activity. The estimated total units in the base of the rate is called the denominator activity.
  • The predetermined overhead rate can be broken down into fixed and variable components. As we have already seen, the variable overhead component is useful for preparing and analyzing variable overhead variances. We will soon see that the fixed overhead component is useful in preparing and analyzing fixed overhead variances.
  • In a normal cost system (as discussed in Chapter Three), overhead is applied to work in process on the basis of the actual number of hours worked. In a standard cost system, overhead is applied to work in process based on the standard hours allowed for the output of the period.
  • Here we see the general model for computing fixed overhead variances. The fixed overhead budget variance is the difference between actual fixed overhead incurred and budgeted fixed overhead. The volume variance is the difference between budgeted fixed overhead and fixed overhead applied to production. In equation form, the volume variance is equal to the fixed portion of the predetermined overhead rate times the difference between denominator hours and standard hours allowed.
  • ColaCo prepared a flexible budget for overhead at two levels of activity, three thousand machine hours and four thousand machine hours. Notice that total variable overhead increases when activity increases, while total fixed overhead is the same at both levels of activity.
  • We calculate the variable overhead rate by dividing total variable overhead by the activity in machine hours. The variable overhead rate of two dollars per machine hour is the same for both levels of activity. Notice that this is the same variable overhead rate that we used in the previous ColaCo example.
  • We calculate the fixed overhead rate by dividing total fixed overhead by the activity in machine hours. The fixed overhead rate differs at each level of activity. It declines as activity increases because we are dividing a fixed total by an increasing activity.
  • The total predetermined overhead rate is the sum of the variable and fixed rates.
  • We will continue the ColaCo example to illustrate fixed overhead variance computations. Because the fixed overhead rate differs at different activity levels, an activity level must be chosen. Colaco decided to base its predetermined overhead rate on three thousand machine hours.
  • Now, let’s focus on the computations for fixed overhead variances.
  • The fixed overhead budget variance is the difference between eight thousand four hundred fifty dollars of actual fixed overhead incurred and the nine thousand dollars fixed overhead budget. Since the actual fixed overhead is less than the budget for fixed overhead, the budget variance is favorable.
  • The fixed overhead budget variance is the difference between the amount that should been spent and the amount that was actually spent for fixed overhead.
  • The volume variance is the difference between budgeted fixed overhead and fixed overhead applied to production. The fixed overhead applied is computed by multiplying the three thousand two hundred standard hours allowed times the three dollars fixed portion of the predetermined overhead rate. Since the budgeted fixed overhead is less than the applied fixed overhead, the volume variance is favorable.
  • An unfavorable volume variance results when the standard hours allowed are less than the denominator hours. A favorable volume variance results when the standard hours allowed are greater than the denominator hours.
  • The volume variance does not measure over-or under-spending. It is a measure of utilization of facilities. In essence, the volume variance is the error that occurs as a result of treating fixed overhead as though it were a variable cost. Next, we will look at two questions that will require us to compute fixed overhead budget and volume variances.
  • Here’s the first question asking us to compute a fixed overhead budget variance.
  • The fixed overhead budget variance is the difference between fourteen thousand eight hundred dollars of actual fixed overhead incurred and the fourteen thousand four hundred fifty dollars fixed overhead budget. Since the actual fixed overhead is greater than the budget for fixed overhead, the budget variance is unfavorable.
  • Here’s the second question asking us to compute a fixed overhead volume variance.
  • The volume variance is the difference between the fourteen thousand four hundred fifty dollar fixeds overhead budget and the fourteen thousand seven hundred dollars of fixed overhead applied to production. The fixed overhead applied is computed by multiplying the two thousand one hundred standard hours allowed times the seven dollars fixed portion of the predetermined overhead rate. Since the budgeted fixed overhead is less than the applied fixed overhead, the volume variance is favorable.
  • Here we see a summary of our computations from the previous two questions in a convenient three-column format. The total fixed overhead variance is the combination of the unfavorable budget variance and the favorable volume variance, one hundred dollars unfavorable.
  • Often its helpful to look at the fixed overhead relationships in graphical form. We will use the ColaCo data from the previous example for our graphical approach.
  • Fixed overhead cost is plotted on the vertical axis and activity in machine hours is plotted on the horizontal axis. The fixed overhead budget is nine thousand dollars at the three thousand hours denominator level of activity. The line from the origin sloping upward to the right represents the application of fixed overhead to production. The slope of this line indicates that the fixed overhead is applied at a rate of three dollars per machine hour. Note that the total amount of fixed overhead applied is equal to the budgeted amount of fixed overhead only at the denominator level of activity because we are treating nine thousand dollars of fixed overhead as if it were a variable cost of three dollars per machine hour.
  • Next, we enter the actual amount of fixed overhead on the graph. The broken horizontal line below the budgeted fixed overhead represents the eight thousand four hundred fifty dollars of actual fixed manufacturing overhead. The vertical distance between the budgeted fixed overhead line and the actual fixed overhead line represents the fixed overhead budget variance of five hundred fifty dollars. Since the actual fixed overhead is less than the budgeted fixed overhead, the fixed overhead budget variance is favorable.
  • Next, we enter the three thousand two hundred standard hours of activity on the horizontal axis and the nine thousand six hundred dollars of applied fixed overhead on the vertical axis. The vertical distance between the budgeted fixed overhead line and the applied fixed overhead line represents the fixed overhead volume variance of six hundred dollars. Since the budgeted fixed overhead is less than the applied fixed overhead, the volume variance is favorable.
  • In a standard cost system, the sum of the overhead variances equals the under-or overapplied overhead cost for a period. Unfavorable variances are equivalent to underapplied overhead. Favorable variances are equivalent to overapplied overhead.
  • Flexible budgets show what costs should be for various levels of activity. Performance evaluation is improved using flexible budgets. The application of flexible budgeting concepts to manufacturing overhead also improves our ability to analyze and control variable and fixed manufacturing overhead cost variances.
  • Managerial Accounting by G. Norren Chap011

    1. 1. 11 th Edition Chapter 11
    2. 2. Flexible Budgets and Overhead Analysis Chapter Eleven
    3. 3. Static Budgets and Performance Reports <ul><li>Static budgets are prepared for a single, planned level of activity. </li></ul>Performance evaluation is difficult when actual activity differs from the planned level of activity. Hmm! Comparing static budgets with actual costs is like comparing apples and oranges.
    4. 4. Flexible Budgets Improve performance evaluation. May be prepared for any activity level in the relevant range. Show costs that should have been incurred at the actual level of activity, enabling “apples to apples” cost comparisons. Reveal variances related to cost control. Let’s look at CheeseCo.
    5. 5. Static Budgets and Performance Reports CheeseCo
    6. 6. Static Budgets and Performance Reports CheeseCo
    7. 7. Static Budgets and Performance Reports CheeseCo U = Unfavorable variance CheeseCo was unable to achieve the budgeted level of activity.
    8. 8. Static Budgets and Performance Reports CheeseCo F = Favorable variance that occurs when actual costs are less than budgeted costs.
    9. 9. Static Budgets and Performance Reports Since cost variances are favorable, have we done a good job controlling costs? CheeseCo
    10. 10. Static Budgets and Performance Reports I don’t think I can answer the question using a static budget. Actual activity is below budgeted activity. So, shouldn’t variable costs be lower if actual activity is lower?
    11. 11. <ul><li>The relevant question is . . . </li></ul><ul><ul><li>“ How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?” </li></ul></ul><ul><li>To answer the question, we must the budget to the actual level of activity. </li></ul>Static Budgets and Performance Reports
    12. 12. Preparing a Flexible Budget <ul><li>To a budget we need to know that: </li></ul><ul><ul><li>Total variable costs change in direct proportion to changes in activity. </li></ul></ul><ul><ul><li>Total fixed costs remain unchanged within the relevant range. </li></ul></ul>Fixed Variable
    13. 13. Preparing a Flexible Budget Let’s prepare budgets for CheeseCo.
    14. 14. Preparing a Flexible Budget CheeseCo Fixed costs are expressed as a total amount. Variable costs are expressed as a constant amount per hour. $40,000 ÷ 10,000 hours is $4.00 per hour.
    15. 15. Preparing a Flexible Budget CheeseCo $4.00 per hour × 8,000 hours = $32,000
    16. 16. Preparing a Flexible Budget CheeseCo
    17. 17. Preparing a Flexible Budget CheeseCo Total fixed costs do not change in the relevant range.
    18. 18. Quick Check  <ul><li>What should be the total overhead costs for the Flexible Budget at 12,000 hours? </li></ul><ul><ul><li>a. $92,500. </li></ul></ul><ul><ul><li>b. $89,000. </li></ul></ul><ul><ul><li>c. $106,800. </li></ul></ul><ul><ul><li>d. $104,000. </li></ul></ul>
    19. 19. <ul><li>What should be the total overhead costs for the Flexible Budget at 12,000 hours? </li></ul><ul><ul><li>a. $92,500. </li></ul></ul><ul><ul><li>b. $89,000. </li></ul></ul><ul><ul><li>c. $106,800. </li></ul></ul><ul><ul><li>d. $104,000. </li></ul></ul>Quick Check  Total overhead cost = $14,000 + $7.50 per hour  12,000 hours = $14,000 + $90,000 = $104,000
    20. 20. Preparing a Flexible Budget
    21. 21. Flexible Budget Performance Report Let’s prepare a budget performance report for CheeseCo.
    22. 22. Flexible Budget Performance Report CheeseCo Flexible budget is prepared for the same activity level (8,000 hours) as actually achieved.
    23. 23. Quick Check  <ul><li>What is the variance for indirect labor when the flexible budget for 8,000 hours is compared to the actual results? </li></ul><ul><ul><li>a. $2,000 U </li></ul></ul><ul><ul><li>b. $2,000 F </li></ul></ul><ul><ul><li>c. $6,000 U </li></ul></ul><ul><ul><li>d. $6,000 F </li></ul></ul>
    24. 24. <ul><li>What is the variance for indirect labor when the flexible budget for 8,000 hours is compared to the actual results? </li></ul><ul><ul><li>a. $2,000 U </li></ul></ul><ul><ul><li>b. $2,000 F </li></ul></ul><ul><ul><li>c. $6,000 U </li></ul></ul><ul><ul><li>d. $6,000 F </li></ul></ul>Quick Check 
    25. 25. Flexible Budget Performance Report CheeseCo
    26. 26. Quick Check  <ul><li>What is the variance for indirect material when the flexible budget for 8,000 hours is compared to the actual results? </li></ul><ul><ul><li>a. $1,500 U </li></ul></ul><ul><ul><li>b. $1,500 F </li></ul></ul><ul><ul><li>c. $4,500 U </li></ul></ul><ul><ul><li>d. $4,500 F </li></ul></ul>
    27. 27. <ul><li>What is the variance for indirect material when the flexible budget for 8,000 hours is compared to the actual results? </li></ul><ul><ul><li>a. $1,500 U </li></ul></ul><ul><ul><li>b. $1,500 F </li></ul></ul><ul><ul><li>c. $4,500 U </li></ul></ul><ul><ul><li>d. $4,500 F </li></ul></ul>Quick Check 
    28. 28. CheeseCo Flexible Budget Performance Report
    29. 29. Flexible Budget Performance Report Remember the question: “How much of the total variance is due to lower activity and how much is due to cost control?”
    30. 30. Static Budgets and Performance How much of the $11,650 favorable variance is due to lower activity and how much is due to cost control?
    31. 31. Flexible Budget Performance Report Overhead Variance Analysis Let’s place the flexible budget for 8,000 hours here. Difference between original static budget and actual overhead = $11,650 F.
    32. 32. Flexible Budget Performance Report Overhead Variance Analysis This $15,000 F variance is due to lower activity. Activity This $3,350 U variance is due to poor cost control. Cost control
    33. 33. The Measure of Activity – A Critical Choice Three important factors in selecting an activity base for an overhead flexible budget Activity base and variable overhead should be causally related. Activity base should not be expressed in dollars or other currency. Activity base should be simple and easily understood.
    34. 34. Variable Overhead Variances – A Closer Look If flexible budget is based on actual hours If flexible budget is based on standard hours Only a spending variance can be computed. Both spending and efficiency variances can be computed.
    35. 35. <ul><li>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. The standard variable overhead cost per machine hour is $2.00. </li></ul><ul><li>Compute the variable overhead spending variance first using actual hours. Then use standard hours allowed to calculate the variable overhead efficiency variance. </li></ul>Variable Overhead Variances – Example
    36. 36. Variable Overhead Variances Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours AH × SR AH × AR Spending Variance Spending variance = AH(AR – SR) AH = Actual hours AR = Actual variable overhead rate SR = Standard variable overhead rate
    37. 37. Variable Overhead Variances – Example Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours 3,300 hours × $2.00 per hour = $6,600 $6,740 Spending Variance = $140 unfavorable
    38. 38. Variable Overhead Variances – A Closer Look <ul><li>Spending Variance </li></ul>Results from paying more or less than expected for overhead items and from excessive usage of overhead items. Now, let’s use the standard hours allowed, along with the actual hours, to compute the efficiency variance.
    39. 39. Variable Overhead Variances AH × SR AH × AR Spending variance = AH(AR - SR) Efficiency variance = SR(AH - SH) SH × SR Spending Variance Efficiency Variance Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
    40. 40. Variable Overhead Variances – Example 3,300 hours 3,200 hours × × $2.00 per hour $2.00 per hour $6,740 $6,600 $6,400 Spending variance $140 unfavorable Efficiency variance $200 unfavorable $340 unfavorable flexible budget total variance Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
    41. 41. Variable Overhead Variances – A Closer Look <ul><li>Efficiency Variance </li></ul>Controlled by managing the overhead cost driver.
    42. 42. Quick Check  <ul><li> Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the spending variance? </li></ul><ul><ul><li>a. $450 U </li></ul></ul><ul><ul><li>b. $450 F </li></ul></ul><ul><ul><li>c. $700 F </li></ul></ul><ul><ul><li>d. $700 U </li></ul></ul>
    43. 43. <ul><li> Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the spending variance? </li></ul><ul><ul><li>a. $450 U </li></ul></ul><ul><ul><li>b. $450 F </li></ul></ul><ul><ul><li>c. $700 F </li></ul></ul><ul><ul><li>d. $700 U </li></ul></ul>Quick Check  Spending variance = AH (AR - SR) = Actual variable overhead incurred – (AH  SR) = $10,950 – (2,050 hours  $5 per hour) = $10,950 – $10,250 = $700 U
    44. 44. Quick Check  <ul><li> Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the efficiency variance? </li></ul><ul><ul><li>a. $450 U </li></ul></ul><ul><ul><li>b. $450 F </li></ul></ul><ul><ul><li>c. $250 F </li></ul></ul><ul><ul><li>d. $250 U </li></ul></ul>
    45. 45. <ul><li> Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the efficiency variance? </li></ul><ul><ul><li>a. $450 U </li></ul></ul><ul><ul><li>b. $450 F </li></ul></ul><ul><ul><li>c. $250 F </li></ul></ul><ul><ul><li>d. $250 U </li></ul></ul>Quick Check  Efficiency variance = SR (AH – SH) = $5 per hour (2,050 hours – 2,100 hours) = $250 F
    46. 46. Quick Check Summary 2,050 hours 2,100 hours × × $5 per hour $5 per hour Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours $10,950 $10,250 $10,500 Spending variance $700 unfavorable Efficiency variance $250 favorable $450 unfavorable flexible budget total variance
    47. 47. Activity-based Costing and the Flexible Budget It is unlikely that all variable overhead will be driven by a single activity. Activity-based costing can be used when multiple activity bases drive variable overhead costs.
    48. 48. Overhead Rates and Overhead Analysis <ul><li>Recall that overhead costs are assigned to products and services using a predetermined overhead rate (POHR): </li></ul>Overhead from the flexible budget for the denominator level of activity POHR = Assigned Overhead = POHR × Standard Activity Denominator level of activity
    49. 49. Overhead Rates and Overhead Analysis The predetermined overhead rate can be broken down into fixed and variable components. The variable component is useful for preparing and analyzing variable overhead variances. The fixed component is useful for preparing and analyzing fixed overhead variances.
    50. 50. Normal versus Standard Cost Systems In a normal cost system, overhead is applied to work in process based on the actual number of hours worked in the period. In a standard cost system, overhead is applied to work in process based on the standard hours allowed for the output of the period.
    51. 51. Budget Variance Volume Variance FR = Standard Fixed Overhead Rate SH = Standard Hours Allowed DH = Denominator Hours SH × FR Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied Fixed Overhead Variances DH × FR
    52. 52. <ul><li>ColaCo prepared this budget for overhead: </li></ul>Overhead Rates and Overhead Analysis – Example Total Variable Total Fixed Machine Variable Overhead Fixed Overhead Hours Overhead Rate Overhead Rate 3,000 6,000 $ ? 9,000 $ ? 4,000 8,000 ? 9,000 ? ColaCo applies overhead based on machine-hour activity. Let’s calculate overhead rates.
    53. 53. <ul><li>ColaCo prepared this budget for overhead: </li></ul>Overhead Rates and Overhead Analysis – Example This rate is constant at all levels of activity. Rate = Total Variable Overhead ÷ Machine Hours Total Variable Total Fixed Machine Variable Overhead Fixed Overhead Hours Overhead Rate Overhead Rate 3,000 6,000 $ 2.00 $ 9,000 $ ? 4,000 8,000 2.00 9,000 ?
    54. 54. <ul><li>ColaCo prepared this budget for overhead: </li></ul>Overhead Rates and Overhead Analysis – Example This rate decreases when activity increases. Total Variable Total Fixed Machine Variable Overhead Fixed Overhead Hours Overhead Rate Overhead Rate 3,000 6,000 $ 2.00 $ 9,000 $ 3.00 $ 4,000 8,000 2.00 9,000 2.25 Rate = Total Fixed Overhead ÷ Machine Hours
    55. 55. <ul><li>ColaCo prepared this budget for overhead: </li></ul>Overhead Rates and Overhead Analysis – Example Total Variable Total Fixed Machine Variable Overhead Fixed Overhead Hours Overhead Rate Overhead Rate 3,000 6,000 $ 2.00 $ 9,000 $ 3.00 $ 4,000 8,000 2.00 9,000 2.25 The total POHR is the sum of the fixed and variable rates for a given activity level.
    56. 56. <ul><li>ColaCo’s actual production required 3,200 standard machine hours. Actual fixed overhead was $8,450. The predetermined overhead rate is based on 3,000 machine hours. </li></ul>Fixed Overhead Variances – Example
    57. 57. Overhead Variances Now let’s turn our attention to calculating fixed overhead variances .
    58. 58. Fixed Overhead Variances – Example Budget variance $550 favorable $8,450 $9,000 Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
    59. 59. Fixed Overhead Variances – A Closer Look <ul><li>Budget Variance </li></ul>Results from spending more or less than expected for fixed overhead items. Now, let’s use the standard hours allowed to compute the fixed overhead volume variance.
    60. 60. Fixed Overhead Variances – Example 3,200 hours × $3.00 per hour Budget variance $550 favorable $8,450 $9,000 $9,600 Volume variance $600 favorable SH × FR Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
    61. 61. 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 Favorable when standard hours > denominator hours
    62. 62. 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 Favorable when standard hours > denominator hours Does not measure over- or under spending It results from treating fixed overhead as if it were a variable cost.
    63. 63. Quick Check  <ul><li> Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the budget variance? </li></ul><ul><ul><li>a. $350 U </li></ul></ul><ul><ul><li>b. $350 F </li></ul></ul><ul><ul><li>c. $100 F </li></ul></ul><ul><ul><li>d. $100 U </li></ul></ul>
    64. 64. <ul><li> Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the budget variance? </li></ul><ul><ul><li>a. $350 U </li></ul></ul><ul><ul><li>b. $350 F </li></ul></ul><ul><ul><li>c. $100 F </li></ul></ul><ul><ul><li>d. $100 U </li></ul></ul>Quick Check  Budget variance = Actual fixed overhead – Budgeted fixed overhead = $14,800 – $14,450 = $350 U
    65. 65. Quick Check  <ul><li> Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the volume variance? </li></ul><ul><ul><li>a. $250 U </li></ul></ul><ul><ul><li>b. $250 F </li></ul></ul><ul><ul><li>c. $100 F </li></ul></ul><ul><ul><li>d. $100 U </li></ul></ul>
    66. 66. <ul><li> Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the volume variance? </li></ul><ul><ul><li>a. $250 U </li></ul></ul><ul><ul><li>b. $250 F </li></ul></ul><ul><ul><li>c. $100 F </li></ul></ul><ul><ul><li>d. $100 U </li></ul></ul>Quick Check  Volume variance = Budgeted fixed overhead – (SH  FR) = $14,450 – (2,100 hours  $7 per hour) = $14,450 – $14,700 = $250 F
    67. 67. Quick Check Summary 2,100 hours × $7.00 per hour Budget variance $350 unfavorable $14,800 $14,450 $14,700 Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied Volume variance $250 favorable SH × FR
    68. 68. Overhead Variances Let’s look at a graph showing fixed overhead variances. We will use ColaCo’s numbers from the previous example.
    69. 69. Fixed Overhead Variances Activity Cost 3,000 Hours Expected Activity $9,000 budgeted fixed OH Fixed overhead applied to products
    70. 70. Fixed Overhead Variances $8,450 actual fixed OH $8,450 actual fixed OH $550 Favorable Budget Variance { Activity Cost 3,000 Hours Expected Activity $9,000 budgeted fixed OH Fixed overhead applied to products
    71. 71. Fixed Overhead Variances { $8,450 actual fixed OH 3,200 machine hours × $3.00 fixed overhead rate $600 Favorable Volume Variance $9,600 applied fixed OH 3,200 Standard Hours $550 Favorable Budget Variance { $8,450 actual fixed OH Activity Cost 3,000 Hours Expected Activity $9,000 budgeted fixed OH Fixed overhead applied to products
    72. 72. 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.
    73. 73. End of Chapter 11

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