Flexible Budgeting

Chapter 13

Manufacturing Overhead
Costs
Are not traceable to individual products.
They

are a pool of many different kind of

costs with different relationship to
productive activity (variable vs. fixed).

Different

individuals responsible for

different type of overhead costs.

Overhead Budgets
Since

overhead costs are not

traceable to products we cant set
standards for them.

Flexible

Budgets not based on only

one level of activity, but covers a
range of activity.

Static

Budget based on a particular

level of activity.

Static Budget Versus Flexible Budget

Electricity - $.50 per machine hour

Static Budget
Activity
(machine hours) 7,500
Budgeted
electricity cost $3,750
AAstatic
staticbudget
budget isis
based
basedon
ononly
onlyone
one
anticipated
anticipatedactivity
activity
level.
level.

Flexible Budget
6,000 7,500 9,000
$3,000$3,750$4,500
AAflexible
flexiblebudget
budget
includes
includesseveral
several
possible
possibleactivity
activity
levels.
levels.

Notice that the static budget and the flexible

budget are the same (in this example) when
machine activity is 7,500 machine hours.

Flexible Budgeting
Static budgets are prepared for a
single, planned level of activity.

Hmm! Comparing
costs at different
levels of activity
is like comparing
apples with oranges.

Performance evaluation is
difficult when actual activity
differs from the activity
originally budgeted.

Consider
Consider the
the following
following
condensed
condensed example
example
from
from Barton,
Barton, Inc.
Inc. .. .. ..

Flexible Budgeting
Prepared for an expected activity of
10000 units but actual activity for the
period was only 8000 units

Flexible Budgeting

U = Unfavorable variance Barton,

Inc. was unable to achieve the
budgeted level of activity.

Flexible Budgeting

F = Favorable variance: actual costs

are less than budgeted costs.
Since cost variances are favorable, have
we done a good job controlling costs?

Static Budgets and

Performance Reports
I dont think I can
answer this question
using a static budget.

I do know that
actual activity is below
budgeted activity which
is unfavorable.
But shouldnt variable costs
be lower if actual activity
is below budgeted activity?

Static Budgets and

Performance Reports
The

relevant question is . . .

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
the budget to the
actual level of activity.

Shortcomings of the Traditional

Master Budget Process
Departmental

orientation

Plan from resources to outputs

Does not recognize interdependencies among
departments
Static

budgets

Developed for a single level of activity

Based on incremental adjustments
Results

orientation

Disconnects the process from its output

Cost-cutting accomplished by across-the-board
cuts
11

Flexible Budgeting
Show 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 cost
control or lack of cost control.
Managers can locate possible
problem areas by examining the
variances revealed on a
performance report that compares
budgeted costs for the actual level
of activity to the actual costs for
the same level.

Flexible Budgets
for Planning and Control
Static budgets
Master budget
Vital for planning
Less useful for
control
Developed around
a single level of
activity
Budgeted activity
level rarely equals
actual activity

Flexible budgets
Variable budget
Provides
expected costs
for a range of
activity
Provides
budgeted costs
for the actual
activity level
13

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.

Flexible Budgeting
To
a budget for different activity
levels, we must know how costs
behave with changes in activity levels.
Total variable costs change
in direct proportion to
changes in activity.
Total fixed costs remain
unchanged within the
relevant range.

le
b
a
ri
a
V
Fixed

23-15

Flexible Budgeting
Lets prepare
budgets for
Barton, Inc.

Flexible Budget
What are the three steps to prepare a
flexible budget?
Determine a relevant range over which production is expected to
vary during the coming period.

Analyze the projected manufacturing costs for the coming

period.
Using the per-unit costs for each element, prepare a budget
showing what costs are expected to be incurred at several
points within the relevant range.

Flexible Budgeting

Flexible Budgeting
Cost
Formula
Per Hour
Units of Activity
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs

4.00
3.00
0.50
7.50

Total
Fixed
Cost

Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours

8,000are expressed
10,000 as a constant
12,000
Variable costs
amount per hour.
In the $
original
32,000 budget, indirect labor was
$40,000 for 10,000 hours resulting in a rate
24,000
of $4.00 per hour.
4,000
$ 60,000
$12,000
2,000

Fixed costs are expressed as a

total amount that does not
change within the relevant
range of activity.

Flexible Budgeting
Cost
Formula
Per Hour
Units of Activity
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs

4.00
3.00
0.50
7.50

Total
Fixed
Cost

Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000

10,000

12,000

$ 32,000
24,000
4,000
$ 60,000

$ 40,000
30,000
5,000
$ 75,000

$ 48,000
36,000
6,000
$ 90,000

$12,000 $ 12,000
2,000
2,000
$ 14,000
$ 74,000

$ 12,000
2,000
$ 14,000
$ 89,000

$ 12,000
2,000
$ 14,000
$ 104,000

Flexible Budgeting
Cost
Formula
Per Hour
Units of Activity

Total
Fixed
Cost

Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000

10,000

12,000

$ 32,000
24,000
4,000
$ 60,000

$ 40,000
30,000
5,000
$ 75,000

$ 48,000
36,000
6,000
$ 90,000

Fixed costs
Depreciation
$12,000 $ 12,000
$ 12,000
Insurance
2,000
2,000
2,000
Total fixed cost
$ 14,000
$ 14,000
Total variable
cost
= $7.50 per unit budget
level in units
Total
overhead
costs
$ 74,000
$ 89,000

$ 12,000
2,000
$ 14,000
$ 104,000

Variable costs
Indirect labor
Indirect material
Power
Total variable cost

4.00
3.00
0.50
7.50

Flexible Budgeting

Note: There is no flex

in the fixed costs.

Fixed costs are expressed as a total

amount that does not change within the
relevant range of activity.

Flexible Budgeting

Flexible Budgeting
Performance Report
Flexible

budget
performance
report
Compare budgeted
costs given the actual
level of activity to the
actual costs for the
same level
Locate possible
problem areas by
examining the flexible
budget variances
Examines efficiency

Managerial

performance
report
Flexible budget
variances
Actual results vs.
flexible budget
Examines efficiency
Volume variances
Static budget vs.
flexible budget
Examines
effectiveness

Flexible Budget
Performance Report
Now lets prepare a
budget performance
report
at 8,000 actual mach
ine
hours

Flexible Budgeting
Performance Report

Flexible Budgeting
Performance Report
Flexible budget is prepared
for the same activity level
(8,000 hours) as actually
achieved.

Flexible Budgeting
Performance Report

Flexible Budgeting
Performance Report
Cost
Formula
Per Hour

Total
Fixed
Costs

Units of Activity
Variable costs
Indirect labor
$
Indirect material
Power
Total variable costs $
Fixed Costs
Depreciation
Insurance
Total fixed costs
Total overhead costs

4.00
3.00
0.50
7.50
$12,000
2,000

Flexible
Budget

Actual
Results

8,000

8,000

$ 32,000
24,000
4,000
$ 60,000

$ 34,000
25,500
3,800
$ 63,300

$ 2,000 U
1,500 U
200 F
$ 3,300 U

$ 12,000
2,000
$ 14,000
$ 74,000

$ 12,000
2,000
$ 14,000
$ 77,300

0
0
0
$ 3,300 U

Variances
0

Flexible Budgeting
Performance Report
Cost
Formula
Per Hour

Total
Fixed
Costs

Units of Indirect
Activity labor and indirect

material
Variable
costshave large unfavorable
variances
because$ actual
Indirect
labor
4.00costs
are more than the flexible
Indirect material
3.00
budget costs.
Power
0.50
Total variable costs $ 7.50
These
Fixed
Costsvariances are due to cost
control issues because we have
Depreciation
$12,000
removed the activity differences
Insurance
2,000
by flexing the original budget
Total fixed costs
from 10,000 units down to the
Total overhead costs
actual activity of 8,000 units.

Flexible
Budget

Actual
Results

8,000

8,000

$ 32,000
24,000
4,000
$ 60,000

$ 34,000
25,500
3,800
$ 63,300

$ 2,000 U
1,500 U
200 F
$ 3,300 U

$ 12,000
2,000
$ 14,000
$ 74,000

$ 12,000
2,000
$ 14,000
$ 77,300

0
0
0
$ 3,300 U

Variances
0

Flexible Budgeting
Performance Report
Cost
Formula
Per Hour
Units of Activity

Total
Fixed
Costs

Flexible
Budget

Actual
Results

8,000

8,000

Variable costs
Indirect labor
$ 4.00
$ 32,000
$ 34,000
Power has a favorable variance
Indirect material
3.00
24,000
25,500
because the actual cost is less
Power
0.50
4,000
3,800
than the flexible budget
cost.
Total variable costs $ 7.50
$ 60,000
$ 63,300
Fixed Costs
Depreciation
$12,000 $ 12,000
$ 12,000
Insurance
2,000
2,000
2,000
Total fixed costs
$ 14,000
14,000
Fixed costs remain unchanged
so the$total
Total overhead costs
$ 74,000
$ 77,300
overhead variance is $3,300
unfavorable.
Now we have a better indication on overhead
cost control at Barton.

Variances
0
$ 2,000 U
1,500 U
200 F
$ 3,300 U
0
0
0
$ 3,300 U

Flexible Budget
Performance Report
Remember the ques
tion:
How much of the to
ta
variance is due to ac l
tivity
and how much is du
e to
cost control?

Flexible Budgeting
How much of the $11,700 is due to activity
and how much is due to cost control?

Flexible Budget
Performance Report
Overhead Variance Analysis
Lets place
the flexible
budget for
8,000 hours
here.

Difference between original static budget

and actual overhead = $11,700 F.

Flexible Budget
Performance Report
Overhead Variance Analysis

Activity
This $15,000F variance is
due to lower activity.

Cost control
This $3,300U flexible
budget variance is due
to poor cost control.

Flexible Budget
Performance Report
What causes
the cost
control variance?

There are two primary

reasons for unfavorable
variable overhead variances:
1. Spending too much for
resources.
2. Using the resources
inefficiently.