1. Chapter 11
Flexible Budgeting and the Management of Overhead and Support Activity Costs

2. Learning Objective 1

3. Static budgets are prepared for a single, planned level of activity.
Flexible Budgets
Hmm! 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.

4. Consider the following example from the Cheese Company . . .
Flexible Budgets
Hmm! Comparing static budgets with actual costs is like comparing apples and oranges.
Consider the following example from the Cheese Company . . .

5. Static Budgets and Performance Reports
U = Unfavorable variance Cheese Company was unable to achieve the budgeted level of activity.

6. Static 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?

7. Static 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.

8. Static 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.

9. Flexible 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.

10. Advantages 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 cost
control or lack of cost control.
Improve performance evaluation.

11. Learning Objective 2

12. Preparing a Flexible Budget
Let’s prepare budgets for the Cheese Company.

13. Preparing a Flexible Budget

14. Preparing a Flexible Budget
Variable costs are expressed as a constant amount per hour.
Fixed costs are expressed as a total amount that does not change within the relevant range of activity.

15. Preparing a Flexible Budget

16. Preparing a Flexible Budget

17. Preparing a Flexible Budget
Note: There is no flex in the fixed costs.

18. Preparing a Flexible Budget
Total budgeted overhead cost =
Budgeted variable Total overhead cost per activity activity unit units × +
Budgeted fixed overhead cost

19. Flexible Budget Performance Report
Now let’s prepare a budget performance report at 8,000 actual machine hours for the Cheese Co.

20. Flexible Budget Performance Report

21. Flexible Budget Performance Report
Flexible budget is prepared for the same activity level (8,000 hours) as actually achieved.

22. Flexible Budget Performance Report

23. Flexible Budget Performance Report
Indirect labor and indirect material have unfavorable variances because actual costs are more than the flexible budget costs.

24. Flexible Budget Performance Report
Power has a favorable variance because the actual cost is less than the flexible budget cost.

25. Learning Objective 3

26. Overhead Application in a Standard Costing System

27. Overhead Application in a Standard Costing System

28. Learning Objective 4

29. Choice 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.

30. Learning Objective 5

31. Cost Management Using Overhead Cost Variances
Let’s turn our attention to the computation of overhead cost variances. We will begin with variable overhead.

32. 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 × SVR
SH × SVR
Spending Variance
Efficiency Variance
AH = Actual Hours of Activity AR = Actual Variable Overhead Rate SVR = Standard Variable Overhead Rate SH = Standard Hours Allowed

33. 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 × SVR
SH × SVR
Spending Variance
Efficiency Variance
Spending variance = AH(AR - SVR)
Efficiency variance = SVR(AH - SH)

34. Variable 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.

35. Variable 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 cost
Total budgeted overhead cost =
$2.00 per machine hour ×
Total machine hours +
$9,000

36. Variable Overhead Variances – Example
Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
3,300 hours ,200 hours × × $2.00 per hour $2.00 per hour
$6,740
$6,600
$6,400
Spending variance $140 unfavorable
Efficiency variance $200 unfavorable

37. Variable Overhead Variances – Example
Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
3,300 hours ,200 hours × × $2.00 per hour $2.00 per hour
$6,740
$6,600
$6,400
The $140 unfavorable spending variance and the $200 unfavorable efficiency variance result in a $340 unfavorable flexible budget variance.

38. Variable Overhead Variances – A Closer Look
Spending Variance
Efficiency Variance
Results 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.

39. Now let’s turn our attention to fixed overhead.

40. Fixed Overhead Variances
Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
SH × PFOHR
Budget Variance
Volume Variance
PFOHR = Predetermined Fixed Overhead Rate SH = Standard Hours Allowed

41. Budgeted 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 Hours
Budgeted Fixed Overhead Planned Activity in Hours
PFOHR =

42. Fixed Overhead Variances – Example
ColaCo used the following predetermined fixed overhead rate:
PFOHR =
Budgeted Fixed Overhead Planned Activity in Hours
$9,000 3,000 machine hours
PFOHR = $3.00 per machine hour

43. Fixed 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.

44. Fixed Overhead Variances – Example
Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
3,200 hours × $3.00 per hour
$8,450
$9,000
$9,600
Budget variance $550 favorable
Volume variance $600 (neither favorable nor unfavorable)

45. Fixed Overhead Variances
Let’s look at a graph showing fixed overhead variances. We will use ColaCo’s numbers from the previous example.

46. Fixed Overhead Variances – A Closer Look
Budget Variance
Volume Variance
Results 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.

47. Fixed Overhead Variances
3,200 machine hours × $3.00 fixed overhead rate
Cost
$9,600 applied fixed OH
$600 Volume Variance {
$9,000 budgeted fixed OH {
$550 Favorable Budget Variance
$8,450 actual fixed OH
Fixed overhead
applied to products
Volume
3,000 Hours Planned Activity
3,200 Standard Hours

48. Learning Objective 6

49. Overhead Cost Performance Report

50. Learning Objective 7

51. Activity-Based Flexible Budget
The Cheese Co. flexible budget is based on a single cost driver, machine hours

52. Activity-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.

53. Learning Objective 8

54. Standard Costs and Product Costing

55. Standard Costs and Product Costing

56. Learning Objective 9

57. A General Model for Variance Analysis
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Price Variance
Quantity Variance
Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance Variable overhead Variable overhead spending variance efficiency variance
AQ(AP - SP) SP(AQ - SQ)
AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity

58. A General Model for Variance Analysis
Actual Sales Volume Actual Sales Volume Budgeted Sales Volume × × × Actual Sales Price Budgeted Sales Price Budgeted Sales Price
Sales Price Variance
Sales Volume Variance
ASV(ASP - BSP) BSP(ASV - BSV)
ASV = Actual Sales Volume BSP = Budgeted Sales Price ASP = Actual Sales Price BSV = Budgeted Sales Volume

59. I’m here to your budget. Are you ready to ante up?
End of Chapter 11
I’m here to your budget. Are you ready to ante up?