Chapter 9 Flexible Budgets and Overhead Analysis

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Chapter 9Flexible Budgets andOverhead Analysis

• adapted from Fundamental
• Cornerstones of Managerial Accounting
• Heitger, Mowen and Hansen

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Flexible Budgets versusStatic Budgets

• A static budget is a budget for a particular
  level of activity. The master budget is a good
  example of a static budget.
• A flexible budget is, in effect, a set of budgets
  that present expected costs for a range of
  potential activity levels.
• Flexible budgets can be prepared before-the-fact
  or after-the-fact.

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Flexible Budgets versusStatic Budgets

• Flexible budgets tell us what costs should have
  been during the period, given the actual level of
  output.
• By comparing the actual operating results to the
  flexible budget, we can compute flexible budget
  variances.
• The use of flexible budget variances in
  performance evaluation is much more consistent
  with holding managers responsible only for costs
  and revenues they can actually control.
• The flexible budget variance thus helps us
  understand how well a manager controlled costs,
  given the actual level of output.

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Predetermined Overhead Rate

• The overhead rate is the total budgeted overhead
  dollars for the year divided by the budgeted
  activity for the year.
• The overall overhead rate consists of the sum of
  the estimated
• fixed overhead cost per input hour (FOH Budg.
  Vol.)
• variable overhead cost per input hour (VOH Rate).

Standard Overhead Rate
Budgeted Overhead
Budgeted Activity


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Variable Overhead Terminology

• We will base our overhead terminology on direct
  labor hours (DLH) to be consistent with the
  textbook, although other drivers/activities can
  be used to assign overhead.
• AH Actual amount of DLH used.
• AR Actual VOH rate per DLH used.
• SH Standard DLH allowed for actual output.
• SR Standard VOH rate per DLH.

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Variable Overhead Variances

• Actual Variable Flexible
  Budget
• Overhead Costs Variable
  Overhead
• (actual VOH)
  (applied
  VOH)
• (AH x AR) (AH x SR) (SH
  x SR)
• (AR - SR) x AH (AH - SH) x SR
• ______________________________________
  ______________
• VOH Spending Variance VOH Efficiency
  Variance
• (AH x AR) - (SH x SR)
• ____________________________________________
  _________
• Under/Overallocated Variable Overhead

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Interpretation of VariableOverhead Variances

• An unfavorable (favorable) VOH efficiency
  variance implies that the firm is less (more)
  efficient than planned in its use of DLH.
• VOH spending variance
• A higher or lower price is paid than expected on
  VOH components (a purchasing issue).
• More or less of the underlying VOH items are used
  than expected (an operations issue).
• An unfavorable (favorable) spending variance
  could imply that the firm spent more (less) than
  expected on the VOH items, used the VOH items
  less (more) efficiently than expected, or both.

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Fixed Overhead Terminology

• SH Standard DLH allowed for actual output.
• SR Standard FOH cost per DLH. This rate is
  dependent on the volume of DLH used to compute
  the rate (obviously!).
• Budgeted FOH the amount of fixed overhead
  estimated for the period.

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Fixed Overhead Variances

• Actual Applied FOH
• FOH Costs Budgeted FOH
  (SH x SR)
• ___________________________________________
  __
• FOH Spending Variance FOH Volume
  Variance
• ______________________________________________
• Under/Overallocated Fixed Overhead

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Interpretation of FixedOverhead Variances

• FOH spending variance - arises due to the firm
  spending more or less on the FOH items relative
  to its budget.
• A favorable (unfavorable) spending variance
  implies that the firm spent less (more) on the
  fixed overhead items than expected.
• FOH volume variance - arises only because SH
  differs from the level of DLH used to compute the
  FOH application rate (i.e., the denominator
  level).
• A favorable (unfavorable) volume variance implies
  that SH is greater (less) than the level of DLH
  used to compute the FOH rate. In other words,
  output volume was greater (less) than planned.

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Flexible BudgetsAn Example

• A firm plans on producing and selling 100,000
  units of its main product.
• Each unit should require 1.5 pounds of material
  costing 6.00 per pound and 0.5 direct labor hour
  at 14.00 per hour.
• Budgeted variable overhead is to be applied at
  the rate of 8.00 per direct labor hour.
• Budgeted fixed overhead of 500,000 is to be
  applied at the rate of 10 per direct labor hour
  500,000/(100,000 units x 0.5 direct labor hour
  per unit).

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Flexible BudgetsAn Example

• Actual results during the period
• Production during the period was 110,000 units
• Actual material costs totaled 800,000
• Actual direct labor costs were 900,000
• Actual variable overhead costs were 400,000
• Actual fixed overhead costs of 600,000.
• Actual materials used was 160,000 pounds.
• Actual direct labor used was 60,000 hours.
• Required
• Prepare the flexible budget at the 110,000 actual
  output level.
• Compute the variances.