Achyut Gyawali.

Lecturer
CDM.TU,
Flexible Budgeting and Overhead Cost Control
INTRODUCTION

A budget prepared at different level of activities is a flexible budget. Flexible

budget will furnish the budgeted figures for any level of activity, which a
company may actually attain. It reflects costs, revenues and profits at the
various level of budgeted activity. A flexible budget, as also called a variable
budget, step budget, sliding-scale budget, expense-formula budget, dynamic
budget and expense control budget. It is a budget which permits revision of
estimates of operating cost and profits with changes in sales or production
volume. This budget is prepared on the basis of time, demand of product,
cost of product, availability of demand of product, cost of product, season
and availability of factor of production. In static budget, it is prepared at a
single level of activity; with prospect of modification in the light of the
changed circumstances is fixed/static budget. Fixed budgets have lacks of
flexibility; some degree of flexibility is required to adjust the activity with
changed business environment which is not possible under the static budget.
Uncertainty in the factor of level of activity, impossibility of comparing actual
with budget and complicated task of revising the original budget etc. are
defects found in fixed budgeting and these make imperative to avoid the
rigidity regarding the level of activity and to introduce flexibility in the
system of budgeting.
It is difficult to forecast the future activities accurately, which demands some
degree of changes to cope within the business environment. In the case a
flexible budget can be used comfortably to reduce the margin of deviation
between estimation and actual performance. The case of deviation should be
properly analyzed, whether it is due to volume or under control of
management. Effort is required to estimate the expenditure at different level
of activities. Thus a flexible budget enables an organization to estimate the
expenditure at different level of activities. It is used as a yardstick to
measure the efficiency at the level of performance achieved and tool for
controlling the cost. The flexible budget approach says, Give me any activity
level you choose, and I will provide a budget tailored to that particular level.
According to the Chartered Institute of Management Accountants, London,

Terminology, a flexible budget is defined as a budget which by recognising is

designed to change as volume of output changes. Under flexible budgeting,
budgets are drawn for a series of possible sales and production volumes
including the actual. In the beginning of the period, budgets are constructed
for a number of alternative production volume to take care of the changing
market conditions and government policies. Instead of making a point
estimate for a single most likely outcome, schedules of costs and revenues
are made for a range of possible outcomes. Usually flexible budgets are
prepared for minimum of three activity levels: the most optimistic, the most
pessimistic and the most likely.
CHARACTERISTICS OF FLEXIBLE BUDGET
1. It covers a range of activity.
2. It provides a dynamic basis for comparison with the actual results because
it is automatically matched to change in activities.
3. It can be changed according to actual production level.
4. It facilitates performance measurement and evaluation.
5. These are based upon adequate knowledge of cost behaviour pattern.
NEEDS AND SIGNIFICANCE OF FLEXIBLE BUDGETING
A flexible budget is a great planning and co-ordinating tool. It becomes frame
of reference a set of expectations against which actual can be compared.
The main advantages of flexible budgeting are listed below.
1. It helps to obtain detailed information of cost, sales, output and profit at
different level of operation, useful for analysis.
2. It makes possible the comparison of actual performance and budgeted one
for actual level of operation in a very easy and understanding way.
3. It helps to attain the objective of cost reduction and better cost control.
4. It enables to assist the organization, depending upon export, new products
and demand of customers.
5. It helps to estimate the profit and cost of the products such as luxury
goods, fashionable goods or soft drinks, whose production and sales are
uncertain.

6. It helps to present a monthly report based upon comparative analysis of

budgeted and actual cost at given level of operation.
7. It helps to measure the capacity utilization of plant or labour force, in term
of level of activity.
8. It helps on planning the expenditure of responsible centres, who care
responsible for tactical profit plan.
9. It helps to develop the labour oriented business sector, where labour are
scare.
10. It helps in taking localized decision, identifying the possible factors
affection the cost and profit.
Flexible budgeting is generally needed in the following cases:
i) Where business depends heavily on export markets
ii) Where the demand for the product is based on taste and fashion
iii)
If the organization is suffering from shortage of factors of production
e.g. raw material, labour, equipment etc.
iv)
Where the customers reaction (i.e. demand) towards a new product is
almost impossible to foresee and to predict.
v) Where business is subject to the vagaries of nature such as weather
condition, like raincoats, soft drink, woollen industries, agro-based
industries etc
vi)
Where production is carried out only after receiving the customers
orders.
vii) Where sales are unpredictable due to typical nature of business and
influence of external factors (i.e. luxury goods).
viii) Where levels of activity fluctuate due to frequent introduction of a new
product
CLASSIFICATION OF COSTS
It is necessary to identify the cost items before the preparation of a flexible
budget. For the purpose, the cost can be classified into three categories
according to their behaviour.

1. Fixed Cost
2. Variable Cost
3. Semi-variable /Semi-fixed Cost
1.

Fixed Cost:

Fixed costs are those which remain constant within the given range of
activity in spite of change in volume of production. The unit fixed cost per
unit decreases as the level of production increases within the volume. In
other words, fixed cost per unit always change with the volume of
production. Salary, rent, depreciation, insurance are the examples of fixed
costs. They are the period cost, and should be incurred for a period of time.
2.

Variable Cost:

Those costs which increase directly and proportionately with the level of
activity are called variable costs. Total cost increases or decreases towards
the direction of production or sales units. Where as the variable cost per unit
will remain constant, if other thing remaining the same. Direct material,
direct labour and direct chargeable expenses are the example of variable
cost.
3.

Semi-variable Cost (Mixed Cost):

Composition of fixed and variable cost is the mixed cost or semi variable
cost. Such costs increase with the level of activity, but by intermittent jumps
than continuously. In other words the cost does not change proportionately
with the level of output. These costs include heating, lighting, repair and
maintenance, supervision etc. It is necessary to segregate the cost between
fixed and variable for preparing flexible budget. The methods available for
segregation of mixed cost are High-low point method, Least-square method
and Scattered diagram method.
PREPARATION OF FLEXIBLE BUDGET
The following methods are used for preparing a flexible budget.
1. Multi-activity level/Tabular method
2. Formula method
1.

Tabular method:

The budget prepared at different level of activities within the range of

output. The factors to be taken into consideration for preparing the flexible
budget under this method are summarized below:
(a)

Determination of level of activity:

The activity levels are determined on the basis of units of output or

machine hours, labour hours used in production.
(b)

Estimation of cost and its behaviour for each level of activity:

The costs and estimated for each element of cost together with the cost
centres at the level of output determined. The organization should
determine cost behaviour-fixed, variable and semi-variable.
(c)

Determination of units at the level of activities:

The units of output to be produced at different level of activities are

determined for estimating the budget.
(d)

Preparation of flexible budget:

XYZ & CO. LTD.
Flexible Budget
For the year . . .

Level of activity
Sales units/output units
Sales Revenues Rs.

(A)

Variable Costs:
Direct material @ Rs. . . .
Direct wages @ Rs. . . .
Direct expenses @ Rs . . .
Total Variable Cost

(B)

Semi-variable Costs:
Indirect material @ Rs. . . .
Indirect wages @ Rs. . . .
Repair and maintenance @ Rs . . .
Total Semi-variable Cost

(C)

Fixed Costs:
Depreciation
Salaries
Supervision and inspection
Insurance
Other Fixed Costs
Total Fixed Costs

(D)

...%

...%

...%

Total Costs
Net Profit (Loss)
2.

(B + C + D) = E
(A E)

Formula Format:

This format provides a formula for such expense account in each responsibility centre. The
formula gives the fixed amount and the variable rate. This is more compact and generally
more useful because the components of each expenses are given. The formula format uses
straight line relationships. It is a widely used for expressing expenses budget in actual
practice. The formula is the flexible budget under formula format.
Flexible Budget
Under Formula Format Y = a + bX
Expenses

Nature
of cost

Fixed Cost/Period

Variable cost per hour/unit

Salaries
Indirect labour

Depreciation
Miscellaneous

Direct material

Total

Question 1. A company's cost structure at two different levels of activities is

given below:
Level
of
50,000
100,000
activity
hours
hours
Total cost
Rs.500,00 Rs.800,000
0
Required
a)
Segregation of cost into variable and fixed components.
b)
Develop the flexible budget formula
c)
Estimate a budget for 70,000 and 110,000 labour hours.
Question 2. Costs for an output level of 10,000 units in a factory are given below:
Details
Direct material ..................................
Direct labour .....................................
Variable overheads ...........................
Fixed overheads Rs.50,000 ..............
Selling expenses (10% fixed) ............
Administrative expenses (100%
fixed) .................................................

Cost per
unit
Rs.35
12.5
10
5
6.5
2.5

Distribution expenses (20% fixed) ....

Total costs .........................................

3.5
Rs.75

Required
Prepare a flexible budget for the output level of 6,000 and 8,000 units using the
columnar approach.
Question 3. Out of the following expenses for a normal capacity of 10,000 units,
prepare a flexible budget for 80% and 90% output to be attained in the next month.
Direct materials ...................................................
Rs.400,000
Direct labour .......................................................
Rs.300,000
Prime costs...........................................................
Rs.700,000
Mix overheads:
Indirect expenses 30% variable and 70% fixed ...
Rs.100,000
Maintenance expenses 60% variable and 40% fixed
Rs.300,000
Salaries 100% fixed .............................................
Rs.25,000
Depreciation (fixed) .............................................
Rs.50,000
Power and fuel variable 70% and fixed 30% .......
Rs.400,000
Question 4.
Costs at two different levels of output are as follows:
Output.............................................. 3,000units 5,000units
Direct material................................. Rs.15,000 Rs.25,000
Direct labour..................................... Rs.30,000 Rs.50,000
Manufacturing overheads................. Rs.16,000 Rs.20,000
Office overheads..............................
Rs.8,000 Rs.10,000
Selling overheads.............................
Rs.3,500
Rs.4,500
Selling price per unit........................
Rs.25
Rs.25
Required
Flexible Budget for 4,000 units, showing the profit.

Question 5. Costs for two different levels of activities for the month of September 2003
have been supplied to you:
Cost elements

Direct material costs

Direct labour costs
Indirect labour costs
Repairs & Maintenance
Depreciation Expenses
Selling and Administrative Expenses
Total costs

Levels of Activity
units
7,000
112,000
35,000
33,800
23,400
7,400
11,000
222,600

In
9,000
144,000
45,000
35,000
23,800
7,400
11,000
266,200

Required
a)
Calculate the variable cost per unit and the total fixed costs after necessary
segregation
b)
Develop the flexible budget formula & find out the total costs for 8,000 units of

output.
Question 6. The following data relates to the working of a factory at Butwal for the current
year:
Capacity worked
50%
Fixed Costs:
Salaries
84,000
Rent and Rates
56,000
Depreciation
70,000
Other administrative expenses
80,000 290,000
Variable costs:
Materials
240,000
Labour
256,000
Other expenses
38,000 534,000
Possible Sales at various levels of working are:
Capacity (%)
Sales (Rs.)
60
950,000
75
1,150,000
90
1,375,000
100
1,525,000
Prepare a flexible budget and show the forecast of profit at 60%, 75%, 90% and 100%
capacity operations.
Question 7. Kathmandu Enterprises manufacturing dressing table is working at 40%
capacity producing 10,000 tables per year. The cost elements for each table are given
as under:
Material

Rs. 20

Labour

Rs. 6

Overhead

Rs. 10 (40% variable)

Each table sells for Rs. 40. The selling price falls by 3% if production is at 50% capacity, and
by 5% if it worked at 90% capacity. The fall is selling prices is accompanied by similar falls in
material prices.
Required: Flexible budget showing fixed cost, variable cost and profit.
Question 8. Costs for an output level of 5,000 units in a factory are given below:
Details
Direct material
Direct labour
Variable overheads
Fixed overheads Rs.50,000
Variable expenses (direct)
Selling expenses (10% fixed)
Administrative expenses (Rs.25,000)

Cost per
unit
Rs.70
25
20
10
5
13
5

Distribution expenses (20% fixed)

Total cost

7
Rs.155

Required
Prepare a flexible budget for the output levels of 3,000 and 4,000 units using the
columnar approach.
(Ans.: Total cost (A + B) 3,000 units: Rs.500,400; 4,000 units: Rs.637,700)
Question 9. The costs for 30,000 units of a product are given below:
Direct material................................. Rs.120,000
Direct wages..................................... Rs.180,000
Direct expenses................................ Rs.60,000
Repairs and maintenance................. Rs.36,000
Insurance.......................................... Rs.45,000
Additional information:
i.
The difference in costs for repair and maintenance is Rs.0.05 per unit between
30,000 and 27,000units.
ii.
Insurance cost at 27,000 units volume amounted to Rs.42,000
Required
Flexible Budget for 25,000 and 20,000 units.
Problem 10. A company manufactures a single product for which market demand exist for
additional quantity. At present the company is utilizing only 70% of the plant capacity and
the following data are available:
Sales Revenue
Selling price per unit
Variable cost per unit
Fixed Cost
Step fixed cost

Rs.35,000
Rs.10
Rs.4
Rs.10,000
Rs.6,000

Additional information
i. At above 70% working capacity, the selling price falls by 10%
ii. The step fixed cost will remain unchanged at 60% to 80% capacity, but will increase by
Rs.1000 between 80% to 100% capacity.
Required
Flexible Budget for 80% and 90% of capacity.
Overhead Variances
Concept of Overheads
The previous chapter described the various prime cost variances regarding direct material
and direct labour cost variances and it will be recalled that the objective of that analysis was
to help management to control costs. Apart from the prime costs, other indirect expenses
may be incurred in the process of production or providing services, such expenses are
denoted by a broad term i.e. overhead expenses.
The term overhead has been defined by the Institute of Cost and Management
Accountants (CIMA) as an aggregate of indirect materials, indirect wages and indirect
expenses.

Similarly Harold J. Wheldon has defined overheads as the costs of indirect materials,
indirect labours and such other expenses including services as cannot conveniently be
charged directly to a specific cost unit.
Thus, all the indirect expenses incurred in order to bring the goods to a saleable
condition are termed as overheads or supplementary costs.
Overhead Variance
The overhead variance is the deviation from the standard costs of overhead allowed for the
actual output achieved and actual overhead costs incurred. With a view to conveying the
useful information to control the overhead expenses; overhead variances can be classified
as follows:

Capacity or Volume Variance: The overhead volume variance is a deviation of

the actual from the budgeted overhead expenses. Generally, the capacity or
volume variances denote the deviation from the budgeted fixed overheads of
the fixed overheads applied to the product. It is denoted as a volume variance
because it can be calculated for variable as well as fixed overheads into a single
rate based on the same activity.
Spending Variance: Spending variance is the difference between the actual
overheads incurred and the flexible budget overheads for the actual volume.
This variance arises due to the deviation of the actual overheads from the
flexible budget overheads for the actual volume.
Efficiency Variance: The overhead efficiency variance is the difference
between the actual and standard hours of an activity. In other words, it is the
difference between the actual output and the standard output multiplied by the
variable overhead rate.

Calculation of Overhead Variances

The following steps are to be followed for the calculation of overhead variances.
Step 1
Identify the level of activity in terms of hours and calculate a standard
quantity/hours required for actual output
Standard quantity/hours required for actual output = Actual output
Step 2
Calculate the standard fixed and variable manufacturing overhead
rates per hour i.e. SFOR and SVOR
SFOR =
Develop the working table for the calculation of overhead variances.

Step 3
Cod
e

Qty/Hour
s

A
B
C
D

S
S
A
A

Rate (Variable per

unit
and Fixed total)
SFOR + SVOR
S/V + FC
S/V + FC
A/V + FC

Result
(Qty
Rate)

Variances

Capacity Variance(CV) = A B, if +F, if U

Efficiency Variance(EV) = B C, if +F, if U
Spending Variance (SV) = C D, if +F, if U

where, A, B, C, and D are code numbers. Instead of these, other symbols or letters can aso
be used
S

= Standard hours required for the actual output.

SFOR

= Standard fixed overhead rate per hour.

= Actual hours worked for actual output.

S/V

= Standard variable overhead rate per hour (SVOR).

A/V

= Actual variable overhead rate per hour (AVOR).

FC

= Fixed costs in total.

Deriving formula from the above table

i)

As Overhead Capacity Variance (CV) = A B

A

= The result of SH(SFOR + SVOR)

= The result of (SH SVOR) + FC

Hence, Capacity Variance(CV) = SH(SFOR + SVOR) (SH SVOR) + FC

OR
ii)

Capacity Variance (CV) = (SFOR SH) FC

As Overhead Efficiency Variance (EV) = B C

B = The result of (SH SVOR) + FC
C = The result of (AH SVOR) + FC
Hence, Efficiency Variance (EV) = (SH SVOR) + FC (AH SVOR) + FC
OR

iii)

(EV) = SVOR (SH AH)

As Overhead Spending Variance (SV) = C D

C = The result of (AH SVOR) + FC
D = The result of (AH AVOR) + FC
Hence, Spending Variance (SV) = (AH SVOR) + FC (AH AVOR) + FC
OR

(SV) = AH( SFOR SVOR)

Question 12. Based on the following information, you are required to calculate the three
overhead variances.
Normal Capacity.......................................
10,000 direct labour hours
Standard time allowed..............................
0.5 direct labour per unit of output
Actual production......................................
22,000units
Actual hours worked.................................
10,700
Factory overhead costs incurred...............
Rs.191,000

Fixed overhead costs for normal capacity

Rs.90,000
Standard variable manufacturing overhead rate

Rs.9per hour

Question 13. The flexible budgeting data and other information have been presented
below:
BA = Rs.400,000 + Rs.5 DLH
Normal capacity 100,000DLH
Standard time per unit of output 2 DLH
Actual output 52,000 units.
Actual hours worked 98,000 DLH
Actual overheads paid Rs.865,500
Required
The three overhead variances
Question 14. The details regarding the manufacturing overhead costs and other
relevant information have been provided below:
Activity level..................................... 50,000 DLH100,000 DLH
Manufacturing costs........................ Rs.300,000 Rs.400,000
Other information
Normal capacity............................... 100,000 DLH
Actual DLH (Standard) produced..... 102,000 DLH
Actual hours worked and paid......... 98,000 DLH
Actual overheads paid..................... Rs.420,500
Required
a)
Amount of fixed manufacturing costs
b)
The three overhead variances
(TU 2058)
(Ans.: Total cost 25,000 units: Rs.375,750; 20,000 units: Rs.310,500)
Question 15. Based on the following information, you are required to calculate the three
overhead variances.
Cost Items
Fixed overheads
Variable overheads Rate
Fixed overhead rate
Working hours

Planned
Rs.90,000
Rs.9 per hour
Rs.9 per hour
11,000 hours

Actual
Rs.90,000
Rs.9.44 per hour
Rs.9 per hour
10,700 hours

(Ans.: CV = Rs.9,000 (F); EV = Rs.2,700 (F); SV = Rs.4,708 (U))

Question 16. The flexible budgeting data and other information have been presented below:
BA = Rs.150,000 + Rs.1 DLH
Normal capacity: 100,000DLH
Standard time per unit of output: 4 DLH
Actual output: 27,500 units.
Actual hours worked: 105,000 DLH
Actual overheads paid: Rs.423,000
Required
Three overhead variances.
(Ans.: CV = Rs.15,000 (F); EV = Rs.5,000 (F); SV = Rs.168,000 (U))
Question 17. ABC Ltd. is following the standard costing system. The flexible budgeting data and

additional information have been presented below:

BA = Rs.80,000 + Rs.6 DLH
Normal capacity = 20,000DLH
Standard output per DLH = 4units
Actual output = 88,000units
Actual overheads paid = Rs.190,000
Required
The three overhead variances.
(Ans.: CV = Rs.8,000 (F); EV = Rs.12,000 (F); SV = Rs.10,000 (F))
Question 18. The activity levels and cost per direct labour hours of a manufacturing co. are
summarized below:
Activity levels in direct labour
25,000
50,000
hours
Factory overheads:
Indirect materials
Rs.25,000 Rs.50,000
Indirect labour
37,500
75,000
Supervision cost
22,500
35,000
Heat, Light and power
17,500
30,000
Depreciation
53,000
53,000
Rent and taxes
12,000
12,000
Total
167,500
255,000
Other data:
Normal capacity: 40,000 direct labour hours
Hours worked: 42,000 direct labour hours
Actual hours produced: 38,000 direct labour hours
Actual factory overhead costs incurred: Rs.203,000
Required
Factory overhead variance analysis i.e. capacity, efficiency and spending variances
(Ans.: CV = Rs.4,000 (U); EV = Rs.14,000 (U); SV = Rs.24,000 (F))
Question 19. The following information was obtained from the records of a manufacturing
company using a standard costing system.
Activity level in units........................
10,000
20,000
Budgeted overheads........................ Rs.40,000 Rs.60,000
Direct labour hours:
Normal capacity .............................. 5,000 direct labour hours
Output per labour hour..................... 2 units
Actual production............................. 12,000 units
Actual overheads incurred................ Rs.45,000
Required
a)
By using the flexible budget formula, estimate the budget for the actual level of
output.
b)
Calculate the three overhead variances.
(Ans.: a) Rs.44,000 (b) CV = Rs.4,000 (F); EV = Rs.4,000 (F); SV = Rs.5,000 (U))
Question 20. The details of overhead costs of a manufacturing co. and other information have
been provided below:
Output in units
5,000
10,000
Factory overheads:
Indirect materials
Rs.5,000 Rs.10,000

Indirect labour
Supervision cost
Heat, Light and power
Depreciation
Tent and taxes

10,000
10,000
5,000
5,000
15,000
50,000

20,000
15,000
7,500
7,500
15,000
75,000

Total
Other data:
Normal capacity: 5,000 direct labour hours
Direct labour hours required for 1 unit of output: 0.5
Actual output: 11,000units
Actual hours worked: 4,750
Actual overhead costs paid: Rs.73,450
Required
a)
Construct a formula flexible budget for the company
b)
Calculate the budgeted overheads for 7,500 units
c)
Calculate the three overhead variances.
(Ans.: a) BA = Rs.25,000 + Rs.5 Output units b) Rs.62,500 c) CV = Rs.2,500 (F); EV
= Rs.7,500 (F); SV = Rs.950 (U))

Cost volume profit

Following information of cost and sales are given to you.
Selling price per unit = Rs. 1
Variable cost per unit = Rs. 0.50
Fixed cost = Rs. 50,000
Draw a break-even chart showing the likely profit at the expected production level of
150,000 units.
Solution:
Sales revenues (150,000 Re. 1)
Less: Variable cost (150,000 Rs. 0.50)
Contribution margin
Less: Fixed cost
Net Profit

=
=

Rs. 150,000
75,000

=
=
=

Rs. 75,000
50,000
25,000

Cost, Price and Profit (in 000 Rs.)

Sales revenue

250
Profit

Total cost

200
BE Point

150

Variable

100

50

Cost

Loss
Fixed Cost

50

150
100
200
Quantity in units (in 000 units)

250

In this graphical presentation, 150000 units or Rs. 150,000 is the break even point where
income is equal to expenditure and there is neither profit nor loss.
STEP (MOVING) FIXED COST IN CVP ANALYSIS
Moving fixed is a kind of fixed cost which is based upon certain level of activities. Fixed cost
such as deprecation and rent, are normally remains constant for a certain level of activities.
On the other hand the fixed cost like repairs and maintenance, supervisions do change many
times between various capacity volumes. If costs are changed up on those capacity
volumes, they are known as step fixed cost.

Following information is extracted:

Selling price per unit
Rs. 20
Variable cost per unit
Rs. 12
Fixed costs:
Depreciation
Rs. 80,000
Rent &Rates
Rs. 20,000
Repairs Rs. 10,000 for every 5,000 units
Supervision Rs. 10,000 for every 10,000 units

Required: BEP (in units)

(Adopted from Seminar Paper)

Solution:
Assume all moving fixed costs (Repairs and supervision) as variable for sometime
Repairs cost per unit = = Rs. 2
Supervision cost per unit = = Re 1
Find out assumed CMPU:
Assumed CMPU = SP Regular VC Assumed VC = Rs. 20 12 3 = Rs. 5 per unit
Find out the range where BE possibly lies (BE range)
BE range = = = 20,000 units
Estimate fixed cost for the range
Rs.
Depreciation
80,000
Rent and rates
20,000
Repairs
40,000 (10,0004)
Supervision
20,000 (10,0002)
Total FC
16,0000
Determine Actual BE Sales volume (units)
BE Sales (units) = = = 20,000 units