Flexible Budgets and

Overhead Analysis

Chapter Five

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Static Budgets and Performance Reports

Hmm! Comparing
static budgets with
Static budgets actual costs is
are prepared for like comparing
a single, planned apples and
level of activity. oranges.

Performance
evaluation is difficult
when actual activity
differs from the
planned level of
activity.
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Flexible Budgets

May be prepared for any activity

level in the relevant range.

Show costs that should have been

incurred at the actual level of
activity, enabling “apples to apples”
cost comparisons.

Reveal variances related to

cost control.

Improve performance
evaluation.

McGraw-Hill/Irwin
Let’s look at
Copyright © 2006. The McGraw-Hill Companies, Inc.
Static Budgets and Performance Reports

CheeseCo
Static Actual
Budge t Re sults Va ria nce s
Machine hours 10,000
Variable costs
Indirect labor $ 40,000
Indirect materials 30,000
Power 5,000

Fixed costs
De pre cia tion 12,000
Insurance 2,000
Total overhead $ 89,000
costs
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
Static Budgets and Performance Reports

CheeseCo
Static Actual
Budge t Re sults Variances
Machine hours 10,000 8,000
Variable costs
Indirect labor $ 40,000 $ 34,000
Indirect materials 30,000 25,500
Power 5,000 3,800
Fixed costs
Depreciation 12,000 12,000
Insurance 2,000 2,050

Total overhead costs $ 89,000 $ 77,350

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Static Budgets and Performance Reports

CheeseCo
Static Actual
Budge t Re sults Variances
Ma chine hours 8,000 2,000 U
10,000
Variable costs
U = Unfavorable variance
Indire ct labor $ 40,000 $ $6,000 F
CheeseCo was unable to achieve
34,000 4,500
Indire ct mthe budgeted
a te ria ls level of activity.
30,000 F
25,500 1,200 F
Fixed costs
Powe r 5,000 3,800
Depreciation 12,000 12,000 0
Insurance 2,000 2,050 50 U

Total overhead costs $ 89,000 $ 77,350 $11,650 F

McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.

Static Budgets and Performance Reports

CheeseCo
Static Actual
Budge t Re sults Variances
Machine hours 10,000 8,000 2,000 U
Variable costs
Indirect labor $ 40,000 $ 34,000 $6,000 F
Indirect materials 30,000 25,500 4,500
Power 5,000 3,800 F
F = Favorable
Fixed costs variance that occurs when 1,200 F
actual costs
De pre are less than 12,000
cia tion budgeted costs. 0
12,000
Insura nce 2,000 2,050 50 U
Total overhead costs $ 89,000 $ 77,350 $11,650 F

McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.

Static Budgets and Performance Reports

CheeseCo
Static Actual
Budge t Re sults Variances
Machine hours 10,000 8,000 2,000 U
Variable costs
Indirect labor $ 40,000 $ 34,000 $6,000 F
Indirect materials 30,000 25,500 4,500
Power 5,000 3,800 F
Since
Fixed cost variances are favorable, have
costs
1,200 F
wepre
De done a good job controlling
cia tion 12,000 costs? 0
12,000
Insura nce 2,000 2,050 50 U
Total overhead costs $ 89,000 $ 77,350 $11,650 F

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Static Budgets and Performance Reports

I don’t think I
can answer the Actual activity is below
question using budgeted activity.
a static So, shouldn’t variable costs
budget. be lower if actual activity
is lower?

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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.

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 Preparing a Flexible Budget

To a budget we need to know that:

 Total variable costs change
in direct proportion to
changes in activity.
ble
 Total fixed costs remain ria
Va
unchanged within the
Fixed
relevant range.

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 Preparing a Flexible Budget

Let’s prepare
budgets
for CheeseCo.

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 Preparing a Flexible Budget

CheeseCo
Cos Total Flexible Budgets
t
Formula Fixed 8,000 10,000 12,000
per Hour Cost Hours Hours Hours

Machine hours 8,000 10,000

12,000
Variable costs
Indirect labor $ 4.00 Variable costs are expressed as
Indirect material 3.00 a constant amount per hour.
Power 0.50
Total variable cost $ 7.50 $40,000 ÷ 10,000 hours is
$4.00 per hour.
Fixed costs
Fixed costs are
Depreciation $ 12,000
Insurance 2,000
expressed as
Total fixed cost Total a total
overhead costs amount.
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 Preparing a Flexible Budget

CheeseCo
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
per Cost Hours Hours Hours
Hour
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor $ 4.00 $ 32,000
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost $ 7.50 $ 60,000

Fixed costs $4.00 per hour × 8,000 hours = $32,000

Depreciation $ 12,000
Insurance 2,000
Total fixed cost
Total overhead costs
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 Preparing a Flexible Budget

CheeseCo
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
per Cost Hours Hours Hours
Hour
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor $ 4.00 $ 32,000
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost $ 7.50 $ 60,000

Fixed costs
Depreciation $ 12,000 $ 12,000
Insurance 2,000 2,000
Total fixed cost Total $ 14,000
overhead costs $ 74,000
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 Preparing a Flexible Budget

CheeseCo
Cos Total Flexible Budgets
t
Formula Fixed 8,000 10,000 12,000
per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor $ $ 32,000 $ 40,000
4.003.00 24,0
Indirect material Total
0.50 fixed costs 4,0 00 30,000
5,000
Power do not change $in60,0 00
7.50
Total variable cost $ the relevant range. 00 $ 75,000

Fixed costs
Depreciation $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000
Total fixed cost $ 14,000 $ 14,000
Total overhead costs $ 74,000 $ 89,000 ?
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Quick Check 

What should be the total overhead costs for the

Flexible Budget at 12,000 hours?
a. $92,500.
b. $89,000.
c. $106,800.
d. $104,000.

McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.

 Quick Check 

What should be the total overhead costs for the

Flexible Budget at 12,000 hours?
a. $92,500.
b. $89,000.
c. $106,800.
d. $104,000.

Total overhead cost

= $14,000 + $7.50 per hour  12,000 hours
= $14,000 + $90,000 = $104,000
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Preparing a Flexible Budget

Cos Total Flexible Budgets

t
Formula Fixed 8,000 10,000 12,000
per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor $ 4.00 $ 32,000 $ 40,000 $ 48,000
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost $ 7.50 $ 60,000 $ 75,000 $ 90,000

Fixed costs
Depreciation $ 12,000 $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000 2,000
Total fixed cost Total $ 14,000 $ 14,000 $ 14,000
overhead costs $ 74,000 $ 89,000 $ 104,000
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 Flexible Budget Performance Report

Let’s prepare a
budget performance re
port
for CheeseCo.

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 Flexible Budget Performance Report
CheeseCo
Flexible budget is
Cost Total
prepared for the
Formu la Fixed Flexible Actual
same activity level
per ur Budget Result Variances
Cost s
M (8,000 hours) Ho
as 8,000 8,000 0
actually achieved.
V achine hours
Indirect
ariable labor
costs $ 4.00 $ 34,000
Indirect material 3.00 25,500
Power 0.50 3,800
Total variable cost $ 7.50 $ 63,300

Fixed costs
Depreciation $ 12,000 $ 12,000
Insurance 2,000 2,050
Total fixed cost $ 14,050
Total overhead costs $ 77,350
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Quick Check 

What is the variance for indirect labor when the

flexible budget for 8,000 hours is compared to the
actual results?
a. $2,000 U
b. $2,000 F
c. $6,000 U
d. $6,000 F

McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.

 Quick Check 

What is the variance for indirect labor when the

flexible budget for 8,000 hours is compared to the
actual results?
a. $2,000 U
b. $2,000 F
c. $6,000 U
d. $6,000 F

McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.

 Flexible Budget Performance Report
CheeseCo
Cost Total
Formula Fixed Flexible Actual
per Cost Budget Result Variances
Hour s
Machine hours 8,000 8,000 0
Variable costs
Indirect labor $ 4.00 $ 32,000 $ 34,000 $ 2,000 U
Indirect material 3.00 25,500
Power 0.50 3,800
Total variable cost $ 7.50 $ 63,300

Fixed costs
Depreciation $ 12,000 $ 12,000
Insurance 2,000 2,050
Total fixed cost $ 14,050
Total overhead costs $ 77,350
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Quick Check 

What is the variance for indirect material when the

flexible budget for 8,000 hours is compared to
the actual results?
a. $1,500 U
b. $1,500 F
c. $4,500 U
d. $4,500 F

McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.

 Quick Check 

What is the variance for indirect material when the

flexible budget for 8,000 hours is compared to
the actual results?
a. $1,500 U
b. $1,500 F
c. $4,500 U
d. $4,500 F

McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.

 Flexible Budget Performance Report
CheeseCo
Cost Total
Formula Fixed Flexible Actual
per Cost Budget Result Variances
Hour s
Machine hours 8,000 8,000 0
Variable costs
Indirect labor $ 4.00 $ 32,000 $ 34,000 $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable cost $ 7.50 $ 60,000 $ 63,300 $ 3,300 U

Fixed costs
Depreciation $ 12,000 $ 12,000 $ 12,000 $ 0
Insurance 2,000 2,000 2,050 50 U
Total fixed cost $ 14,000 $ 14,050 50 U
Total overhead costs $ 74,000 $ 77,350 $ 3,350 U
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Flexible Budget Performance Report

Remember the quest

ion:
“How much of the tot
al
variance is due to low
er
activity and how muc
h is
due to cost control?”

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 Static Budgets and Performance
How much of the $11,650 favorable variance is due to
lower activity and how much is due to cost control?
Static Actual
Budge t Re sults Variances
Machine hours 10,000 8,000 2,000 U
Variable costs
Indirect labor $ 40,000 $ 34,000 $6,000 F
Indirect materials 30,000 25,500 4,500
Power 5,000 3,800 F
1,200 F
Fixed costs
De pre cia tion 12,000 12,000 0
Insurance 2,000 2,050 50 U
Total overhead $ 89,000 $ 77,350 $11,650 F
costs
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 Flexible Budget Performance Report

Overhead Variance Analysis

Static Let’s place
Actual Overhead the flexible Overhead

Budget at budget for at

10,000 Hours
8,000 hours
8,000 Hours

$ 89,000 here. $
77,350

Difference between original static budget

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 Flexible Budget Performance Report

Overhead Variance Analysis

Static Flexible Actual
Overhead Overhead Ove rhe a d
Budget at Budget at at
10,000 Hours 8,000 Hours 8,000
Hours
$ 89,000 $ 74,000
$ 77,350
Activity Cost control

This $15,000F variance is This $3,350U

due to lower activity. variance is due
to poor cost
control.
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The Measure of Activity– A Critical Choice

Three important
factors in selecting an
activity base for an overhead
flexible budget
Activity base and
Activity base should
variable overhead
be simple and
should be
easily understood.
causally related.
Activity base should
not be expressed
in dollars or
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 Variable Overhead Variances –
A Closer Look

If flexible budget If flexible budget

is based on is based on
actual hours standard hours

Both spending
Only a spending
and efficiency
variance can
variances can be
be computed.
computed.

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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. The
standard variable overhead cost per machine hour
is $2.00.

Compute the variable overhead spending variance

first using actual hours. Then use standard
hours
allowed to calculate the variable overhead
efficiency variance.
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 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
Spending overhead rate
SR = Standard variable
Variance overhead rate

Spending variance = AH(AR – SR)

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Variable Overhead Variances – Example

Actual Flexible Budget

Variable for Variable
Overhead Overhead at
Incurred Actual Hours
3,300 hours
×
$2.00 per hour
$6,740 = $6,600

Spending Variance
= $140 unfavorable

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 Variable Overhead Variances –
A Closer Look

Spending Variance
Results from paying more
or less than expected for
overhead items and from Now, let’s use the
excessive usage of standard hours allowed,
overhead items. along with the actual
hours, to compute the
efficiency variance.

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 Variable Overhead Variances

Actual Flexible Budget Flexible Budget

Variable for Variable for Variable
Overhead Overhead at Overhead at
Incurre Actual Hours Standard Hours
AH
d × AR AH × SR SH × SR

Spending Efficiency
Variance
Variance
Spending variance = AH(AR - SR)
Efficiency variance = SR(AH - SH)

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Variable Overhead Variances – Example

Actual Flexible Budget Flexible Budget

Variable for Variable for Variable
Overhead Overhead at Overhead at
Actual Hours Standard Hours
Incurre
3,300 hours 3,200 hours
d
× ×
$2.00 per hour $2.00 per hour
$6,740 $6,600 $6,400

Spending variance Efficiency variance

$140 unfavorable $200 unfavorable
$340 unfavorable flexible budget total variance
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Variable Overhead Variances –
A Closer Look

Efficiency Variance

Controlled by
managing the
overhead cost driver.

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 Quick Check 

Yoder Enterprises’ actual production for the

period required 2,100 standard direct labor
hours. Actual variable overhead for the period
was $10,950. Actual direct labor hours worked
were 2,050. The predetermined variable
overhead rate is $5 per direct labor hour. What
was the spending variance?
a. $450 U
b. $450 F
c. $700 F
d. $700 U

McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.

 Quick Check 

Spending variance = AH
Yoder Enterprises’ (AR -production
actual SR) for the
period=required 2,100overhead
Actual variable standard direct–labor
incurred (AH  SR)
hours. Actual variable overhead for the period
= $10,950Actual
was $10,950. – (2,050 hourslabor
direct  $5 per hour)
hours worked
were 2,050. The
= $10,950 predetermined variable
– $10,250
overhead rate is $5 per direct labor hour. What
= $700 U
was the spending variance?
a. $450 U
b. $450 F
c. $700 F
d. $700 U

McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.

 Quick Check 

Yoder Enterprises’ actual production for the

period required 2,100 standard direct labor
hours. Actual variable overhead for the period
was $10,950. Actual direct labor hours worked
were 2,050. The predetermined variable
overhead rate is $5 per direct labor hour. What
was the efficiency variance?
a. $450 U
b. $450 F
c. $250 F
d. $250 U

McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.

 Quick Check 

Yoder Enterprises’ actual production for the

period required 2,100 standard direct labor
hours. Actual variable overhead for the period
Efficiency
was variance
$10,950. = SRdirect
Actual (AH – labor
SH) hours worked
were 2,050.
= $5 perThe
hourpredetermined variable
(2,050 hours – 2,100 hours)
overhead rate is $5 per direct labor hour. What
= $250
was the F
efficiency variance?
a. $450 U
b. $450 F
c. $250 F
d. $250 U

McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.

Overhead Rates and Overhead Analysis

Recall that overhead costs are assigned to

products and services using a predetermined
overhead rate (POHR):
Assigned Overhead = POHR × Standard Activity

Overhead from the

flexible budget for the
denominator level of activity
POHR =
Denominator level of activity

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Overhead Rates and Overhead Analysis

The predetermined overhead rate

can be broken down into fixed
and variable components.

The variable The fixed

component is useful component is useful
for preparing and analyzing for preparing and analyzing
variable overhead fixed overhead
variances. variances.

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 Fixed Overhead Variances
Fixed
Overhead Fixed
Actual Fixed Overhead
Overhead
DBHud×gFeR AHpp×liFedR
Incurred t

Budget Volume
Variance Variance

FR = Standard Fixed Overhead Rate

SH = Standard Hours Allowed
DH = Denominator Hours
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 Overhead Rates and Overhead
Analysis – Example

ColaCo prepared this budget for overhead:

Total Variable Total Fixed

Machine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
3,000 $ 6,000 ? $ 9,000 ?
4,000 8,000 ? 9,000 ?

Let’s calculate overhead rates.

ColaCo applies overhead based

on machine-hour activity.
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 Overhead Rates and Overhead
Analysis – Example

ColaCo prepared this budget for overhead:

Total Variable Total Fixed
Machine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
3,000 $ 6,000 $ 2.00 $ 9,000 ?
4,000 8,000 2.00 9,000 ?

Rate = Total Variable Overhead ÷ Machine Hours

This rate is constant at all levels of activity.

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 Overhead Rates and Overhead
Analysis – Example

ColaCo prepared this budget for overhead:

Total Variable Total Fixed
Machine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
3,000 $ 6,000 $ 2.00 $ 9,000 $ 3.00
4,000 8,000 2.00 9,000 2.25

Rate = Total Fixed Overhead ÷ Machine Hours

This rate decreases when activity increases.

McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Overhead Rates and Overhead
Analysis – Example

ColaCo prepared this budget for overhead:

Total Variable Total Fixed

Machine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
3,000 $ 6,000 $ 2.00 $ 9,000 $ 3.00
4,000 8,000 2.00 9,000 2.25

The total POHR is the sum of

the fixed and variable rates
for a given activity level.
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 Fixed Overhead Variances – Example

ColaCo’s actual production required 3,200

standard machine hours. Actual fixed
overhead was $8,450. The
predetermined overhead rate is based on
3,000 machine hours.

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 Overhead Variances

Now let’s turn

our attention
to calculating
fixed overhead
variances.

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 Fixed Overhead Variances – Example

Actual Fixed Fixed Fixed

Overhead Overhead Overhead
Incurred Budg Applie
et d

$8,450 $9,000

Budget variance
$550 favorable
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 Fixed Overhead Variances –
A Closer Look

Budget Variance

Results from spending

more or less than
Now, let’s use the
expected for fixed
standard hours allowed
overhead items.
to compute the fixed
overhead volume
variance.

McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.

 Fixed Overhead Variances – Example

Actual Fixed Fixed Fixed

Overhead Overhead Overhead
Incurred Budg A pp×liFe
S H
et
SHXFR
dRhours
3,200
×
$3.00 per
hour
$8,450 $9,000
$9,600

Budget variance Volume variance

$550 favorable $600 favorable
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Volume Variance – A Closer Look

Volume
Variance

Results when standard hours

allowed for actual output differs
from the denominator activity.

Unfavorable Favorable
when standard hours when standard hours
< denominator > denominator
hours hours
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Quick Check 

Yoder Enterprises’ actual production for the

period required 2,100 standard direct labor
hours. Actual fixed overhead for the period
was $14,800. The budgeted fixed overhead
was $14,450. The predetermined fixed
overhead rate was $7 per direct labor hour.
What was the budget variance?
a. $350 U
b. $350 F
c. $100 F
d. $100 U
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Quick Check 

Budget
Yoder variance
Enterprises’ actual production for the
period required
= Actual 2,100 standard
fixed overhead – Budgeteddirect labor
fixed overhead
hours. Actual fixed overhead for the period
= $14,800 – $14,450
was $14,800. The budgeted fixed overhead
was= $14,450.
$350 U The predetermined fixed
overhead rate was $7 per direct labor hour.
What was the budget variance?
a. $350 U
b. $350 F
c. $100 F
d. $100 U
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Quick Check 

Yoder Enterprises’ actual production for the

period required 2,100 standard direct labor
hours. Actual fixed overhead for the period
was $14,800. The budgeted fixed overhead
was $14,450. The predetermined fixed
overhead rate was $7 per direct labor hour.
What was the volume variance?
a. $250 U
b. $250 F
c. $100 F
d. $100 U
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Quick Check 

Volume variance
Yoder Enterprises’ actual production for the
= Budgeted fixed overhead – (SH  FR)
period required 2,100 standard direct labo r
hours. =Actual
$14,450fixed
– (2,100 hours  $7
overhead forper
thehour)
period
s $14,800.
= $14,450The budgeted fixed overhead
– $14,700
wa s $14,450.
= $250 F The predetermined fixed
overhead rate was $7 per direct labor hour.
What was the volume variance?
a. $250 U
b. $250 F
c. $100 F
d. $100 U
McGraw-Hill/Irwin Copyright © 2006. The McGraw-Hill Companies, Inc.
 Quick Check Summary

Actual Fixed Fixed Fixed

Overhead Overhead Overhead
Incurred Budg
A pp×liFe
S H
et
2,100 hours
d×R
$7.00 per
hour
$14,800 $14,450
$14,700

Budget variance Volume variance

$350 unfavorable $250 favorable
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 End of Chapter 5

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