1. Flexible Budgets, Variances, and Management Control:II
Session 8
Cost Accounting Horngreen, Datar, Foster

2. Learning Objectives
Explain similarities and differences in the planning of variable overhead costs and the planning of fixed overhead costs
Identify the key features of a standard costing system
Compute variable overhead spending and efficiency variances
Compute the budgeted fixed overhead rate
Explain two caveats to consider when interpreting the production-volume variance as a measure of the economic cost of unused capacity
Show how the 4-Variance Analysis approach reconciles the actual overhead incurred with the overhead amounts allocated during the period
Illustrate how the flexible-budget variance approach can be used in activity-based costing
Cost Accounting Horngreen, Datar, Foster

3. Learning Objective 1
Explain similarities and differences in the planning of variable overhead costs and the planning of fixed overhead costs
Cost Accounting Horngreen, Datar, Foster

4. Planning of Variable and Fixed Overhead Costs
Rockville Co. manufactures a dress suit that is then sold to distributors.
Variable overhead costs include:
Energy
Machine maintenance
Indirect materials
Indirect labor
Fixed manufacturing overhead costs include:
Plant leasing costs
Some administrative costs (plant manager’s salary)
Depreciation
Cost Accounting Horngreen, Datar, Foster

5. Planning of Variable and Fixed Overhead Costs
Effective planning of variable overhead costs involves undertaking only those variable overhead activities that add value for customers using the product or service.
Rockville’s customers perceive sewing to be an essential activity, therefore, maintenance activities for sewing machines included in variable overhead costs are also essential.
Effective planning of fixed overhead costs involves planning to undertake only essential activities and then planning to be efficient in that undertaking.
Cost Accounting Horngreen, Datar, Foster

6. Planning of Variable and Fixed Overhead Costs
The key challenge with planning fixed overhead is choosing the appropriate level of capacity or investment that will benefit the company over an extended time period.
Most of the key decisions that determine the level of fixed overhead costs to be incurred are made at the start of a budget period.
Day-to-day, ongoing operating decisions play a large role in determining the level of variable overhead costs incurred in the budget period.
Cost Accounting Horngreen, Datar, Foster

7. Identify the key features of a standard costing system
Learning Objective 2
Identify the key features of a standard costing system
Cost Accounting Horngreen, Datar, Foster

8. Standard Costing
Standard costing is a costing method that traces direct costs to a cost object by multiplying the standard price(s) or rate(s) times the standard inputs allowed for actual outputs produced.
Costs of every product or service planned to be worked on during the period can be computed at the start of that period.
Once standards have been set, the costs of operating a standard costing system can be low relative to an actual or normal costing system.
Cost Accounting Horngreen, Datar, Foster

9. Developing Budgeted Variable Overhead Allocation Rates
Variable overhead cost allocation rates can be developed with a four step approach.
Step 1: Choose the time period used to compute the budget.
Rockville uses a twelve-month budget period.
Cost Accounting Horngreen, Datar, Foster

10. Developing Budgeted Variable Overhead Allocation Rates
Variable overhead cost allocation rates can be developed with a four step approach.
Step 1: Choose the time period used to compute the budget.
Step 2: Select the cost-allocation bases to use in allocating variable overhead-costs to the cost object(s).
Rockville selects standard labor-hours as the cost allocation base.
Rockville budgets 26,000 labor hours for a budgeted output of 13,000 suits in year 2001.
Cost Accounting Horngreen, Datar, Foster

11. Developing Budgeted Variable Overhead Allocation Rates
Variable overhead cost allocation rates can be developed with a four step approach.
Step 1: Choose the time period used to compute the budget.
Step 2: Select the cost-allocation bases to use in allocating variable overhead-costs to the cost object(s).
Step 3: Identify the variable overhead costs associated with each cost-allocation base.
Rockville groups all its variable manufacturing overhead costs (energy, machine maintenance, engineering support, indirect materials, indirect labor) into a single cost pool.
Rockville’s budgeted variable manufacturing costs for 2001 are $312,000.
Cost Accounting Horngreen, Datar, Foster

12. Developing Budgeted Variable Overhead Allocation Rates
Variable overhead cost allocation rates can be developed with a four step approach.
Step 1: Choose the time period used to compute the budget.
Step 2: Select the cost-allocation bases to use in allocating variable overhead-costs to the cost object(s).
Step 3: Identify the variable overhead costs associated with each cost-allocation base.
Step 4: Compute the rate per unit of each cost-allocation base used to allocate variable overhead costs to the cost object(s).
Rockville estimates a rate of $12/labor hour for its variable manufacturing overhead costs.
$312,000 ÷ 26,000 hours = $12/hour
Cost Accounting Horngreen, Datar, Foster

13. Developing Budgeted Variable Overhead Allocation Rates
What is the budgeted variable overhead cost rate per output unit (dress suit)?
2.00 hours allowed per output unit × $12 budgeted variable overhead cost rate per input unit = $24 per suit (output unit)
Cost Accounting Horngreen, Datar, Foster

14. Compute variable overhead spending and efficiency variances
Learning Objective 3
Compute variable overhead spending and efficiency variances
Cost Accounting Horngreen, Datar, Foster

15. Variable Overhead Cost Variances
The following data are for 2001 when Rockville Co. produced and sold 10,000 suits:
Output units: 10,000
Labor-hours: Actual results: 21, Flexible-budget amount: 20,000
Labor-hours/output unit: Actual results: 21,500 ÷ 10,000 = Flexible-budget amount: 20,000 ÷ 10,000 = 2.00
Variable manufacturing overhead costs: Actual results: $244, Flexible-budget amount: $240,000
Variable manufacturing overhead cost per labor hour: Actual results: $244,775 ÷ 21,500 = $ Flexible-budget amount: $240,000 ÷ 20,000 = $12.00
Variable manufacturing overhead cost per output unit: Actual results: $244,775 ÷ 10,000 = $ Flexible-budget amount: $240,000 ÷ 10,000 = $24.00
Cost Accounting Horngreen, Datar, Foster

16. Flexible-Budget Analysis
The variable overhead flexible-budget variance measures the difference between the actual variable overhead costs and the flexible-budget variable overhead costs.
Actual Budgeted Inputs
Costs Allowed for Actual
Incurred Outputs at Budgeted Rate
21,500 × $ ,000 × $12.00
= $244, = $240,000
$4,775 U
Flexible-budget variance
Cost Accounting Horngreen, Datar, Foster

17. Variable Overhead Efficiency Variance
The variable overhead efficiency variance measures the efficiency with which the cost-allocation base is used.
(Actual units of variable overhead cost-allocation base used for actual output Budgeted units of variable overhead cost-allocation base allowed for actual output) x Budgeted variable overhead rate = (21,500 – 20,000) × $12 = $18,000 U
This unfavorable variance means that actual labor-hours were higher than the budgeted labor-hours allowed.
Actual Quantity of Inputs at Budgeted Inputs Allowed for Actual
Budgeted Rate Outputs at Budgeted Rate
21,500 × $ ,000 × $12.00
= $258, = $240,000
$18,000 U
Variable overhead efficiency variance
Cost Accounting Horngreen, Datar, Foster

18. Variable Overhead Spending Variance
The variable overhead spending variance is the difference between the actual amount of variable overhead incurred and the budgeted amount allowed for the actual quantity of the variable overhead allocation base used for the actual output units produced.
Actual Actual Quantity
Costs of Inputs at
Incurred Budgeted Rate
21,500 × $ ,500 × $12.00
= $244, = $258,000
$13,225 F
Variable overhead spending variance
Cost Accounting Horngreen, Datar, Foster

19. Variable Overhead Variances
Flexible-budget variance
$4,775 U
Efficiency variance
$18,000 U
Spending variance
$13,225 F
Cost Accounting Horngreen, Datar, Foster

20. Compute the budgeted fixed overhead rate
Learning Objective 4
Compute the budgeted fixed overhead rate
Cost Accounting Horngreen, Datar, Foster

21. Developing Budgeted Fixed Overhead Allocation Rates
Fixed overhead costs are a lump sum that remains unchanged in total for a given time period despite wide changes in the related total activity or output level.
While total fixed costs are frequently included in flexible budgets, they remain the same total amount within the relevant range regardless of the output level chosen.
Cost Accounting Horngreen, Datar, Foster

22. Developing Budgeted Fixed Overhead Allocation Rates
4 steps in developing the budgeted fixed overhead rate:
Step 1: Choose the time period used to compute the budget.
The budget period is typically twelve months.
Cost Accounting Horngreen, Datar, Foster

23. Developing Budgeted Fixed Overhead Allocation Rates
4 steps in developing the budgeted fixed overhead rate:
Step 1: Choose the time period used to compute the budget.
Step 2: Select the cost-allocation base to use in allocating fixed overhead costs to the cost object(s).
Rockville uses standard labor hours as the cost allocation base for fixed manufacturing overhead costs.
This is the denominator of the budgeted fixed overhead rate computation.
It is called the denominator level or production-denominator level.
In year 2001, Rockville budgets 26,000 labor hours for a budgeted output of 13,000 suits.
Cost Accounting Horngreen, Datar, Foster

24. Developing Budgeted Fixed Overhead Allocation Rates
4 steps in developing the budgeted fixed overhead rate:
Step 1: Choose the time period used to compute the budget.
Step 2: Select the cost-allocation base to use in allocating fixed overhead costs to the cost object(s).
Step 3: Identify the fixed overhead costs associated with each cost-allocation base.
Rockville groups all its fixed manufacturing overhead costs (depreciation, leasing costs, plant manager’s salary) in a single cost pool.
Rockville’s fixed manufacturing budget for 2001 is $286,000.
Cost Accounting Horngreen, Datar, Foster

25. Developing Budgeted Fixed Overhead Allocation Rates
4 steps in developing the budgeted fixed overhead rate:
Step 1: Choose the time period used to compute the budget.
Step 2: Select the cost-allocation base to use in allocating fixed overhead costs to the cost object(s).
Step 3: Identify the fixed overhead costs associated with each cost-allocation base.
Step 4: Compute the rate per unit of each cost-allocation base used to allocate fixed overhead costs to the cost object(s).
Rockville estimates a rate of $11/labor-hour for its fixed manufacturing overhead costs.
$286,000 ÷ 26,000 = $11
Cost Accounting Horngreen, Datar, Foster

26. Developing Budgeted Fixed Overhead Allocation Rates
What is the budgeted fixed overhead cost rate per output unit (dress suit)?
2.00 hours allowed per output unit
$11 budgeted fixed overhead cost rate per input unit
$22 per suit (output unit)
Cost Accounting Horngreen, Datar, Foster

27. Fixed Overhead Cost Variances
The flexible budget amount for a fixed cost item is the amount included in the static budget prepared at the start of the period.
No adjustment is required for differences between the actual output and the budgeted output for fixed costs.
Fixed costs are unaffected by changes in the level of output.
Cost Accounting Horngreen, Datar, Foster

28. Flexible-Budget Variance
The fixed overhead flexible-budget variance (spending variance) is the difference between actual fixed overhead costs and the fixed overhead costs in the flexible budget.
Assume that Rockville’s actual total fixed overhead is $300,000.
Actual costs incurred $300,000 – Flexible-budget amount $286,000 = $14,000 U
The variable overhead flexible-budget variance was subdivided into a spending variance and an efficiency variance.
For fixed overhead there is not an efficiency variance. Why?
Because a lump sum of fixed costs will be unaffected by the degree of operating efficiency in a given budget period.
Cost Accounting Horngreen, Datar, Foster

29. Production-Volume Variance
The production-volume variance is the difference between budgeted fixed overhead and the fixed overhead allocated on the basis of the budgeted quantity of the fixed overhead allocation base allowed for the actual output produced.
Denominator-level variance
Output-level overhead variance
Flexible Budget: Fixed Overhead
Budgeted Allocated Using Budgeted Input
Fixed Overhead Allowed for Actual
Output Units Produced
$286, $220,000
$66,000 U
Production-volume variance
10,000 × 2.00 × $11 = $220,000
Cost Accounting Horngreen, Datar, Foster

30. Fixed Overhead Variances
$80,000 U
Volume variance
$66,000 U
Spending variance
$14,000 U
Cost Accounting Horngreen, Datar, Foster

31. Fixed overhead variances
Actual Cost Function
Cost
Budgeted Cost Function 66
300 14
286
Labor hours 20 26
Cost Accounting Horngreen, Datar, Foster

32. Learning Objective 5
Explain two caveats to consider when interpreting the production-volume variance as a measure of the economic cost of unused capacity
Cost Accounting Horngreen, Datar, Foster

33. Interpreting the Production-Volume Variance
Caution is appropriate before interpreting the production-volume variance as a measure of the economic cost of unused capacity.
One caveat is that management may have maintained some extra capacity to meet uncertain demand surges that are important to satisfy customer demands.
A second caveat is that the production-volume variance focuses only on costs. It does not take into account any price changes necessary to spur extra demand that would in turn make use of any idle capacity.
Cost Accounting Horngreen, Datar, Foster

34. Interpreting the Production-Volume Variance
Lump-sum fixed costs represent resources sacrificed in acquiring capacity.
Plant
Equipment leases
These costs cannot be decreased if the resources needed are less than the resources acquired.
Cost Accounting Horngreen, Datar, Foster

35. Interpreting the Production-Volume Variance
The unfavorable $66,000 production-volume variance measures the amount of extra fixed costs that Rockville incurred for manufacturing capacity it planned to use but did not.
Had Rockville manufactured 13,000 suits instead of 10,000, allocated fixed overhead would have been 13,000 × 2.00 × $11 = $286,000.
No production-volume variance would have occurred.
Cost Accounting Horngreen, Datar, Foster

36. Interpreting the Production-Volume Variance
Assume that in year 2001, Rockville’s denominator level is exactly the capacity used for that budget period, but actual demand and production turns out to be 8% below the denominator level.
Rockville would report an unfavorable production-volume variance.
Cost Accounting Horngreen, Datar, Foster

37. Learning Objective 6
Show how the 4-Variance Analysis approach reconciles the actual overhead incurred with the overhead amounts allocated during the period
Cost Accounting Horngreen, Datar, Foster

38. Integrated Analysis A 4-Variance Analysis presents spending and
efficiency variances for variable overhead costs
and spending and
production-volume variances for fixed overhead costs.
Managers can reconcile the actual overhead costs with the overhead amounts allocated during the period.
Cost Accounting Horngreen, Datar, Foster

39. Integrated Analysis
Actual manufacturing overhead incurred: Variable manufacturing overhead $244,775 Fixed manufacturing overhead ,000 Total $544,775 Overhead allocated: Variable manufacturing overhead $240,000 Fixed manufacturing overhead ,000 Total $460,000 Amount underallocated $ 84,775
Cost Accounting Horngreen, Datar, Foster

40. Integrated Analysis
4-Variance Analysis Variable manufacturing overhead: Spending variance $13,225 F Efficiency variance ,000 U Fixed manufacturing overhead: Spending variance ,000 U Volume variance ,000 U Total $84,775 U
Cost Accounting Horngreen, Datar, Foster

41. Integrated Analysis
3-Variance Analysis Variable and fixed manufacturing overhead: Spending variance $13,225 F + $14,000 U = $ U Variable manufacturing overhead: Efficiency variance ,000 U Fixed manufacturing overhead: Volume variance ,000 U Total $84,775 U
Cost Accounting Horngreen, Datar, Foster

42. Integrated Analysis
2-Variance Analysis Variable and fixed manufacturing overhead: Spending variance $ U Variable manufacturing overhead: Efficiency variance ,000 U Flexible-budget variance: $18,775 U Fixed manufacturing overhead Volume variance: ,000 U Total $84,775 U
Cost Accounting Horngreen, Datar, Foster

43. Different Purposes of Overhead Cost Analysis
Variable manufacturing overhead costs are variable with respect to output units (suits) for both planning and control purposes and inventory costing purpose.
The greater the number of output units manufactured, the higher the budgeted total variable manufacturing overhead costs and the higher the total variable manufacturing overhead costs allocated to output units
Cost Accounting Horngreen, Datar, Foster

44. Different Purposes of Overhead Cost Analysis
Fixed overhead costs do not change within the relevant range.
Management can do little to change the lump-sum fixed cost.
Under generally accepted accounting principles, fixed manufacturing costs are allocated as an inventoriable cost based on the level of output units produced.
Cost Accounting Horngreen, Datar, Foster

45. Different Purposes of Overhead Cost Analysis
Every output unit that Rockville manufactures will increase the fixed overhead allocated to products by $22.
Managers should not use this unitization of fixed manufacturing overhead costs for planning and control.
Cost Accounting Horngreen, Datar, Foster

46. Financial and Nonfinancial Performance
Overhead variances are examples of financial performance measures.
Managers also find that nonfinancial measures provide useful information. Examples are:
actual labor time per suit, relative to budgeted labor time per suit, and...
actual indirect materials usage per labor-hour, relative to budgeted indirect materials usage per labor-hour.
Nonfinancial performance measures are best viewed as attention directors, not as problem solvers.
Cost Accounting Horngreen, Datar, Foster

47. Learning Objective 7
Illustrate how the flexible-budget variance approach can be used in activity-based costing
Cost Accounting Horngreen, Datar, Foster

48. Activity-Based Costing and Variance Analysis
ABC systems classify costs of various activities into a cost hierarchy (output-unit level, batch level, product sustaining, and facility sustaining).
The basic principles and concepts for variable and fixed manufacturing overhead costs can be extended to ABC systems.
Flexible budgeting in activity-based costing systems enables insight into why actual activity costs differ from those budgeted.
With well-defined output and input measures for an activity, a 4-variance analysis can be conducted.
Cost Accounting Horngreen, Datar, Foster