1. Flexible Budgets and Overhead Analysis
May 26, 2009
Flexible Budgets and Overhead Analysis
Chapter 9: Flexible Budgets and Overhead Analysis.
This chapter expands the study of overhead variances that was started in Chapter 8. It also explains how flexible budgets can be used to control variable and fixed overhead costs.

2. Today’s Agenda What is a Flexible Budget Flexible versus Static Budget
Shortcomings of Static Budgets
Advantages of Flexible Budgets
Building a Flexible Budget
Variance Analysis

3. Flexible Budgets
May be prepared for any activity level within the relevant range.
Show costs that should have been incurred at the actual level of activity, enabling “apples to apples” cost comparisons.
Flexible Budget
Improve performance evaluation.
Reveal variances related to cost control.
Flexible budgets provide estimates of what costs should be at any level of activity within the relevant range. When used for performance evaluation, actual costs are compared to the costs that should have been incurred at the actual level of activity, thereby enabling “apples to apples” cost comparisons.

4. Variable Budgets Budgeting in this Brewer chapter focuses on overhead
Note that the same concepts can be applied to direct costs as well
Eg, materials cost can vary over volume as price breaks are achieved
Start with a Static Budget - Steps:
1. Select an activity base that scales with volume – eg, Manufacturing Hours
2. Divide forecast costs into variable costs and fixed costs
3. Arrive at total forecast overhead costs
4. Compare to actual results
5. Identify Favourable and Unfavourable items
6. Determine what actions need to be taken

5. The Measure of Activity– A Critical Choice
Three important factors in selecting an activity base for an overhead flexible budget
Activity base and variable overhead should be causally related.
Activity base should not be expressed in dollars or other currency.
Activity base should be simple and easily understood.
At least three factors are important in selecting an activity base for an overhead flexible budget:
The activity base and variable overhead should be causally related;
The activity base should not be expressed in dollars or other currency. Direct labor cost is usually a poor choice
for an activity base because changes in wage rates do not result in proportionate changes in overhead; and
The activity base should be simple and easily understood.

6. Static Budgets and Performance Reports
Remember, we’re focusing on MOH at this point
Static Budgets provide meaningful information if activity does not change
We will want to look at what variances are attributable to activity changes, and performance changes

7. Static Budgets and Performance Reports
Certain variances could be perfectly acceptable because of activity changes
When actual results come in, it is difficult to see what variances are really favourable or unfavourable

8. Static Budgets and Performance Reports
Machine Hours are below budget
Unfavourable
Variable Costs are at or below budget
Neutral to Unfavourable?
Fixed Costs are neutral to over budget
Unfavourable?
Overall
Favourable?

9. Static Budgets and Performance Reports
How much of the variance is due to:
Volume?
Efficiency?
Prices?
A Flexible Budget can help answer these questions
Variable costs will flex with volume
Fixed costs will be static

10. Building a Flexible Budget
Flexible Budgets require Cost Formulas for Variable Costs

11. Building a Flexible Budget
Cost Formula is applied to variable costs at differing activity rates

12. Flexible Budget – Performance Report
Develop a Performance Report for Actual Activity – 25,000 Machine Hours

13. Flexible Budget – Performance Report
Using the Flexible Budget, we see that the variances are unfavourable

14. Variance Analysis
Calculate the variance between the initial budget (static budget) and the actual results

15. Variance Analysis Static Analysis Activity variance is negative
Cost variance is positive
Flexible Analysis
Calculate the variances after including the flexible budget for the actual volume

16. Variance Analysis
After inserting the appropriate Flexible Budget numbers for the actual activity level, more accurate variances are produced
Lower activity resulted in $15,000 less of costs than initially budgeted (favourable)
However, the company spent $7,500 more than it should have based on the activity level
Variance from the Flexible Budget is $7,500 Unfavourable versus from the Static Budget which is $7,500 Favourable

17. Variable Overhead Variances
Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours
AH × AR
AH × SR
AH = Actual hours AR = Actual variable overhead rate SR = Standard variable overhead rate
Spending Variance
The overhead spending variance is the difference between actual variable overhead and the flexible budget at actual hours for variable overhead. We can express this in a formula: The spending variance is equal to actual hours times the difference between the actual variable overhead rate and the standard variable overhead rate.
Spending variance = AH(AR – SR)

18. Variable Overhead Variances – Example
Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours
25,000 hours × $3.00 per hour = $75,000
$82,000
Spending Variance = $7,000 unfavorable

19. Variable Overhead Variances
Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
AH × AR
AH × SR
SH × SR
Spending Variance
Efficiency Variance
The general model for computing both variable overhead variances is presented on this slide. Note that the efficiency variance is based on the difference between actual hours and standard hours.
Spending variance = AH(AR - SR)
Efficiency variance = SR(AH - SH)

20. Variable Overhead Variances – Example
Assume Standard Hours for the Output Volume were 27,000
Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
25,000 hours ,000 hours × × $3.00 per hour $3.00 per hour
$82,000
$75,000
$81,000
Spending variance $7,000 unfavourable
Efficiency variance $6,000 favourable
$1,000 unfavourable flexible budget total variance

21. Computing Overhead Rates
Recall that overhead costs are assigned to products and services using a predetermined overhead rate (POHR):
Assigned Overhead = POHR × Standard Activity
Overhead costs are assigned to products by multiplying the predetermined overhead rate by the activity. The estimated total units in the base of the rate is called the denominator activity.
Overhead from the flexible budget for the denominator level of activity
POHR =
Denominator level of activity

22. Fixed Cost OH Variance & Adjustment
If fixed overhead costs have been applied on a per unit basis, a POHR would have been established
Estimated Total Fixed Overhead / Estimated Total Basis (MHs) for the given production volume
The OH is applied only to machine hours logged
Fixed costs, in this example have been under-applied by $4,352
$500 is due to spending over budget
$3,852 is due to the difference between actual and standard machine hours

23. Review What is a Flexible Budget Flexible versus Static Budget
Shortcomings of Static Budgets
Advantages of Flexible Budgets
Building a Flexible Budget
Variance Analysis

24. Tutorial
Assignment
Study Review Problems
Complete Question