sld11 PDF

Chapter
11
Flexible Budgets and
Overhead Analysis
11-2
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Prepare a flexible budget and explain the
advantages of the flexible budget approach
over the static budget approach.
2. Prepare a performance report for both variable
and fixed overhead costs using the flexible
budget approach.
3. Use the flexible budget to prepare a variable
overhead performance report containing only
a spending variance.
© McGraw-Hill Ryerson Limited., 2001

11-3
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
4. Use the flexible budget to prepare a variable
overhead performance report containing both a
spending and an efficiency variance.
5. Explain the significance of the denominator
activity figure in determining the standard cost
of a unit of product.
6. Apply overhead cost to units of product in a
standard cost system.
7. Compute and interpret the fixed overhead
budget and volume variances.

11-4
Static Budgets and Performance

Reports Hmm! Comparing
static budgets with
actual costs is like
Static budgets are comparing apples
prepared for a single, and oranges.
planned level of
activity.
Performance
evaluation is difficult
when actual activity
differs from the
planned level of
activity.
Let’s look at CheeseCo.
11-5

Reports
CheeseCo
Static Actual
Budget Results Variances
Machine hours 10,000 8,000
Variable costs
Indirect labour $ 40,000 $ 34,000
Indirect materials 30,000 25,500
Power 5,000 3,800
Fixed costs
Amortization 12,000 12,000
Insurance 2,000 2,050
Total overhead costs $ 89,000 $ 77,350

11-6

Reports
CheeseCo
Static
Static Actual
Actual
Budget
Budget Results
Results Variances
Variances
Machine hours
Machine hours 10,000
10,000 8,000
8,000 2,000 U
2,000 U
Variable costs
Variable costs
Indirect U = Unfavourable
Indirectlabour
labor 40,000 variance
$ 40,000 $ 34,000
34,000 $6,000 F
$6,000 F
IndirectCheeseCo
Indirect materials was30,000
materials unable to achieve
30,000 25,500
25,500 4,500 F
4,500 F
Power the budgeted 5,000
Power level of activity.
5,000 3,800
3,800 1,200 F
1,200 F
Fixed costs
Fixed costs
Depreciation
Amortization 12,000
12,000 12,000
12,000 00
Insurance
Insurance 2,000
2,000 2,050
2,050 50 U
U
Total overheadcosts
Total overhead costs $ 89,000
89,000 $ 77,350
77,350 $11,650 F
$11,650 F

11-7

Reports
CheeseCo
Static
Static Actual
Actual
Budget
Budget Results
Results Variances
Variances
Machine hours
10,000 8,000
8,000 2,000 U
2,000 U
Variable costs
Variable costs
Indirectlabour
Indirect labor $ 40,000
40,000 $ 34,000
34,000 $6,000 F
$6,000 F
Indirectmaterials
Indirect materials 30,000
30,000 25,500
25,500 4,500 F
4,500 F
Power
Power 5,000
5,000 3,800
3,800 1,200 F
1,200 F
F = Favourable
Fixed
Fixed costs
costs variance that occurs when
actual costs are less than
Depreciation
Amortization budgeted12,000
12,000
12,000 costs.
12,000 00
Insurance
Insurance 2,000
2,000 2,050
2,050 50 U
U
Total overheadcosts
89,000 $ 77,350
77,350 $11,650 F
$11,650 F

11-8

Reports
CheeseCo
Static
Static Actual
Actual
Budget
Budget Results
Results Variances
Variances
Machine hours
10,000 8,000
8,000 2,000 U
2,000 U
Variable costs
Variable costs
Indirectlabour
Indirect labor $ 40,000
40,000 $ 34,000
34,000 $6,000 F
$6,000 F
Indirectmaterials
Indirect materials 30,000
30,000 25,500
25,500 4,500 F
4,500 F
Power
Power 5,000
5,000 3,800
3,800 1,200 F
1,200 F
Since
Fixed cost variances are favourable, have
costs
Fixed costs
we done a good job controlling
Depreciation
Amortization 12,000
12,000 costs?
12,000
12,000 00
Insurance
Insurance 2,000
2,000 2,050
2,050 50 U
U
Total overheadcosts
89,000 $ 77,350
77,350 $11,650 F
$11,650 F

11-9

Reports
I don’t think I Actual activity is below
can answer the budgeted activity which
question using is unfavourable.
a static budget.
So, shouldn’t variable costs
be lower if actual activity
is lower?

11-10

Reports
! The relevant question is . . .
“How much of the favourable cost variance
is due to lower activity, and how much is due
to good cost control?”
! To answer the question,

we must
the budget to the
actual level of activity.
11-11
Flexible Budgets
Show revenues and expenses
that should have occurred at the
actual level of activity.
May be prepared for any activity

level in the relevant range.
Reveal variances due to good cost

control or lack of cost control.
Improve performance evaluation.

11-12
Flexible Budgets
Central Concept
If you can tell me what your activity was

for the period, I will tell you what your costs
and revenue should have been.

11-13
Preparing a Flexible Budget
To a budget we need to know that:

"Total variable costs change
in direct proportion to
changes in activity.
b le
"Total fixed costs remain ria
V a
unchanged within the
relevant range. Fixed

11-14
Let’s prepare
budgets
for CheeseCo.

11-15

CheeseCo
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Variable costs are expressed as
Indirect labour 4.00 a constant
$ 32,000 amount per hour.
Indirect material 3.00 24,000
Power 0.50 $40,000
4,000 ÷ 10,000 hours is
Total variable cost $ 7.50 $4.00 per hour.
$ 60,000
Fixed costs
Amortization $12,000
Fixed costs are
Insurance 2,000 expressed as a
Total fixed cost total amount.
Total overhead costs

11-16

CheeseCo
Formula Fixed 8,000 10,000 12,000
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labour 4.00 $ 32,000
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost $ 7.50 $ 60,000
Fixed costs
Amortization $4.00 per hour × 8,000 hours = $32,000
$12,000
Insurance 2,000
Total fixed cost
Total overhead costs

11-17

CheeseCo
Formula Fixed 8,000 10,000 12,000
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labour 4.00 $ 32,000 $ 40,000 $ 48,000
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost $ 7.50 $ 60,000 $ 75,000 $ 90,000
Fixed costs
Amortization $12,000 $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000 2,000
Total fixed cost $ 14,000 $ 14,000 $ 14,000
Total overhead costs $ 74,000 $ 89,000 $ 104,000

11-18

CheeseCo
Formula Fixed 8,000 10,000 12,000
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labourfixed costs
Total 4.00 $ 32,000 $ 40,000 $ 48,000
Indirect material 3.00 24,000 30,000 36,000
Power
do not change0.50 in 4,000 5,000 6,000
the relevant
Total variable cost $ range.
7.50 $ 60,000 $ 75,000 $ 90,000
Fixed costs
Amortization $12,000 $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000 2,000
Total fixed cost $ 14,000 $ 14,000 $ 14,000
Total overhead costs $ 74,000 $ 89,000 $ 104,000

11-19
Flexible Budget
Performance Report
Let’s prepare a
budget performance
repor t
for CheeseCo.

11-20
Flexible Budget
Performance Report
CheeseCo
Cost Total
FlexibleFormula
budget is Fixed Flexible Actual
prepared for theCosts
Per Hour Budget Results Variances
Machine hours
same activity level 8,000 8,000 0
(8,000 hours) as
Variable costs
actually$achieved.
Indirect labour 4.00 $ 32,000 $ 34,000
Indirect material 3.00 24,000 25,500
Power 0.50 4,000 3,800
Total variable costs $ 7.50 $ 60,000 $ 63,300
Fixed Expenses
Amortization $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,050
Total fixed costs $ 14,000 $ 14,050
Total overhead costs $ 74,000 $ 77,350

11-21
Flexible Budget
Performance Report
CheeseCo
Cost Total
Formula Fixed Flexible Actual
Per Hour Costs Budget Results Variances
Machine hours 8,000 8,000 0

Variable costs
Indirect labour $ 4.00 $ 32,000 $ 34,000 $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable costs $ 7.50 $ 60,000 $ 63,300 $ 3,300 U
Fixed Expenses
Amortization $ 12,000 $ 12,000 $ 12,000 0
Insurance 2,000 2,000 2,050 50 U
Total fixed costs $ 14,000 $ 14,050 50 U
Total overhead costs $ 74,000 $ 77,350 $ 3,350 U

11-22
Flexible Budget
Performance Report
Remember the ques
tio
“How much of the to n:
ta
variance is due to ac l
tivity
and how much is du
e to
cost control?”

11-23

How much of the $11,650 is due to activity
and how much is due to cost control?
Static Actual
Budget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs
Indirect labour $ 40,000 $ 34,000 $6,000 F
Indirect materials 30,000 25,500 4,500 F
Power 5,000 3,800 1,200 F
Fixed costs
Amortization 12,000 12,000 0
Insurance 2,000 2,050 50 U
Total overhead costs $ 89,000 $ 77,350 $11,650 F

11-24
Flexible Budget
Performance Report
Overhead Variance Analysis
Static Let’s place Actual
Overhead the flexible Overhead
Budget at budget for at
10,000 Hours 8,000 Hours
8,000 hours
$ 89,000 here. $ 77,350
Difference between original static budget

and actual overhead = $11,650 F.

11-25
Flexible Budget
Performance Report
Overhead Variance Analysis
Static Flexible Actual
Overhead Overhead Overhead
Budget at Budget at at
10,000 Hours 8,000 Hours 8,000 Hours
$ 89,000 $ 74,000 $ 77,350
Activity Cost control
This $15,000F variance is This $3,350U flexible

due to lower activity. budget variance is due
to poor cost control.

11-26
Flexible Budget
Performance Report
There are two primary
reasons for unfavourable
variable overhead variances:
What causes 1. Spending too much for
the cost resources.
control variance?
2. Using the resources
inefficiently.

11-27
Overhead Rates and Overhead

Analysis
Recall that overhead costs are assigned to
products and services using a
predetermined overhead rate (POHR):
Assigned Overhead = POHR × Standard Activity
Overhead from the

flexible budget for the
denominator level of activity
POHR =
Denominator level of activity

11-28

Analysis – Example
Let’s look at overhead

rates in a
budget for ColaCo.

11-29

ColaCo prepared this budget for overhead:
Total Variable Total Fixed
Machine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
2,000 $ 4,000 ? $ 9,000 ?
4,000 8,000 ? 9,000 ?
Let’s calculate overhead rates.
ColaCo
ColaCo applies
appliesoverhead
overheadbased
based
on
onmachine
machinehour
houractivity.
activity.
11-30

2,000 $ 4,000 $ 2.00 $ 9,000 ?
4,000 8,000 2.00 9,000 ?
Rate = Total Variable Overhead ÷ Machine Hours
This rate is constant at all levels of activity.

11-31

2,000 $ 4,000 $ 2.00 $ 9,000 $ 4.50
4,000 8,000 2.00 9,000 2.25
Rate = Total Fixed Overhead ÷ Machine Hours
This rate decreases when activity increases.

11-32

2,000 $ 4,000 $ 2.00 $ 9,000 $ 4.50
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.
11-33
Overhead Variances
Let’s use the

overhead rates, to
determine variable
and fixed overhead
variances.

11-34
Variable Overhead Variances –

Example
ColaCo’s actual production for the period required
3,200 standard machine hours. Actual variable
overhead incurred for the period was $6,740.
Actual machine hours worked were 3,300.
Compute the variable overhead spending and

efficiency variances.

11-35
Variable Overhead Variances

Actual Flexible Budget Flexible Budget
Variable for Variable for Variable
Overhead Overhead at Overhead at
Incurred Actual Hours Standard Hours
AH × AR AH × SR SH × SR
Spending Efficiency
Variance Variance
Spending variance = AH(AR - SR)
Efficiency variance = SR(AH - SH)

11-36
Variable Overhead Variances –

Example
Actual Flexible Budget Flexible Budget
Variable for Variable for Variable
Overhead Overhead at Overhead at
Incurred Actual Hours Standard Hours
3,300 hours 3,200 hours
× ×
$2.00 per hour $2.00 per hour
$6,740 $6,600 $6,400
Spending variance Efficiency variance

$140 unfavourable $200 unfavourable
$340
$340unfavourable
unfavourableflexible
flexiblebudget
budgettotal
totalvariance
variance
11-37
Variable Overhead Variances – A

Closer Look
Spending Variance Efficiency Variance
Results from paying more
Controlled by
or less than expected for
managing the
overhead items and from
overhead cost driver.
excessive usage of
overhead items.

11-38
Overhead Variances
Now let’s turn

our attention
to fixed
overhead.

11-39

2,000 $ 4,000 $ 2.00 $ 9,000 $ 4.50
4,000 8,000 2.00 9,000 2.25
What is ColaCo’s fixed overhead rate for an

estimated activity of 3,000 machine hours?

11-40

2,000 $ 4,000 $ 2.00 $ 9,000 $ 4.50
4,000 8,000 2.00 9,000 2.25
What is ColaCo’s
Fixedfixed overhead
Overhead Rate rate for an
estimated
FR = activity
$9,000 ÷of 3,000
3,000 machine
machine hours?
hours
FR = $3.00 per machine hour

11-41
Fixed Overhead Variances –

Example
ColaCo’s actual production required

3,200 standard machine hours. Actual
fixed overhead was $8,450.
Compute the fixed overhead budget and

volume variances.

11-42
Fixed Overhead Variances

Actual Fixed Fixed Fixed
Incurred Budget Applied
SH × FR
Budget Volume
Variance Variance
FR = Standard Fixed Overhead Rate
SH = Standard Hours Allowed

11-43

Example
Actual Fixed Fixed Fixed
Incurred Budget Applied
SH × FR
3,200 hours
×
$3.00 per hour
$8,450 $9,000 $9,600
Budget variance Volume variance

$550 favourable $600 favourable
11-44

A Closer Look
Budget Variance Volume Variance
Results from paying more Results from operating

or less than expected for at an activity level
overhead items. different from the
denominator activity.

11-45
Overhead Variances
Let’s look at a
graph showing
fixed overhead
variances. We will
use ColaCo’s
numbers from the
previous example.
11-46

Cost
e ad
e rh ucts
o v d
d pr o
ixe o
F t
l ied
p p
a Volume
3,000 Hours 3,200
Expected Standard
Activity Hours
11-47

3,200 machine hours × $3.00 fixed overhead rate
Cost
$9,600 applied fixed OH
$9,000 budgeted fixed OH
$8,450 actual fixed OH
e ad
e rh ucts
o v d
d pr o
ixe o
F t
l ied
p p
a Volume
3,000 Hours 3,200
Expected Standard
Activity Hours
11-48

3,200 machine hours × $3.00 fixed overhead rate
Cost
$600
Favourable $9,600 applied fixed OH
Volume
{
Variance $9,000 budgeted fixed OH
$550 { $8,450 actual fixed OH
Favourable
Budget ad
Variance e
rh ucts
ve d
d o r o
ixe o p
F t
l ied
p p
a Volume
3,000 Hours 3,200
Expected Standard
Activity Hours
11-49
Volume Variance – A Closer Look
Volume
Variance
Results when standard hours

allowed for actual output differs
from the denominator activity.
Unfavourable Favourable
when standard hours when standard hours
< denominator hours > denominator hours

11-50
Volume Variance – A Closer Look
Volume
Variance
Does not measure over-
or under spending
Results when standard hours
allowed for actual output
Explainable by anddiffers
from the denominator activity.
controllable only through
activity
Unfavorable Favorable
when standard hours when standard hours
< denominator hours > denominator hours

11-51
Overhead Variances and Under- or

Overapplied Overhead Cost
In a standard
cost system:
Unfavourable Favourable
variances are equivalent variances are equivalent
to underapplied overhead. to overapplied overhead.
The sum of the overhead variances

equals the under- or overapplied
overhead cost for a period.
11-52
End of Chapter 11
I’m here to your

budget. Are you ready to
ante up?

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Chapter

© McGraw-Hill Ryerson Limited., 2001

© McGraw-Hill Ryerson Limited., 2001

Static Budgets and Performance

Static Budgets and Performance

© McGraw-Hill Ryerson Limited., 2001

Static Budgets and Performance

© McGraw-Hill Ryerson Limited., 2001

Static Budgets and Performance

© McGraw-Hill Ryerson Limited., 2001

Static Budgets and Performance

© McGraw-Hill Ryerson Limited., 2001

Static Budgets and Performance

© McGraw-Hill Ryerson Limited., 2001

Static Budgets and Performance

! To answer the question,

May be prepared for any activity

Reveal variances due to good cost

Improve performance evaluation.

© McGraw-Hill Ryerson Limited., 2001

If you can tell me what your activity was

© McGraw-Hill Ryerson Limited., 2001

Preparing a Flexible Budget

To a budget we need to know that:

© McGraw-Hill Ryerson Limited., 2001

Preparing a Flexible Budget

© McGraw-Hill Ryerson Limited., 2001

Preparing a Flexible Budget

© McGraw-Hill Ryerson Limited., 2001

Preparing a Flexible Budget

© McGraw-Hill Ryerson Limited., 2001

Preparing a Flexible Budget

© McGraw-Hill Ryerson Limited., 2001

Preparing a Flexible Budget

© McGraw-Hill Ryerson Limited., 2001

© McGraw-Hill Ryerson Limited., 2001

© McGraw-Hill Ryerson Limited., 2001

Machine hours 8,000 8,000 0

© McGraw-Hill Ryerson Limited., 2001

© McGraw-Hill Ryerson Limited., 2001

Static Budgets and Performance

© McGraw-Hill Ryerson Limited., 2001

Difference between original static budget

© McGraw-Hill Ryerson Limited., 2001

Activity Cost control

This $15,000F variance is This $3,350U flexible

© McGraw-Hill Ryerson Limited., 2001

© McGraw-Hill Ryerson Limited., 2001

Overhead Rates and Overhead

Overhead from the

© McGraw-Hill Ryerson Limited., 2001

Overhead Rates and Overhead

Let’s look at overhead

© McGraw-Hill Ryerson Limited., 2001

Overhead Rates and Overhead

Let’s calculate overhead rates.

Overhead Rates and Overhead

Rate = Total Variable Overhead ÷ Machine Hours

This rate is constant at all levels of activity.

Overhead Rates and Overhead

Rate = Total Fixed Overhead ÷ Machine Hours

This rate decreases when activity increases.

Overhead Rates and Overhead