Hilton Maher Selto

17
Flexible Budgets, Overhead Cost Management, and Activity-Based Budgeting
McGraw-Hill/Irwin 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

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What Are Flexible Overhead Budgets?

A flexible budget is valid for a range of activity

A static budget is based on a particular planned level of activity

This range of activity is the relevant range

A flexible overhead budget is defined as a detailed plan for controlling overhead cost valid in the firms relevant range of activity

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Exh. 17-1

Static Budget Versus Flexible Budget Based on planned

Static budget
Based on only ONE anticipated activity level

Activity (machine hours) Budgeted electricity cost

6,000 $1,200

June production of 4,000 tents, at 1.5 machine hours per tent. We cannot tell from this budget what it would cost to make 3,000 tents.

Flexible budget
Activity (machine hours) Budgeted electricity cost

Includes several possible activity levels

4,500 $900

6,000 $1,200

7,500 $1,500

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Advantages Of Flexible Budgets

Actual Electricity Cost

Budgeted Electricity Cost (static budget) $1,200

Cost Variance

$1,050

$150 Favorable

The manager is comparing the electricity cost incurred at the ACTUAL activity level (3,000 tents) with the budgeted electricity cost at the PLANNED activity level (4,000 tents).

These activity levels are different, therefore we would expect the electricity cost to be different

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Advantages Of Flexible Budgets

Actual Electricity Cost

Budgeted Electricity Cost (flexible budget) $900

Cost Variance

$1,050

$150 Unfavorable

The manager is comparing the electricity cost incurred at the ACTUAL activity level, 3,000 tents with the budgeted electricity cost at the ACTUAL activity level, (3,000 tents x 1.5 machine hours) = 4,500 machine hours

Electrical cost was greater than it should have been, given the actual level of output

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Activity Measure: Based On Input Or Output

Output measures can be used if you only make one product
Product Tree Line Model River's Edge Model Valley Model Total Standard Machine Hours Per Unit 1.5 1.8 2 Total Standard Allowed Machine Hours 1,800 1,620 1,400 4,820

Units Produced 1,200 900 700 2,800

Output measures require different inputs

Flexible budget must be based on outputs that can be compared

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Flexible Budgets: Inputs Versus Outputs

Output is measured in terms of the standard allowed input, given actual output 1.5 standard allowed machine hours per tent

Flexible budget (based on input)

Activity: Standard allowed machine hours Budgeted electricity costs 4,500 $900 6,000 7,500

$1,200 $1,500

Flexible budget (based on output)

Activity: tents manufactured Budgeted electricity costs 3,000 $900 4,000 $1,200 5,000 $1,500

Usually not a meaningful measure in a multi-product firm because it would require us to add numbers of unlike products

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Formula Flexible Budget

Total Budgeted Monthly Overhead Cost Budgeted Total Variable= Activity Overhead Cost Units . per Activity Unit Budgeted Fixed+ Overhead Cost per Month

EXAMPLE Assume that the company needs flexible budget numbers for three activity levels: 4,500 hours, 6,000 hours, and 7,500 hours. Also, assume that the Predetermined Budgeted Variable-Overhead Cost per Activity Unit is $6 per hour. Budgeted Fixed-Overhead Cost for the month is $30,000.

If you recall, this is similar to the Predetermined Cost-Driver Rate discussed in Chapter 4.

Flexible Budget?

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Formula Flexible Budget

Total Budgeted Monthly Overhead Cost Budgeted Total Variable= Activity Overhead Cost Units per Activity Unit Budgeted Fixed+ Overhead Cost per Month

$57,000 $66,000 $75,000

$6

4,500 6,000 7,500

$30,000

The flexed total budgeted monthly overhead for each activity level can now be used effectively in planning and variance analysis.

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Exh. 17-4

Overhead Application Normal Costing

Manufacturing Overhead
Actual overhead Applied overhead Actual hours The Difference between Normal Costing and Standard Costing lies in the quantity of hours used X Predetermined overhead rate

Work-in-Process Inventory
Applied overhead Actual hours X Predetermined overhead rate

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Exh. 17-4

Overhead Application Standard Costing

Manufacturing Overhead
Actual overhead Applied overhead

Work-in-Process Inventory
Applied overhead

The Difference between Normal Costing and Standard Costing lies in the quantity of hours used

Standard allowed hours X

Predetermined or standard overhead rate

Standard allowed hours X

Predetermined or standard overhead rate

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Exh. 17-5

Predetermined Overhead Rates

Both normal-costing and standard-costing systems use an overhead rate computed at the beginning of the accounting period (predetermined overhead rate)

Variable Fixed Total

Budgeted Overhead $36,000 $30,000

Planned Monthly Predetermined Activity Overhead Rate 6,000 machine hours $6.00 6,000 machine hours $5.00 $11.00

$66,000 6,000 machine hours

Computed annually

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Choice Of Activity Measure

How should the cost manager select the activity measure for the flexible budget? Dollar measures, such as direct-labor or material costs can be misleading because they are subject to price-level changes and other fluctuations

The variable overhead cost and the activity measure should move together

Direct labor time has traditionally been the most popular activity measure in manufacturing firms

As automation increases, more firms are switching to machine hours or process time

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Overhead Cost Variances

Koala manufactured 3,000 tree line tents X 1.5 machine hours per tent = standard allowed 4,500 machine hours For standard allowed 4,500 machine hours the budget overhead (from Exhibit 17-3) for June = Variable overhead $27,000 Fixed overhead $30,000

From the cost accounting records, the actual overhead for June = Variable overhead $30,480 Fixed overhead $32,500 $62,980 The total variable overhead variance for June = Actual variable overhead $30,480 Budget variable overhead $27,000 $ 3,480 F

Actual machine hours for June = 4,800

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Exh. 17-6

Variable Overhead Variances

The VARIABLE-OVERHEAD SPENDING VARIANCE is the difference between the actual variable overhead cost and the product of the standard variable -overhead rate and the actual hours of an activity base (or cost driver) Actual machine hours the standard rate

Actual variable overhead

Actual machine hours (AH)

4,800 machine ? hours

Actual rate (AVR)

$6.35 per ? machine hour

Actual machine hours (AH)

4,800 machine ? hours

Standard rate (SVR)

$6.00 per ? machine hour

$30,480

$28,800

$1,680 Unfavorable Variable-overhead spending variance

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Exh. 17-6

Variable Overhead Variances

The VARIABLE-OVERHEAD EFFICIENCY VARIANCE is the difference between the actual and the standard hours of an activity base (or cost driver) multiplied by the standard variable overhead rate

Actual machine hours times the standard rate

Flexible budget: variable overhead

Actual machine hours (AH)

4,800 machine ? hours $28,800

Standard rate (SVR)

$6.00 per ? machine hour

Standard allowed machine hours (SH)

4,500 machine ? hours

Standard rate (SVR)

$6.00 per ? machine hour

$27,000

$1,800 Unfavorable Variable-overhead efficiency variance

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Exh. 17-6

Variable Overhead Variances

The flexible budget amount for variable overhead $27,000 is the amount that will be applied to Work-in-Process for product-costing purposes Flexible budget: variable overhead Standard allowed machine hours (SH) 4,500 machine ? hours Standard rate (SVR) $6.00 per ? machine hour Variable overhead applied to work in process Standard allowed machine hours (SH) 4,500 machine ? hours Standard rate (SVR) $6.00 per ? machine hour $27,000 No difference

$27,000

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How To Interpret The Variable Overhead Variances

Efficiency variance Spending variance
The actual labor rate per hour differs from the standard rate

The unfavorable variance resulting from using more machine hours than the standard quantity, given actual output

The variable overhead efficiency variance has nothing to do with efficient or inefficient use of variable overhead items

An unfavorable variance means that the total actual cost of variable overhead is > expected, after adjusting for the actual quantity of machine hours used The spending variance is the real control variance for variable overhead

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Fixed Overhead Budget Variance

The FIXED-OVERHEAD BUDGET VARIANCE is the difference between actual fixed overhead and budgeted fixed overhead
Fixed-overhead budget variance Actual Fixed overhead Budgeted fixed overhead

Fixed-overhead budget variance

Actual Fixed overhead = $32,500

Budgeted fixed overhead = $30,000

Unfavorable variance of $2,500, because we spent more than budgeted

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Fixed Overhead Volume Variance

The FIXED-OVERHEAD VOLUME VARIANCE is the difference between budgeted fixed overhead and actual fixed overhead. Assume that the predetermined fixed overhead per machine hour = $5 and that it is based on 4,500 machine hours.
Fixed-overhead volume variance Budgeted fixed overhead Applied fixed overhead

Fixed-overhead volume variance

Budgeted fixed overhead = $30,000

Applied fixed overhead = $22,500

Variance = $7,500 U, because we produced less than budgeted.

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Managerial Interpretation Of Fixed-Overhead Variances

Budget Variance Volume Variance

The real control variance for fixed overhead because it compares actual expenditures with budgeted fixed overhead costs

Reconciles the two different purposes of the cost accounting system

For cost-management purposes, the costaccounting system recognizes that fixed overhead does not change as production activity varies

For product-costing purposes, budgeted fixed overhead is divided by planned activity to obtain a predetermined or standard fixedoverhead rate

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Exh. 17-8

Fixed Overhead Budget And Volume Variances

(1) Actual fixed O/H (2) Budgeted fixed O/H
(3) Fixed overhead applied to work in process Standard fixed overhead rate $5.00 per machine hr

Standard allowed machine hours 4,500 machine hrs

X
$22,500

$32,500

$30,000

Fixed-overhead budget variance = $2,500 U

Fixed-overhead volume variance = $7,500 U

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Exh. 17-9

Budgeted Versus Applied Fixed Overhead

Fixed overhead
Applied fixed overhead ($5.00 per standard allowed machine hour) Budgeted fixed overhead

$30,000

Volume variance $7,500

$22,500 Applied fixed overhead in June

4,500 Standard 6,000 allowed hours, Planned given actual monthly output activity

Machine hours

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Exh. 17-10

4-, 3-, & 2-way Variance Analysis

Variableoverhead spending variance Four-way analysis $1,680 U Fixedoverhead budget variance $2,500 U Variableoverhead efficiency variance $1,800 U Fixedoverhead volume variance $7,500 U

Combined spending variance Three-way analysis $4,180 U $1,800 U $7,500 U

Combined budget variance

Two-way analysis $62,980 actual overhead - overhead applied to WIP, 49,500 = $13,480 $5,980 U $7,500 U

Underapplied overhead

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Using The Overhead Cost Performance Report In Cost Management An Overhead Cost Performance Report
Shows the variable overhead spending and efficiency variances, along with the actual and budgeted cost for each variable overhead item.

Shows the fixed overhead budget variance ,along with the actual and budgeted cost for each fixed overhead item.

The report would be used by management to exercise control over each of the overhead costs.

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Using Standard Costs In Product Costing

Manufacturing Overhead

Actual

$62,980

$49,500

Applied

Debit: Cost of goods sold Debit: $13,480 Work-in-process inventory Applied overhead: $11.00 (predetermined overhead rate) X 4,500 (standard allowed hours

$49,500

$13,480 Credit: Indirect-material inventory Wages payable Utilities payable Accumulated depreciation Prepaid insurance and property taxes Engineering salaries payable

19,350 32,610 2,170 1,300 1,050 6,500

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Activity-Based Flexible Budget

An activity-based flexible budget may provide more useful cost management information than a conventional flexible budget

The traditional budget Costs are categorized as variable based on volume measures Direct labor hours

Activity-based flexible budget Costs are categorized as variable based on several cost drivers
Cost that may seem fixed with respect to a single volume-based cost driver may be variable with respect to other non-volume related cost drivers

Machine hours

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End of Chapter 17

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