11-1
11
11-1
11-2
Flexible Budgets
Chapter
Eleven
Static budgets are
prepared for a single,
planned level of
activity.
Performance
evaluation is difficult
when actual activity
differs from the
planned level of
activity.
Flexible Budgeting and
the Management of
Overhead and Support
Activity Costs
McGraw-Hill/Irwin
McGraw-Hill/Irwin
11-3
Hmm! Comparing
static budgets
with actual costs
is like comparing
apples and oranges.
Consider
the following
example from
the Cheese
Company . . .
Sta tic
Budge t
Ma chine hours
Va ria ble costs
Indire ct la bor
Indire ct m a te ria ls
Pow e r
Fix e d costs
De pre cia tion
Insura nce
Tota l ove rhe a d costs
McGraw-Hill/Irwin
11-4
Static Budgets and
Performance Reports
Flexible Budgets
10,000
$ 40,000
30,000
5,000
Actua l
Re sults
Va ria nce s
8,000
2,000 U
U = Unfavorable variance
Cheese Company was
unable to achieve the
budgeted level of activity.
12,000
2,000
$ 89,000
McGraw-Hill/Irwin
11-5
Static Budgets and
Performance Reports
Sta tic
Budge t
Ma chine hours
Va ria ble costs
Indire ct la bor
Indire ct ma te ria ls
Pow e r
Fix e d costs
De pre cia tion
Insura nce
Tota l ove rhe a d costs
McGraw-Hill/Irwin
Hmm! Comparing
static budgets
with actual costs
is like comparing
apples and oranges.
10,000
Actua l
Re sults
Va ria nce s
8,000
2,000 U
$ 40,000
30,000
5,000
$ 34,000
25,500
3,800
12,000
2,000
12,000
2,000
$ 89,000
$ 77,300
$6,000 F
4,500 F
1,200 F
0
0
$11,700 F
11-6
Static Budgets and
Performance Reports
Sta tic
Budge t
Ma chine hours
Va ria ble costs
Indire ct la bor
Indire ct m a te ria ls
Pow e r
Actua l
Re sults
Va ria nce s
10,000
8,000
2,000 U
$ 40,000
30,000
5,000
$ 34,000
25,500
3,800
$6,000 F
4,500 F
1,200 F
F e=dFavorable
variance since actual costs
Fix
costs
less than budgeted
De preare
cia tion
12,000 costs.
12,000
Insura nce
2,000
2,000
Tota l ove rhe a d costs
McGraw-Hill/Irwin
$ 89,000
$ 77,300
0
0
$11,700 F
11-2
11-7
Static Budgets and
Performance Reports
Sta tic
Budge t
Ma chine hours
Va ria ble costs
Indire ct la bor
Indire ct ma te ria ls
Pow e r
Actua l
Re sults
Va ria nce s
10,000
8,000
2,000 U
$ 40,000
30,000
5,000
$ 34,000
25,500
3,800
$6,000 F
4,500 F
1,200 F
Since
cost variances are favorable, have
Fix
e d costs
we
done
a good job controlling
costs?
De pre
cia tion
12,000
12,000
Insura nce
2,000
2,000
Tota l ove rhe a d costs
$ 89,000
$ 77,300
Static Budgets and
Performance Reports
I don’t think I can
answer this question
using a static budget.
11-8
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?
0
0
$11,700 F
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Static Budgets and
Performance Reports
11-9
11-10
Flexible Budgets
Central Concept
☯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?”
If you can tell me what your activity was
for the period, I will tell you what your costs and
revenue should have been.
☯To answer the question,
we must
the budget to the
actual level of activity.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
11-11
Preparing a Flexible Budget
11-12
Advantages of Flexible Budgets
Show revenues and expenses
that should have occurred at the
actual level of activity.
To
a budget for different activity
levels, we must know how costs behave
with changes in activity levels.
Total variable costs change
in direct proportion to
changes in activity.
Total fixed costs remain
unchanged within the
relevant range.
McGraw-Hill/Irwin
May be prepared for any activity
level in the relevant range.
Va
ble
ria
Reveal variances due to good cost
control or lack of cost control.
Fixed
Improve performance evaluation.
McGraw-Hill/Irwin
11-3
11-13
Preparing a Flexible Budget
11-14
Preparing a Flexible Budget
Variable
Cost
Per Hour
Let’s prepare
budgets for the
Cheese Company.
Total
Fixed
Cost
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
8,000
$
Flexible Budgets
10,000
12,000
Hours
Hours
10,000
$12,000
2,000
McGraw-Hill/Irwin
11-15
Preparing a Flexible Budget
Using an input activity measure
Variable
as units of output
may notTotal
be
Cost
Fixed
8,000
meaningful in a multiproduct
firm. Hours
Per Hour Cost
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
8,000
$
11-16
Preparing a Flexible Budget
Flexible Budgets
10,000
12,000
Hours
Hours
10,000
12,000
Variable
Cost
Per Hour
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
4.00
3.00
0.50
7.50
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
$12,000
2,000
Total
Fixed
Cost
8,000
Hours
8,000
$
4.00
3.00
0.50
7.50
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
McGraw-Hill/Irwin
Flexible Budgets
10,000
12,000
Hours
Hours
10,000
$ 32,000
24,000
In the
original static budget,
4,000
indirect
labor was $40,000 for
$ 60,000
10,000 hours resulting in a rate
of $4.00 per hour.
$12,000
2,000
McGraw-Hill/Irwin
Preparing a Flexible Budget
Variable
Cost
Per Hour
Total
Fixed
Cost
Machine hours
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
McGraw-Hill/Irwin
12,000
Variable costs are expressed as
a constant amount per hour.
11-17
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
12,000
4.00
3.00
0.50
7.50
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
McGraw-Hill/Irwin
8,000
Hours
8,000
Hours
8,000
$
4.00
3.00
0.50
7.50
Preparing a Flexible Budget
Flexible Budgets
10,000
12,000
Hours
Hours
10,000
12,000
Fixed costs are expressed as
$ 32,000
a total
amount that does not
24,000
change
within the relevant
4,000
range of activity.
$ 60,000
$12,000
2,000
11-18
Variable
Cost
Per Hour
Total
Fixed
Cost
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
McGraw-Hill/Irwin
8,000
Hours
8,000
$
4.00
3.00
0.50
7.50
$ 32,000
24,000
4,000
$ 60,000
$12,000
2,000
$ 12,000
2,000
$ 14,000
$ 74,000
Flexible Budgets
10,000
12,000
Hours
Hours
10,000
12,000
11-4
11-19
Preparing a Flexible Budget
Variable
Cost
Per Hour
Total
Fixed
Cost
Machine hours
8,000
Hours
$
4.00
3.00
0.50
7.50
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
$12,000
2,000
Preparing a Flexible Budget
Flexible Budgets
10,000
12,000
Hours
Hours
8,000
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
11-20
10,000
12,000
Variable
Cost
Per Hour
Machine hours
$ 32,000
24,000
4,000
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$ 48,000
36,000
6,000
$ 90,000
Variable costs
IndirectThere
labor is no
Note:
Indirect material
inPower
the fixed costs.
Total variable cost
$
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
McGraw-Hill/Irwin
4.00
flex
3.00
0.50
7.50
$12,000
2,000
8,000
Hours
Flexible Budgets
10,000
12,000
Hours
Hours
8,000
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$ 48,000
36,000
6,000
$ 90,000
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
McGraw-Hill/Irwin
11-21
Variable
Cost
Per Hour
Total
Fixed
Cost
Machine hours
8,000
Hours
Flexible Budgets
10,000
12,000
Hours
Hours
8,000
Total budgeted
=
Variable costs
overhead
cost
Indirect labor
4.00
Indirect material
3.00
Power
0.50
Budgeted variable
Total variableoverhead
cost
$ cost
7.50 per
activity
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
unit
×
$12,000
2,000
$ 32,000
24,000
4,000
Total
$
60,000
activity
units
$ 12,000
2,000
$ 14,000
$ 74,000
10,000
Now let’s prepare a
budget performance
report
at 8,000 actual machi
ne
hours for the Cheese
Co.
12,000
$ 40,000
$ 48,000
30,000
36,000
5,000
6,000
Budgeted
fixed
$ 75,000
$ 90,000
+
11-22
Flexible Budget
Performance Report
Preparing a Flexible Budget
overhead cost
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
McGraw-Hill/Irwin
McGraw-Hill/Irwin
11-23
Flexible Budget
Performance Report
Va ria ble
Cost
Pe r Hour
Tota l
Fix e d
Costs
Ma chine hours
Va ria ble costs
Indire ct la bor
$
Indire ct m a te ria l
Pow e r
Tota l va ria ble costs $
Fix e d Ex pe nse s
De pre cia tion
Insura nce
Tota l fix e d costs
Tota l ove rhe a d costs
McGraw-Hill/Irwin
Total
Fixed
Cost
Fle x ible
Budge t
Actua l
Re sults
8,000
4.00
3.00
0.50
7.50
$ 34,000
25,500
3,800
$ 63,300
$12,000
2,000
$ 12,000
2,000
$ 14,000
$ 77,300
Va ria nce s
0
11-24
Flexible Budget
Performance Report
Original actual
for
Va riaresults
ble
Tota
l
Costthat Fix
Fle x ible
Cheese Company
wee dsaw
Pe r Hour Costs
Budge t
earlier.
Ma chine hours
Va ria ble costs
Indire ct la bor
$
Indire ct m a te ria l
Pow e r
Tota l va ria ble costs $
Fix e d Ex pe nse s
De pre cia tion
Insura nce
Tota l fix e d costs
Tota l ove rhe a d costs
McGraw-Hill/Irwin
Actua l
Re sults
8,000
4.00
3.00
0.50
7.50
$ 34,000
25,500
3,800
$ 63,300
$12,000
2,000
$ 12,000
2,000
$ 14,000
$ 77,300
Va ria nce s
0
11-5
11-25
Flexible Budget
Performance Report
Va ria ble
Tota l
Flexible budget
is
Cost
Fix e d
prepared
Pe r for
HourtheCosts
same activity level
Ma chine hours
(8,000 hours) as
Va ria ble costs
Indire ct laactually
bor
$achieved.
4.00
Indire ct m a te ria l
Pow e r
Tota l va ria ble costs $
Fix e d Ex pe nse s
De pre cia tion
Insura nce
Tota l fix e d costs
Tota l ove rhe a d costs
Fle x ible
Budge t
Actua l
Re sults
8,000
8,000
$12,000
2,000
Va ria ble costs
Indire ct la bor
$
Indire ct m a te ria l
Pow e r
Tota l va ria ble costs $
Fix e d Ex pe nse s
De pre cia tion
Insura nce
Tota l fix e d costs
Tota l ove rhe a d costs
$ 12,000
2,000
$ 14,000
$ 77,300
McGraw-Hill/Irwin
Fle x ible
Budge t
Actua l
Re sults
8,000
8,000
4.00
3.00
0.50
7.50
$ 32,000
24,000
4,000
$ 60,000
$ 34,000
25,500
3,800
$ 63,300
$ 2,000 U
1,500 U
200 F
$ 3,300 U
$12,000
2,000
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 77,300
0
0
0
$ 3,300 U
Va ria nce s
0
McGraw-Hill/Irwin
11-27
Flexible Budget
Performance Report
Va ria ble
Cost
Tota l
Fix e d
Indirect labor
and Costs
Pe r Hour
indirect
Ma chine
hours material have
unfavorable variances
Va ria ble costs
because
costs
Indire
ct la bor actual
$ 4.00
Indireare
ct m amore
te ria l than3.00
the
Powflexible
er
budget 0.50
costs.
Tota l va ria ble costs $
Fix e d Ex pe nse s
De pre cia tion
Insura nce
Tota l fix e d costs
Tota l ove rhe a d costs
7.50
$12,000
2,000
Fle x ible
Budge t
Actua l
Re sults
8,000
8,000
0
Va ria ble
Cost
Pe r Hour
Tota l
Fix e d
Costs
Fle x ible
Budge t
Actua l
Re sults
8,000
8,000
$ 32,000
24,000
4,000
$ 60,000
$ 34,000
25,500
3,800
$ 63,300
$ 2,000 U
1,500 U
200 F
$ 3,300 U
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 77,300
0
0
0
$ 3,300 U
Ma chine hours
Power has a favorable
$ 32,000
24,000
4,000
$ 60,000
$ 34,000
25,500
3,800
$ 63,300
$ 2,000 U
1,500 U
200 F
$ 3,300 U
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 77,300
0
0
0
$ 3,300 U
11-28
Flexible Budget
Performance Report
Va ria nce s
McGraw-Hill/Irwin
Va ria ble costs
variance
the
Indire
ct la bor because
$ 4.00
actual
than
Indire
ct mcost
a te riais
l less
3.00
Pow
r
0.50
theeflexible
budget
cost.
Tota l va ria ble costs $ 7.50
Fix e d Ex pe nse s
De pre cia tion
$12,000
Insura nce
2,000
Tota l fix e d costs
Tota l ove rhe a d costs
Va ria nce s
0
McGraw-Hill/Irwin
Cost Management Using
Overhead Cost Variances
Let’s turn our attention
to the computation of
overhead cost variances.
We will begin with
variable overhead.
McGraw-Hill/Irwin
Tota l
Fix e d
Costs
Ma chine hours
$ 34,000
25,500
3,800
$ 63,300
3.00
0.50
7.50
Va ria ble
Cost
Pe r Hour
Va ria nce s
0
11-26
Flexible Budget
Performance Report
11-29
11-30
Variable Overhead Variances
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
Flexible Budget
for Variable
Overhead at
Standard Hours
AH × AR
AH × SVR
SH × SVR
Spending
Variance
AH
AR
SVR
SH
McGraw-Hill/Irwin
Efficiency
Variance
= Actual Hours of Activity
= Actual Variable Overhead Rate
= Standard Variable Overhead Rate
= Standard Hours Allowed
11-6
11-31
Variable Overhead Variances
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
Flexible Budget
for Variable
Overhead at
Standard Hours
AH × AR
AH × SVR
SH × SVR
Spending
Variance
Efficiency
Variance
Variable Overhead Variances –
Example
11-32
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.
Spending variance = AH(AR - SVR)
Efficiency variance = SVR(AH - SH)
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Variable Overhead Variances –
Example
ColaCo prepared this
Total budgeted
overhead cost
budget for overhead:
=
Budgeted variable
overhead cost per
activity unit
Total budgeted
overhead cost
11-33
=
×
$2.00 per
machine
hour
Total
activity
units
×
Budgeted fixed
overhead cost
+
Total
machine
hours
+
$9,000
McGraw-Hill/Irwin
$6,740
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
Flexible Budget
for Variable
Overhead at
Standard Hours
3,300 hours
×
$2.00 per hour
3,200 hours
×
$2.00 per hour
$6,600
$6,400
$6,740
Spending variance
$140 unfavorable
11-35
Efficiency variance
$200 unfavorable
Flexible Budget
for Variable
Overhead at
Actual Hours
Flexible Budget
for Variable
Overhead at
Standard Hours
3,300 hours
×
$2.00 per hour
3,200 hours
×
$2.00 per hour
$6,600
$6,400
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.
The $140 unfavorable spending variance and the $200
unfavorable efficiency variance result in a $340
unfavorable flexible budget variance.
McGraw-Hill/Irwin
11-34
McGraw-Hill/Irwin
Variable Overhead Variances –
Example
Actual
Variable
Overhead
Incurred
Variable Overhead Variances –
Example
McGraw-Hill/Irwin
It does not reflect
overhead control.
11-36
11-7
11-37
11-38
Fixed Overhead
Fixed Overhead Variances
Actual Fixed
Overhead
Incurred
Fixed
Overhead
Budget
Fixed
Overhead
Applied
SH × PFOHR
Now let’s turn
our attention to
fixed overhead.
Budget
Variance
Volume
Variance
PFOHR = Predetermined Fixed Overhead Rate
SH = Standard Hours Allowed
McGraw-Hill/Irwin
McGraw-Hill/Irwin
11-39
Fixed Overhead
Recall that fixed overhead costs are applied to
products and services using a predetermined
fixed overhead rate (PFOHR):
Applied Fixed Overhead = PFOHR × Standard Hours
PFOHR
=
Budgeted Fixed Overhead
Planned Activity in Hours
McGraw-Hill/Irwin
Fixed Overhead Variances –
Example
Fixed Overhead Variances –
Example
ColaCo used the following predetermined
fixed overhead rate:
PFOHR
=
Budgeted Fixed Overhead
Planned Activity in Hours
PFOHR
=
$9,000
3,000 machine hours
PFOHR
=
$3.00 per machine hour
McGraw-Hill/Irwin
11-41
ColaCo’s actual production required 3,200
standard machine hours. Actual fixed overhead
was $8,450.
Compute the fixed overhead budget and volume
variances.
Fixed Overhead Variances –
Example
Actual Fixed
Overhead
Incurred
Fixed
Overhead
Budget
11-42
Fixed
Overhead
Applied
3,200 hours
×
$3.00 per hour
$8,450
Budget variance
$550 favorable
McGraw-Hill/Irwin
11-40
McGraw-Hill/Irwin
$9,000
$9,600
Volume variance
$600 (neither favorable nor
unfavorable)
11-8
11-43
Fixed Overhead Variances –
A Closer Look
11-44
Fixed Overhead Variances
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.
Let’s look at a graph
showing fixed
overhead variances.
We will use ColaCo’s
numbers from the
previous example.
Has no significance for
cost control.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
11-45
Fixed Overhead Variances
Cost
$600
Volume
Variance
$550
Favorable
Budget
Variance
11-46
Activity-Based Flexible Budget
3,200 machine hours × $3.00 fixed overhead rate
Variable
Cost
Per Hour
$9,600 applied fixed OH
{
{
$9,000 budgeted fixed OH
Total
Fixed
Cost
Machine hours
$8,450 actual fixed OH
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
d
ea
s
erh duct
v
d o pro
e
Fix d to
e
pli
ap
3,000 Hours
Planned
Activity
Volume
3,200
Standard
Hours
McGraw-Hill/Irwin
$
4.00
3.00
0.50
7.50
Fixed costs
Depreciation
$12,000
The
Cheese Co. flexible
Insurance
2,000
budget
is
based
on
a
single
Total fixed cost
costoverhead
driver,costs
machine hours
Total
8,000
Hours
Flexible Budgets
10,000
12,000
Hours
Hours
8,000
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$ 48,000
36,000
6,000
$ 90,000
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
McGraw-Hill/Irwin
11-47
11-48
Activity-Based Flexible Budget
Variable
Cost
Per Hour
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
$
4.00
3.00
0.50
7.50
Total
Fixed
Cost
8,000
Hours
End of Chapter 11
Flexible Budgets
10,000
12,000
Hours
Hours
8,000
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$ 48,000
36,000
6,000
$ 90,000
I’m here to
your
budget. Are you ready to
ante up?
Fixed
If costs
different cost drivers are identified for the
Depreciation
$ 12,000
$ 12,000
$ 12,000
different
variable costs,$12,000
an
activity-based
flexible
Insurance
2,000
2,000
2,000
2,000
budget
should be prepared $with
cost$ 14,000
Total
fixed cost
14,000different
$ 14,000
Total overhead
costs
$ 74,000 drivers.
$ 89,000
$ 104,000
formulas
based on the different
McGraw-Hill/Irwin
McGraw-Hill/Irwin