1. ACC602: Strategic Management Accounting Topic 3: Standard costs for control measures: flexible budgets and manufacturing overhead analysis Slides adapted from Langfield-Smith et al., McGraw-Hill Reference Chapter 11 from the recommended textbook

2. Learning Outcome: After the completion of this topic, you should be able to: . Critique the standard costing system for control measures, use of flexible budgets and manufacturing overhead cost analysis.  . Evaluate the advantages of a flexible budget for performance evaluation and controlling costs. . Design and analyze a flexible overhead budget using both a formula and a report format. . Design an overhead cost performance report. . Calculate and interpret the variable overhead spending and efficiency variances, and fixed overhead budget and volume variances. . Compare with flexible budgets in a non-manufaturing environment.

3. Flexible budgets
A detailed budget prepared for a range of levels of activity
Compared to a static budget which relates to one specific planned level of activity
Often restricted to flexing overhead costs to various levels of activity
Allows us to select the most appropriate benchmark for cost control
Provides a valid basis for comparing actual and expected costs to budget, for the actual level of activity

4. Static and flexible budgets

5. Input measures and output measures
Units of output are not usually a meaningful measure of the level of activity in a multi-product firm
Output can be measured as the standard quantity of input allowed, given actual output
Machine hours
Direct labour hours
The choice between input or output measures becomes important when multiple products are being manufactured

6. Flexible overhead budget
Flexible budget report: shows flexible overhead budgets at various levels of activity (refer to the next slide)
Formula flexible budget: shows overhead costs at various levels of activity using the following formula
(cont.)

7. Flexible overhead budget (cont.)

8. Calculating overhead cost variances
The flexible budget provides a tool for controlling manufacturing overhead costs
At the end of an accounting period, the flexible budget can be used to calculate the amount of overhead cost that should have been incurred, given the actual level of activity
Four different overhead variances can be calculated to compare the actual overhead cost incurred with the flexible budget

9. Calculating variable overhead cost variances
Variable overhead spending variance
A measure of the difference between the actual variable overhead and the standard variable overhead rate multiplied by actual activity
= Actual variable overhead – (AH × SVR)
where AH = actual direct labour hours
SVR = standard variable overhead rate
(cont.)

10. Calculating variable overhead cost variances (cont.)
Variable overhead efficiency variance
A measure of the difference between the actual activity and the standard activity allowed, given the actual output multiplied by the standard variable overhead rate
= SVR(AH – SH)
where SH = standard direct labour hours allowed for actual output
AH = actual direct labour hours
SVR = standard variable overhead rate
(cont.)

11. Interpreting variable overhead variances
Spending variance
Results from the actual cost of variable overhead being greater/less than expected, after adjusting for the actual quantity of cost driver used
Could be a result of a high/lower price or quantity for variable cost items
Efficiency variance
The cost effect of excessive or minimal use of the particular activity (cost driver)
The spending variance provides the ‘real’ control information for variable overhead

12. Calculating fixed overhead variances
Fixed overhead budget variance
The difference between actual fixed overhead and budgeted fixed overhead
= actual fixed overhead – budgeted fixed overhead
Fixed overhead volume variance
The difference between budgeted fixed overhead and fixed overhead applied to production
= budgeted fixed overhead – applied fixed overhead
(cont.)

13. Interpreting fixed overhead variances
Fixed overhead budget variance
Used for cost control
Assumes fixed overhead will not change as activity varies
Fixed overhead volume variance
Standard cost driver allowed for actual output is more/less than the planned level of production
Reconciles the two purposes of costing systems: product costing and cost control
(cont.)

14. Standard costs for product costing
Costs of direct material, direct labour and manufacturing overhead are charged to inventory at standard costs, not actual costs
Variances are closed off at end of the accounting period
To Cost of Goods Sold expense
Prorate between WIP, FG and COGS inventory if the amount is large

15. Criticisms of standard costing systems
Variances are too aggregated and concentrate on consequences rather than the causes of problems
Variance reports are too late to be useful
Monthly reporting may be too late to correct problems
Standard costing systems tend to focus too heavily on cost minimisation
May encourage cost reduction which can adversely affect other areas of strategic importance
(cont.)

16. Criticisms of standard costing systems (cont.)
Standard costing systems take a departmental perspective rather than a process perspective
Can lead to missing opportunities for cost control
Controlling one department’s costs may increase costs in other departments
Too much emphasis is placed on the cost and efficiency of direct labour
This is of decreasing importance in the face of increasing automation
Overhead variances give limited cost control information
(cont.)

17. Criticisms of standard costing systems (cont.)
Standard costs do not explicitly encourage continuous improvement
Due to infrequent revisions
Standard costs become outdated quickly due to short product life cycles
Standard costing systems do not capture the full costs of materials
The full cost of ownership includes cost of ordering and paying for materials, storage, handling, rework

18. Advantages of standard costing
Provide a good basis for cost comparisons
Particularly with the use of flexible budgets
Enable managers to use ‘management by exception’
Focus only on those variances that are significant and this saves management time
Provide a basis for managerial performance evaluation and determining bonuses
(cont.)

19. Advantages of standard costing (cont.)
Participation in setting standards and assigning responsibility for certain variances can have motivational effects on employees
Useful for pricing decisions and determining product mix
Can be used for external financial reporting

20. Summary
A flexible budget can be used to control manufacturing costs, based on a range of different levels of activity
Cost variances can be calculated for variable and fixed overheads, but their usefulness for controlling overhead costs can be questioned
Standard costing systems have been criticised in the light of more modern methods for controlling costs and evaluating performance
Activity-based budgeting may provide more accurate benchmarks than a flexible budget, but may be complex and costly to implement

21. Reference:
Smith, L. (etal), 6th ed, “Management Accounting 6/e – Information for Managing and Creating Value. McGraw Hill. Australia.Pages

22. THANK YOU.