1. Flexible Budgets and Overhead Analysis Management Accounting: The Cornerstone for Business Decisions Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.

2. Learning Objectives 1.Prepare a flexible budget and use it for performance reporting. 2.Calculate the variable overhead variances and explain their meaning. 3.Calculate the fixed overhead variances and explain their meaning. 4.Prepare an activity-based flexible budget.

3. Illustrate Static and Flexible Budget Variances

4. How to prepare a performance report based on a static budget (using budgeted production). For Quarter 2 Relationships from the Master Budget Actual Data Budgeted production units 1,590Production units 1,800 Materials:Materials cost: $ 6,570.00 1 plain t-shirt @ $3.00 5 ounces of ink @ $0.20 Labor:Labor cost: $ 2,250.00 0.12 hr. @ $10.00 10-1

5. How to prepare a performance report based on a static budget (using budgeted production). For Quarter 2 Relationships from the Master Budget Actual Data 10-1 Variable overhead MaintenanceMaintenance: $ 802.50 0.12 hr. @ 3.75 Power 0.12 @ $1.25Power $ 255.00 Fixed overhead Grounds keeping: $1,105 per qtr.Grounds keeping $ 1,055.00 Depreciation: $540 per qtr.Depreciation $ 540.00 REQUIRED: Prepare a performance report using a budget based on expected production. Calculation: Appears on next slide.

6. How to prepare a performance report based on a static budget (using budgeted production). 10-1 ActualBudgetedVariance Units 1,590 1,800 $ 210.00F DM cost $ 6,360.00 $ 6,570.00 210.00U DL cost 1,908.00 2,250.00 342.00U Overhead: Variable: Maintenance 715.50 802.50 87.00U Power 238.50 255.00 16.50U Fixed: Grounds Keeping 1,105.00 1,055.00 (50.00)F Depreciation 540.00 - Total $ 10,867.00 $ 11,472.50 $ 605.50U

7. Define the two types of flexible budgets. ◙Before-the-fact Managers deal with uncertainty by seeing expected outcomes for a ranges of activity levels ◙After-the-fact Managers build a flexible budget around the actual level of activity achieved.

8. How to prepare a flexible production budget. Levels of activity 1,100 1,300 1,500 Materials: 1 plain t-shirt @ $3.00 5 ounces of ink @ $0.20 Labor: 0.12 hr. @ $10.00 Variable overhead Maintenance 0.12 hr. @ 3.75 Power 0.12 @ $1.25 Fixed overhead Grounds keeping: $1,105 per qtr. Depreciation: $540 per qtr. 10-2 Required: Prepare a budget for three levels of output: 1,100, 1,300, 1,500 units Calculation: Appears on the following slide

9. How to prepare a flexible production budget. 10-2 Variable CostRange of Production per Unitunits Units 1,100 1,300 1,500 DM cost $ 4.00 $4,400 $5,200 $ 6,000 DL cost 1.20 1,320 1,560 1,800 Overhead: Variable: Mainten. 0.45 495 585 675 Power 0.15 660 780 900 Tot var cost $6,875 $8,125 $ 9,375 Remainder on following slide

10. How to prepare a flexible production budget. 10-2 Fixed: Grds Kp $1,105 Deprec 540 Total fix cost $1,645 Total prod cost $8,520 $9,770 $11,020

11. Budgeted costs for the actual level of activity are calculated using the rates from Cornerstone 10-2 and the activity from Cornerstone 10-1, actual costs come from Cornerstone 10-1. REQUIRED: Prepare a performance report using budgeted costs for the and the actual level of activity. Calculations: Appears on the following slide. How to prepare a performance report using a flexible budget. 10-3

12. How to prepare a performance report using a flexible budget. 10-3 ActualBudgetedVariance Units 1,800 $ -F DM cost $ 6,570.00 $ 7,200 630.00F DL cost 2,250.00 2,160.00 (90.00)U Overhead: Variable: Maintenance 802.50 810.00 7.50F Power 255.00 270.00 15.00F Fixed: Grounds Keeping 1,105.00 1,055.00 (50.00)U Depreciation 540.00 - Total $ 11,522.50 $ 12,035.00 $ 512.50F

13. How to calculate the total variable overhead variance. Standard variable overhead rate (SVOR)$5.00 DLH Actual variable overhead costs200 hrs. (AH) @ $4.70 (AVOR) Standard rate allowed per unit0.12 hr Actual production1,600 units REQUIRED: Calculate the total variable overhead variance Calculation: 10-4 Actual Costs AH x AVOR 200 x $4.70 = $940 Total Variance (AH x AVOR) - (SH x SVOR) = $(60) Applied Costs SH x SVOR 200 x $5.00 = $1,000 -=

14. How to calculate the variable overhead variances: columnar and formula approaches. 10-5 Standard variable overhead rate (SVOR)$5.00 DLH Actual variable overhead rate (AVOR)$4.70 Actual hours worked (AH)200 hrs Number of t-shirts produced1,600 units Hours allowed for production (SH)192 hrs REQUIRED: Calculate the variable overhead spending and efficiency variances Calculation: Columnar appears on next slide. VOH Spending Variance = (AVOR – SVOR)AH = ($4.70 - $5.00)200 = $60 F VOH Efficiency Variance= (AH – SH)SVOR = (200 – 192)$5.00 = $40 U

15. How to calculate the total variable overhead variance. 10-5 1. AH x AVOR (Actual Hours x Actual Rate) 200 x $4.70 = $940 1. AH x AVOR (Actual Hours x Actual Rate) 200 x $4.70 = $940 3. SH x SVOR (Standard Hours x Variable Overhead Rate) = $(60) 3. SH x SVOR (Standard Hours x Variable Overhead Rate) = $(60) 2. AH x SVOR (Actual Hours x Variable Overhead Rate 200 x $5.00 = $1,000 2. AH x SVOR (Actual Hours x Variable Overhead Rate 200 x $5.00 = $1,000 Spending Variance (1-2) $45 F Efficiency Variance (2-3) $30 U Total Variance (1-3) $15 F Total Variance (1-3) $15 F

16. How to prepare a performance report for the variable overhead variances. Standard variable overhead rate (SVOR) $5.00 DLH Actual costs: Maintenance$715 Power$225 Actual hours worked (AH) 200 hrs Number of t-shirts produced1,600 units Variable overhead: Maintenance0.12 hr @ $3.75 Power0.12 hr @ $1.25 REQUIRED: Prepare a performance report that shows the variances on an item-by-item basis. Calculation: Appears on the following slide. 10-6

17. How to prepare a performance report for the variable overhead variances. 10-6 Budget for CostActual SpendingStandardEfficiency CostFormulaCostsHoursVarianceHoursVariance Mainten. $ 3.75 $ 715 $ 750 $(35.00) F $ 720 $ 30.00U Power 1.25 225 250 (25) F 240 10U Total $ 5.00 $ 940 $ 1,000 $(60.00) F $ 960.00 $ 40.00U

18. Discuss Fixed Overhead Variance Analysis ◙ Fixed overhead costs represent capacity costs, manufacturing capacity costs acquired in advance of usage and often allocated over time ◙ The Standard Fixed Overhead Rate (SFOR) = Budgeted Fixed Overhead Costs / Practical Capacity ◙ Measurement is usually done in DLH or MH instead of units

19. How to calculate the total fixed overhead variance. Standard fixed overhead rate (SFOR)$10 DLH Actual fixed overhead costs$1,780 Standard hours allowed per unit0.12 Actual production1,400 units REQUIRED: Calculate the total fixed overhead variance Calculation: 10-7 Actual Costs AFOH $1,780 Total Variance (AFOH – ApFOH) = $100 Applied Fixed Overhead SH x SFOR 168 x $10 = $1,680 -=

20. How to calculate the fixed overhead variances: columnar and formula approaches. 10-8 Information from Cornerstone 10-6 Standard fixed overhead rate (SFOR)$10.00 DLH Budgeted fixed overhead (BFOH)$1,900 Number of t-shirts produced1,400 units Hours allowed for production (SH)168 hrs REQUIRED: Calculate the fixed overhead spending and volume variances Calculation: Columnar appears on next slide. FOH Spending Variance = (AFOH –BFOH) = ($1,780 - $1,900) = $120 F FOH Volume Variance = (BFOH – ApFOH) = (SHp –SH)SHOR = (190 – 168)$10.00 = $220 U

21. How to calculate the total fixed overhead variance. 10-8 1.Actual Fixed Overhead $1,780 1.Actual Fixed Overhead $1,780 3. SH x SFOR (Standard Hours x Fixed Overhead Rate) 168 x $10.00 = $1,680 3. SH x SFOR (Standard Hours x Fixed Overhead Rate) 168 x $10.00 = $1,680 2. Budgeted Fixed Overhead (SHp x SHOR) 190 x $10.00 = $1,900 2. Budgeted Fixed Overhead (SHp x SHOR) 190 x $10.00 = $1,900 Spending Variance (1-2) $120 F Volume Variance (2-3) $220 U Total Variance (1-3) $100 F Total Variance (1-3) $100 F

22. Illustrate Analysis of the Volume Variance

23. How to prepare a static budget for an activity. 1.Demand for purchase orders is based on materials requirements: 18,000 purchase orders. 2.Resources needed: 1.6 purchasing agents, capable of processing 3,000 purchasing orders per year; salary $45,000. 2.Supplies, projected to cost $1.05 per purchase order 3.Desks and computers, depreciation $6,000 4.Office space, rent, and utilities $6,500 REQUIRED: Prepare a budget for the purchasing activity Calculation: Purchasing budget: SalariesDeprec.SuppliesOccup.Total $270,000$6,000$18,900$6,500$301,400 10-9

24. How to prepare an activity flexible budget. For simplicity the full set of information is not listed, but the individual activities, drivers, their cost, formulas, and the output levels are the inputs needed to prepare the budget. To illustrate, the maintenance activity would require the following information for its role in the budget: Activity:Maintenance Driver:Machine hours Fixed activity costs:$20,000 Variable activity rate: $5.50 per machine hour REQUIRED: Prepare an activity-based flexible budget Calculation: Follows on the next slide, Driver = DLH 10-10

25. How to prepare an activity flexible budget. 10-10 Driver: DLHFormulaLevel of Activity FixedVariable 12,000 22,000 DM $ - $ 10 $ 120,000 $ 220,000 DL - 8 96,000 176,000 Subtotal $ - $ 18 $ 228,000 $ 418,000 Driver: MH FixedVariable 10,000 18,000 Mainten. $ 20,000 $ 5.50 $ 75,000 $ 119,000 Machining 15,000 2.00 35,000 51,000 Subtotal $ 35,000 $ 7.50 $ 120,000 $ 188,000 Remainder follows on the next slide

26. How to prepare an activity flexible budget. 10-10 Driver: # of Setups FixedVariable 25 30 Setups $ - $ 1,800 $ 45,000 $ 54,000 Inspect. 80,000 2,100 132,500 143,000 Subtotal $ 80,000 $ 3,900 $ 177,525 $ 197,030 Driver: # of Orders FixedVariable 16,000 27,000 Purchas. $ 220,000 $ 1.00 $ 236,000 $ 247,000

27. How to prepare an activity- based performance report. Actual activity level is the first one for each activity listed in Cornerstone 10-10. Actual cost: Direct materials$103,000 Direct labor83,000 Maintenance57,000 Machining27,000 Inspections128,000 Setups44,000 Purchases230,000 REQUIRED: Prepare an activity-based performance report Calculation: Appears on next slide. 10-11

28. How to prepare an activity- based performance report. 10-11 Act. CostBud. CostBudget Var. DM $103,000 $100,000 $ 3,000U DL 83,000 80,000 3,000U Maint. 57,000 64,000 (7,000)F Machin. 27,000 31,000 (4,000)F Inspec. 128,000 132,500 (4,500)F Setups 44,000 45,000 (1,000)F Purch. 230,000 226,000 4,000U Total $672,000 $678,500 $(6,500)F