3Static budgets are prepared for a single, planned level of activity. Flexible BudgetsHmm! Comparing static budgets with actual costs is like comparing apples and oranges.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.
4Consider the following example from the Cheese Company . . . Flexible BudgetsHmm! Comparing static budgets with actual costs is like comparing apples and oranges.Consider the following example from the Cheese Company . . .
5Static Budgets and Performance Reports U = Unfavorable variance Cheese Company was unable to achieve the budgeted level of activity.
6Static 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?
7Static Budgets and Performance Reports 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?I don’t think I can answer this question using a static budget.
8Static 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.
9Flexible 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.
10Advantages of 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 costcontrol or lack of cost control.Improve performance evaluation.
29Choice of Activity Measure Variable overhead and the activity measure should vary in a similar pattern.Identify variable overhead cost drivers.Examples: machine hours, labor hours, process time.Dollar measures should be avoided as they are subject to price-level changes.
31Cost Management Using Overhead Cost Variances Let’s turn our attention to the computation of overhead cost variances. We will begin with variable overhead.
32Variable Overhead Variances Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard HoursAH × ARAH × SVRSH × SVRSpending VarianceEfficiency VarianceAH = Actual Hours of Activity AR = Actual Variable Overhead Rate SVR = Standard Variable Overhead Rate SH = Standard Hours Allowed
33Variable Overhead Variances Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard HoursAH × ARAH × SVRSH × SVRSpending VarianceEfficiency VarianceSpending variance = AH(AR - SVR)Efficiency variance = SVR(AH - SH)
34Variable 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.
35Variable Overhead Variances – Example ColaCo prepared this budget for overhead:Total budgeted overhead cost=Budgeted variable Total overhead cost per x activity activity unit units+Budgeted fixed overhead costTotal budgeted overhead cost=$2.00 per machine hour×Total machine hours+$9,000
36Variable Overhead Variances – Example Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours3,300 hours ,200 hours × × $2.00 per hour $2.00 per hour$6,740$6,600$6,400Spending variance $140 unfavorableEfficiency variance $200 unfavorable
37Variable Overhead Variances – Example Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours3,300 hours ,200 hours × × $2.00 per hour $2.00 per hour$6,740$6,600$6,400The $140 unfavorable spending variance and the $200 unfavorable efficiency variance result in a $340 unfavorable flexible budget variance.
38Variable Overhead Variances – A Closer Look Spending VarianceEfficiency VarianceResults 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.
40Fixed Overhead Variances Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget AppliedSH × PFOHRBudget VarianceVolume VariancePFOHR = Predetermined Fixed Overhead Rate SH = Standard Hours Allowed
41Budgeted Fixed Overhead Planned Activity in Hours Recall that fixed overhead costs are applied to products and services using a predetermined fixed overhead rate (PFOHR):Applied Fixed Overhead = PFOHR × Standard HoursBudgeted Fixed Overhead Planned Activity in HoursPFOHR =
42Fixed Overhead Variances – Example ColaCo used the following predetermined fixed overhead rate:PFOHR =Budgeted Fixed Overhead Planned Activity in Hours$9,000 3,000 machine hoursPFOHR = $3.00 per machine hour
43Fixed 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.
44Fixed Overhead Variances – Example Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied3,200 hours × $3.00 per hour$8,450$9,000$9,600Budget variance $550 favorableVolume variance $600 (neither favorable nor unfavorable)
45Fixed Overhead Variances Let’s look at a graph showing fixed overhead variances. We will use ColaCo’s numbers from the previous example.
46Fixed Overhead Variances – A Closer Look Budget VarianceVolume VarianceResults 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.
51Activity-Based Flexible Budget The Cheese Co. flexible budget is based on a single cost driver, machine hours
52Activity-Based Flexible Budget If different cost drivers are identified for the different variable costs, an activity-based flexible budget should be prepared with different cost formulas based on the different drivers.
57A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard PricePrice VarianceQuantity VarianceMaterials price variance Materials quantity variance Labor rate variance Labor efficiency variance Variable overhead Variable overhead spending variance efficiency varianceAQ(AP - SP) SP(AQ - SQ)AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity
58A General Model for Variance Analysis Actual Sales Volume Actual Sales Volume Budgeted Sales Volume × × × Actual Sales Price Budgeted Sales Price Budgeted Sales PriceSales Price VarianceSales Volume VarianceASV(ASP - BSP) BSP(ASV - BSV)ASV = Actual Sales Volume BSP = Budgeted Sales Price ASP = Actual Sales Price BSV = Budgeted Sales Volume
59I’m here to your budget. Are you ready to ante up? End of Chapter 11I’m here to your budget. Are you ready to ante up?