1. Chapter Eleven Flexible Budgets and Overhead Analysis COPYRIGHT © 2012 Nelson Education Ltd.

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 11-2

3. OBJECTIVE  1 1 Prepare a flexible budget, and use it for performance reporting

4. COPYRIGHT © 2012 Nelson Education Ltd. Performance Reports Compare actual costs with budgeted costs Two ways: –Compare actual costs with budgeted costs for the budgeted level of activity Based on a static budget –Compare actual costs with the actual level of activity Based on a flexible budget 11-4

5. COPYRIGHT © 2012 Nelson Education Ltd. Static Budget Budget for one particular level of activity Performance report compares: –Direct materials, direct labour, and overhead costs budgeted for the planned level of activity with –Actual costs for the actual level of activity Actual costs and expected costs must be compared at the same level of activity 11-5

6. COPYRIGHT © 2012 Nelson Education Ltd. HOW TO Prepare a Performance Report Based on a Static Budget (Using Budgeted Production) Example: Cornerstone 11-1 Information: From the Master BudgetActual Data for Quarter 1 Production for Quarter 1: 1,060Production: 1,200 units Materials: 1 plain t-shirt @ $3.00 5 grams of ink @ $0.20 Labour: 0.12 hours @ $10.00 Variable overhead: Maintenance: 0.12 hour @ $3.75 Materials cost: $4,380 Labour cost: $1,500 Maintenance cost: $535 Power: 0.12 hour @ $1.25 Power cost: $170 Fixed overhead: Grounds keeping: $1,200 per qtr Grounds keeping: $1,050 Depreciation: $600 per quarter Depreciation: $600 Required: Prepare a performance report using a budget based on expected production 11-6

7. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report Example Units produced 1,060 Budgeted ($3.00 t-shirt + (5 grams x $0.20)) x 1,060 units Direct materials cost $4,240 11-7 The plan is to produce 1,060 units. All budgeted costs will be based on 1,060 units Direct labour cost1,272 (0.12 hours x $10.00 per hour) x 1,060 units

8. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report Example Units produced 1,060 Budgeted (0.12 hours x $3.75 per hour) x 1,060 units Direct materials cost $4,240 Direct labour cost1,272 Variable overhead: Maintenance 477 11-8

9. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report Example Units produced 1,060 Budgeted Direct materials cost $4,240 Direct labour cost1,272 Variable overhead: Maintenance 477 Power 159 Fixed overhead: Grounds keeping1,200 Depreciation600 Grounds keeping and depreciation are both fixed costs. They will be $1,200 and $600 regardless of the number of units produced 11-9 (0.12 hours x $1.25 per hour) x 1,060 units

10. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report Example Units produced 1,060 Budgeted Direct materials cost $4,240 Direct labour cost1,272 Variable overhead: Maintenance 477 Power 159 Fixed overhead: Grounds keeping1,200 Depreciation600 $7,948Total Total budgeted costs for 1,060 units 11-10

11. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report Example Units produced 1,060 Budgeted Direct materials cost $4,240 Direct labour cost1,272 Variable overhead: Maintenance 477 Power 159 Fixed overhead: Grounds keeping1,200 Depreciation600 $7,948Total Actual 1,200 Variance 140 F 140 more units were produced than originally budgeted 11-11

12. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report Example Units produced 1,060 Budgeted Direct materials cost $4,240 Direct labour cost1,272 Variable overhead: Maintenance 477 Power 159 Fixed overhead: Grounds keeping1,200 Depreciation600 $7,948Total Actual 1,200 Variance 140 F Grounds keeping costs were lower than predicted…a favourable variance! $4,830$590 U 1,500228 U 535 58 U 170 11 U 1,050 (150) F

13. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report Example Units produced 1,060 Budgeted Direct materials cost $4,240 Direct labour cost1,272 Variable overhead: Maintenance 477 Power 159 Fixed overhead: Grounds keeping 1,200 Depreciation 600 $7,948 Total Actual 1,200 Variance 140 F $4,830 $590 U 1,500228 U 535 58 U 170 11 U 1,050 (150) F Overall, actual costs exceeded budgeted costs by $737. Budgeted costs were based on 1,060 units and 1,200 units were actually produced 6000 $8,685 $737 U 11-13

14. COPYRIGHT © 2012 Nelson Education Ltd. Flexible Budget Enables a firm to compete expected costs for a range of activity levels Two types: –Before-the-fact Used to generate financial results for a number of plausible scenarios –After-the-fact Used to compute what costs should have been for the actual level of activity Expected costs are then compared with the actual costs in order to assess performance 11-14

15. COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 11-2 Levels of output: 1,000, 1,200 and 1,400 Materials ( 1 plain t-shirt @ $3.00 & 5 grams of ink @ $0.20) Labour: 0.12 hour @ $10.00 per hour Variable overhead: –Maintenance: 0.12 hours @ $3.75 per hour –Power: 0.12 hours @ $1.25 per hour Fixed overhead: –Grounds keeping: $1,200 per quarter & Depreciation: $600 per quarter Information: HOW TO Prepare a Flexible Production Budget Required: Prepare a budget for 3 levels of unit output: 1,000, 1,200 & 1,400 11-15

16. COPYRIGHT © 2012 Nelson Education Ltd. Range of Production (units) Flexible Budget Variable: 1,200 Direct materials 1,400 $4.00 1,000 Variable cost per unit Production costs $4,000$5,600$4,800 $4 x # of units $3.00 t-shirt and $1.00 of ink 11-16

17. COPYRIGHT © 2012 Nelson Education Ltd. Range of Production (units) Flexible Budget Variable: 1,200 Direct materials 1,400 $4.00 1,000 Variable cost per unit Production costs $4,000$5,600$4,800 Direct labour 1.20 1,2001,6801,440 $1.20 × # of units 0.12 hours × $10 per hour 11-17

18. COPYRIGHT © 2012 Nelson Education Ltd. Range of Production (units) Flexible Budget Variable: 1,200 Direct materials 1,400 $4.00 1,000 Variable cost per unit Production costs $4,000$5,600$4,800 Direct labour 1.20 1,2001,6801,440 Variable overhead: Maintenance 0.45450 630 540 0.12 hours × $1.25 per hour Power 0.15150 210 180 0.12 hours × $3.75 per hour 11-18

19. COPYRIGHT © 2012 Nelson Education Ltd. Flexible Budget Variable: 1,200 Direct materials 1,400 $4.00 $4,000$5,600 Direct labour 1.20 1,2001,680 Variable overhead: Maintenance 0.45450 630 Power 0.15150 210 1,000 $4,800 1,440 540 180 $5.80 $5,800 $6,960 $8,120 Total variable costs Variable cost per unit Range of Production (units) Production costs Fixed overhead: Grounds keeping Depreciation 1,200 600 Fixed costs do not change when levels of output change 11-19

20. COPYRIGHT © 2012 Nelson Education Ltd. Flexible Budget continued 1,200 1,400 1,000 Variable cost per unit Range of Production (units) Production costs Fixed overhead: Grounds keeping Depreciation 1,200 600 $1,800 $9,920 $8,760$7,600 Total fixed costs$1,800 Total production costs 11-20

21. COPYRIGHT © 2012 Nelson Education Ltd. HOW TO Prepare a Performance Report using a Flexible Budget Example: Cornerstone 11-3 Budgeted CostsActual Costs @ 1200 units Direct Materials: $4 per unit Direct Materials: $4,830 Direct Labour: $1.20 per unit Variable overhead: Maintenance: $0.45 per unitMaintenance cost: $535 Power: $0.15 per unitPower cost: $170 Fixed overhead: Grounds keeping: $1,200 per qtrGrounds keeping: $1,050 Depreciation: $600 per quarterDepreciation: $600 Direct Labour: $1,500 Information: Required: Prepare a performance report using budgeted costs for the actual level of activity 11-21

22. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report Example Units produced 1,200 Budgeted Actual 1,200 Variance Budgeted costs are based on actual units produced 11-22

23. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report Example Units produced 1,200 Budgeted Actual 1,200 Variance Direct materials costs to produce 1,200 units were $30 higher than expected Direct materials $4,830$4,800$ 30 U 11-23

24. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report Example Units produced 1,200 Budgeted Direct materials cost $4,800 Direct labour cost 1,440 Variable overhead: Maintenance 540 Power 180 Fixed overhead: Grounds keeping$1,200 Depreciation600 $8,760 Total production costs Actual 1,200 Variance $4,830 $30 U 1,50060 U 535 (5) U 170 (10) U $1,050 $(150) F 6000 $8,685 $ (75) F $7,035 Total variable costs $6,960 $ 75 U Total fixed costs $1,650 $1,800 $(150) F

25. OBJECTIVE  2 2 Calculate the variable overhead variances and explain their meaning

26. COPYRIGHT © 2012 Nelson Education Ltd. Variance Overhead Anaylsis Difference between applied and actual overhead Broken down into: –Total Variable Overhead Variance Broken further into: –Variable Overhead Spending Variance –Variable Overhead Efficiency Variance –Total Fixed Overhead Variance Broken further into: –Fixed Overhead Spending Variance –Fixed Overhead Volume Variance 11-26

27. COPYRIGHT © 2012 Nelson Education Ltd. HOW TO Calculate the Total Variable Overhead Variance Example: Cornerstone 11-4 Standard variable overhead rate (SVOR) $5.00 per direct labour hour Actual variable overhead costs –Actual direct labour hours (AH) = 150 hours –Actual Variable Overhead Rate (AVOR) $4.70 per hour Standard hours (SH) allowed per unit 0.12 hour Actual production 1,200 units Information: Required: Calculate the total variable overhead variance 11-27

28. COPYRIGHT © 2012 Nelson Education Ltd. Total Variable Overhead Variance Actual CostsApplied CostsTotal Variance –= (AH × AVOR) 150 hours × $4.70 $705 Actual Hours × Actual Variable Overhead Rate 11-28

29. COPYRIGHT © 2012 Nelson Education Ltd. Total Variable Overhead Variance Actual CostsApplied CostsTotal Variance –= (AH × AVOR) 144 hours × $5.00 $705 –(SH × SVOR) – $720 Hours allowed for production (SH) × Standard Variable Overhead Rate (SVOR) 11-29

30. COPYRIGHT © 2012 Nelson Education Ltd. Total Variable Overhead Variance Actual CostsApplied CostsTotal Variance –= (AH × AVOR) This is a favourable variance since actual costs were less than expected $705 –(SH × SVOR) – $720 = ($15) 11-30

31. COPYRIGHT © 2012 Nelson Education Ltd. Variable Overhead Spending Variance Measures the aggregate effect of the differences between –Actual variable overhead (AVOR) –Standard variable overhead rate (SVOR) Two ways to calculate: –Three-pronged columnar approach –Formula approach (AVOR – SVOR) AH 11-31

32. COPYRIGHT © 2012 Nelson Education Ltd. Variable Overhead Efficiency Variance Measures the change in variable overhead consumption that occurs because of efficient (or inefficient) use of direct labour Two ways to calculate: –Three-pronged columnar approach –Formula approach (AH – SH) SVOR 11-32

33. COPYRIGHT © 2012 Nelson Education Ltd. HOW TO Calculate Variable Overhead Variances: Columnar and Formula Approaches Example: Cornerstone 11-5 Standard variable overhead rate (SVOR) $5.00 per direct labour hour Actual variable overhead rate (AVOR) $4.70 Actual hours worked (AH) 150 hours Number of tee shirts produced 1,200 units Hours allowed for production (SH) 144 hours Information: Required: Calculate the variable overhead spending and efficiency variances 11-33

34. COPYRIGHT © 2012 Nelson Education Ltd. Example Columnar Approach 1. AH × AVOR 150 × $4.70 $705 2. AH × SVOR 150 × $5.00 $750 3. SH × SVOR 144 × $5.00 $720 Spending Variance (1 – 2) $45 F This is a favourable variance since the actual variable overhead rate was less than the expected rate 11-34

35. COPYRIGHT © 2012 Nelson Education Ltd. Example Columnar Approach 1. AH × AVOR 150 × $4.70 $705 2. AH × SVOR 150 × $5.00 $750 3. SH × SVOR 144 × $5.00 $720 Spending Variance (1 – 2) $45 F Efficiency Variance (2 – 3) $30 U This is an unfavourable variance since the actual hours exceeded budgeted hours 11-35

36. COPYRIGHT © 2012 Nelson Education Ltd. Example Columnar Approach 1. AH × AVOR 150 × $4.70 $705 2. AH x SVOR 150 x $5.00 $750 3. SH x SVOR 144 x $5.00 $720 Spending Variance (1 – 2) $45 F Efficiency Variance (2 – 3) $30 U Variable Overhead (1 – 3) $15 F 11-36

37. COPYRIGHT © 2012 Nelson Education Ltd. Example (AVOR AH – SVOR) ($4.70 - $5.00) 150 $45 favourable VOH spending variance Formula Approach 11-37

38. COPYRIGHT © 2012 Nelson Education Ltd. Example (AH - SH) SVOR (150 - 144) $5.00 $30 Unfavourable VOH efficiency variance Formula Approach 11-38

39. COPYRIGHT © 2012 Nelson Education Ltd. HOW TO Performance Report for Variable Overhead Variances Example: Cornerstone 11-6 Standard variable overhead rate (SVOR) $5.00 per direct labour hour Actual costs: Maintenance $535 & Power $170 Actual hours worked (AH) 150 hours Number of t-shirts produced 1,200 units Hours allowed for production (SH) 144 hours Variable overhead: Maintenance 0.12 hour @ $3.75 & Power 0.12 hour @ $1.25 Information: Required: Prepare a performance report that shows the variances on an item-by-item basis 11-39

40. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report For the Quarter Ended March 31, 2011 Budget for Spending Variance Actual Hours Actual Costs Cost Formula $535 $3.75 Cost Maintenance $535 - $562.50 $27.50 F 150 hours × $3.75 $562.50 11-40

41. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report (continued) For the Quarter Ended March 31, 2011 Budget for Spending Variance Actual Hours $27.50 F $562.50 Cost Maintenance Budget for Efficiency Variance Standard Hours $562.50 - $540 $22.50 U$540 144 × $3.75 11-41

42. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report For the Quarter Ended March 31, 2011 Budget for Spending Variance Actual Hours Actual Costs Cost Formula $562.50 $535 $3.75 Cost Maintenance $170 - $187.50 $27.50 F 170 1.25 Power 17.50 F $1.25 × 150 187.50 11-42

43. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report (continued) For the Quarter Ended March 31, 2011 Budget for Spending Variance Actual Hours $27.50 F $562.50 Cost Maintenance Budget for Efficiency Variance Standard Hours $540$22.50 U 7.50 U18017.50 F 187.50 Power 11-43

44. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report For the Quarter Ended March 31, 2011 Budget for Spending Variance Actual Hours Actual Costs Cost Formula $27.50 F $562.50 $535 $3.75 Cost Maintenance 17.50 F 187.50 1701.25 Power Total $5.00$705 $750.00 $45.00 F 11-44

45. COPYRIGHT © 2012 Nelson Education Ltd. Performance Report (continued) For the Quarter Ended March 31, 2011 Budget for Spending Variance Actual Hours $27.50 F $562.50 Cost Maintenance 17.50 F 187.50 Power Total $750.00 $45.00 F Budget for Efficiency Variance $22.50 U Standard Hours $540 7.50 U 180 $720$30.00 U 11-45

46. OBJECTIVE  3 3 Calculate the fixed overhead variances, and explain their meaning

47. COPYRIGHT © 2012 Nelson Education Ltd. Total Fixed Overhead Variance Difference between actual and applied fixed overhead –When applied overhead = standard fixed overhead rate × standard hours allowed for the actual output Broken down into: –Fixed Overhead Spending Variance –Fixed Overhead Volume Variance 11-47

48. COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 11-7 Standard fixed overhead rate (SFOR) $10.00 per direct labour hour Actual fixed overhead costs $1,650 Standard hours allowed per unit 0.12 hours Actual production 1,200 units Information: HOW TO Calculate the Total Fixed Overhead Variance Required: Calculate the total fixed overhead variance 11-48

49. COPYRIGHT © 2012 Nelson Education Ltd. Total Fixed Overhead Variance Actual CostsApplied CostsTotal Variance –= AFOH This is an unfavourable variance since actual costs exceeded applied costs $1605 –(SH X SFOR) – $1,440 = $210 U 11-49

50. COPYRIGHT © 2012 Nelson Education Ltd. Fixed Overhead Spending Variance Difference between –Actual fixed overhead rate (AFOH) –Budgeted fixed overhead rate (BFOH) Two ways to calculate: –Three-pronged columnar approach –Formula approach AFOH – SFOH 11-50

51. COPYRIGHT © 2012 Nelson Education Ltd. Fixed Overhead Volume Variance Difference between –Budgeted fixed overhead (BFOH) –Applied fixed overhead (ApFOH) Two ways to calculate: –Three-pronged columnar approach –Formula approach (SHp – SH) SFOR 11-51

52. COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 11-8 Standard fixed overhead rate (SFOR) $10.00 per direct labour hour Budgeted fixed overhead (BFOH) $1,800 Number of t-shirts produced 1,200 units Hours allowed for production (SH) 144 hours Information: HOW TO Calculate Fixed Overhead Variances: Columnar and Formula Approaches Required: Calculate the fixed overhead spending and volume variances 11-52

53. COPYRIGHT © 2012 Nelson Education Ltd. Fixed Overhead Variances Columnar Approach 1. Actual Fixed Overhead $1,650 2. SH × SFOR 180 × $10 $1,800 3. SH p × SFOR 144 × $10 $1,440 Spending Variance (1 – 2) $150 F Volume Variance (2 – 3) $360 U Fixed Overhead (1 – 3) $210 U 11-53

54. COPYRIGHT © 2012 Nelson Education Ltd. Example AFOH – BFOH $1,650 - $1,800 $150 Favourable Fixed Overhead (FOH) Volume Variance Formula Approach 11-54

55. COPYRIGHT © 2012 Nelson Education Ltd. Example (SH p – SH) SFOR (180 – 144) $10.00 $360 Unfavourable Formula Approach Fixed Overhead (FOH) Efficiency Variance 11-55

56. OBJECTIVE  4 4 Prepare an activity-based flexible budget

57. COPYRIGHT © 2012 Nelson Education Ltd. Activity-Based Budgeting A powerful planning and control tool Can be used to emphasize cost reduction through the elimination of wasteful activities and improving efficiency of necessary activities Two types: –Static activity budgets –Activity-based flexible budget 11-57

58. COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 11-9 Demand for purchase orders based on materials requirements: 15,000 purchase orders Resources needed: –Five purchasing agents, each capable of processing 3,000 orders per year, salary, $40,000 each –Supplies projected to cost $1.00 per purchase order –Desks and computers: depreciation, $5,000 per year –Office space, rent, and utilities, $6,000 Information: HOW TO Prepare Static Budget for an Activity Required: Prepare a budget for the purchasing activity 11-58

59. COPYRIGHT © 2012 Nelson Education Ltd. Purchasing Budget Supplies Depreciation Salaries 5,000 15,000 $1.00 per purchase order × 15,000 purchase orders $200,000 5 agents × $40,000 per agent per year $226,000 6,000 Occupancy Total

60. COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 11-10 The individual activities, drivers, their cost formulas, and the output levels are the inputs needed to prepare the budget For example: –Activity: Maintenance –Driver: Machine hours –Fixed activity cost: $20,000 –Variable activity rate: $5.50 per machine hour Information: HOW TO Prepare an Activity Flexible Budget Required: Prepare an activity-based flexible budget 11-60

61. COPYRIGHT © 2012 Nelson Education Ltd. Activity-Based Flexible Budget $155,000$95,000 $ 7.50 $35,000 $20,000 FormulaLevel of Activity Direct labour Direct materials Fixed 80,000 $ 0 $100,000$ --- Driver: Direct Labour Hours Subtotal $64,000 $ 5.50 Maintenance Machining 2.00 47,000 Variable10,000 20,000 $ 10$200,000 --- 8 160,000 $ 18 $180,000$360,000 Driver: Machine Hours $108,000 15,000 31,000 Subtotal Fixed Variable8,000 16,000 11-61

62. COPYRIGHT © 2012 Nelson Education Ltd. Activity-Based Flexible Budget continued $80,000 $197,000$177,500 $211,000 FormulaLevel of Activity Inspections Setups Fixed 132,500 $ 45,000 $ ---- Driver: Number of Setups Subtotal $226,000 $ 1 Purchasing Variable25 30 $ 1,800$ 54,000 80,000 2,100 143,000 $3,900 Driver: Number of Orders $236,000 Fixed Variable15,000 30,000 11-62

63. COPYRIGHT © 2012 Nelson Education Ltd. Example: Cornerstone 11-11 Information: Actual Activity Level $101,000 10,000 Actual Costs $55,000 10,000 Maintenance Direct labour $80,000 8,000 Machining $29,000 8,000 Inspections$125,500 25 Setups$46,500 Purchasing $220,00015,000 Direct materials HOW TO Prepare an Activity-Based Performance Report Inspections Required: Prepare an activity-based performance report (use budgeted costs from Cornerstone 11-10) 11-63

64. COPYRIGHT © 2012 Nelson Education Ltd. Activity-Based Performance Report Maintenance Direct labour 80,000 $100,000 Direct materials Machining Setups Purchasing Actual Costs Budgeted Costs Budget Variance $101,000 80,000 55,00064,000 Inspections Total $ 1,000 U ---- 9,000 F 29,000 31,000 2,000 F 125,500 132,500 7,000 F 46,50045,000 1,500 U 220,000 226,0006,000 F $657,000$678,500 $21,500 F 11-64