1. Flexible Budgeting and Analysis of Overhead Costs CHAPTER 11 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2. Flexible Budgets Static budgets are prepared for a single, planned level of activity. Performance evaluation for overhead 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. 11-2

3. Static Budgets and Performance Reports U = Unfavorable variance Cheese Company was unable to achieve the budgeted level of activity. 11-3

4. Static Budgets and Performance Reports F = Favorable variance since actual costs are less than budgeted costs. Since cost variances are favorable, have we done a good job controlling costs? 11-4

5. I don’t think I can answer this question using a static budget. I do know that actual activity is below budgeted activity which is unfavorable. But shouldn’t variable costs be lower if actual activity is below budgeted activity? Static Budgets and Performance Reports 11-5

6. 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. 11-6

7. 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. 11-7

8. Advantages of Flexible Budgets Improve performance evaluation. May be prepared for any activity level in the relevant range. Show revenues and expenses that should have occurred at the actual level of activity. Reveal variances due to good cost control or lack of cost control. 11-8

9. Preparing a Flexible Budget 11-9

10. Preparing a Flexible Budget Variable costs are expressed as a constant amount per hour. Fixed costs are expressed as a total amount that does not change within the relevant range of activity. 11-10

11. Preparing a Flexible Budget 11-11

12. Preparing a Flexible Budget 11-12

13. Preparing a Flexible Budget Note: There is no flex in the fixed costs. 11-13

14. Preparing a Flexible Budget Budgeted variable Total overhead cost per activity activity unit units ×+ Budgeted fixed overhead cost Total budgeted overhead cost = 11-14

15. Flexible Budget Performance Report Now let’s prepare a budget performance report at 8,000 actual machine hours for the Cheese Co. 11-15

16. Flexible Budget Performance Report 11-16

17. Flexible Budget Performance Report Flexible budget is prepared for the same activity level (8,000 hours) as actually achieved. 11-17

18. Flexible Budget Performance Report 11-18

19. Flexible Budget Performance Report Indirect labor and indirect material have unfavorable variances because actual costs are more than the flexible budget costs. 11-19

20. Flexible Budget Performance Report Power has a favorable variance because the actual cost is less than the flexible budget cost. 11-20

21. Overhead Application in a Standard Costing System 11-21

22. Overhead Application in a Standard Costing System 11-22

23. Choice of Activity Measure l Variable overhead and the activity measure should vary in a similar pattern. l Identify variable overhead cost drivers. l Examples: machine hours, labor hours, process time. l Dollar measures should be avoided as they are subject to price-level changes. 11-23

24. Cost Management Using Overhead Cost Variances Let’s turn our attention to the computation of overhead cost variances. We will begin with variable overhead.. 11-24

25. Spending Variance Efficiency Variance AH × SVR AH × AR AH = Actual Hours of Activity AR = Actual Variable Overhead Rate SVR = Standard Variable Overhead Rate SH = Standard Hours Allowed SH × SVR Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours Variable Overhead Variances 11-25

26. Spending Variance Efficiency Variance AH × SVR AH × AR SH × SVR Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours Variable Overhead Variances Spending variance = AH(AR - SVR) Efficiency variance = SVR(AH - SH) 11-26

27. 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. 11-27

28. Variable Overhead Variances – Example ColaCo prepared this budget for overhead: Budgeted variable Total overhead cost per x activity activity unit units + Budgeted fixed overhead cost Total budgeted overhead cost = = $2.00 per machine hour × Total machine hours + $9,000 11-28

29. 3,300 hours 3,200 hours × × $2.00 per hour $2.00 per hour Spending variance $140 unfavorable Efficiency variance $200 unfavorable Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours $6,740$6,600$6,400 Variable Overhead Variances – Example 11-29

30. 3,300 hours 3,200 hours × × $2.00 per hour $2.00 per hour Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours $6,740$6,600$6,400 Variable Overhead Variances – Example The $140 unfavorable spending variance and the $200 unfavorable efficiency variance results in a $340 unfavorable flexible budget variance. 11-30

31. Variable Overhead Variances – A Closer Look Spending Variance Efficiency Variance Results from paying more or less than expected for overhead items and from excessive usage of overhead items. A function of the selected cost driver. It does not reflect overhead control. 11-31

32. Fixed Overhead Now let’s turn our attention to fixed overhead. 11-32

33. Budget Variance Volume Variance PFOHR = Predetermined Fixed Overhead Rate SH = Standard Hours Allowed SH × PFOHR Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied Fixed Overhead Variances 11-33

34. PFOHR = Applied Fixed Overhead = PFOHR × Standard Hours Budgeted Fixed Overhead Planned Activity in Hours Fixed Overhead Recall that fixed overhead costs are applied to products and services using a predetermined fixed overhead rate (PFOHR): 11-34

35. Fixed Overhead Variances – Example ColaCo used the following predetermined fixed overhead rate: PFOHR = Budgeted Fixed Overhead Planned Activity in Hours PFOHR = $9,000 3,000 machine hours PFOHR = $3.00 per machine hour 11-35

36. 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. 11-36

37. 3,200 hours × $3.00 per hour Fixed Overhead Variances – Example Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied $8,450$9,000$9,600 Budget variance $550 favorable Volume variance $600 (neither favorable nor unfavorable) 11-37

38. Fixed Overhead Variances – A Closer Look Budget Variance Volume Variance Results from paying more or less than expected for overhead items. Results from the inability to operate at the activity level planned for the period. Has no significance for cost control. 11-38

39. End of Chapter 11 I’m here to your budget. Are you ready to ante up? 11-39