Flexible Budgeting and overhead Variance

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Flexible Budgeting and overhead Variance

• By Ghanendra Fago

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Meaning and definitions

• A budget prepared at different level of
  activities is a flexible budget
• Flexible budget will furnish the budgeted figures
  for any level of activity, which a company may
  actually attain.
• It reflects costs, revenues and profits at the
  various level of budgeted activity.
• A flexible budget as a budget designed to change
  in accordance with the level of activity actually
  attained.
• Also called a variable budget, step budget,
  sliding-scale budget, expense-formula budget,
  dynamic budget and expense control budget.

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Contd.

• Master budget is static or fixed budgets, which
  forecast revenues and expenses for one level of
  sales and production.
• A flexible budget is a summary of anticipated
  costs for a range of activity levels, geared to
  changes in product output.

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Characteristics Of Flexible Budget

• It covers a range of activity.
• It provides a dynamic basis for comparison with
  the actual results because it is automatically
  matched to change in activities.
• It can be changed according to actual production
  level.
• It facilitates performance measurement and
  evaluation.
• These are based upon adequate knowledge of cost
  behaviour pattern.

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Use of Flexible Budget

• Where the level of activity during the year
  varies from period to period, either due to the
  seasonal nature of the industry or to variation
  in demand.
• Where the business is a new one and it is
  difficult to foresee the demand.
• The level of activity depends upon the
  availability of a factor of production such as
  materials, labor, plant capacity etc.
• Where an industry is influenced by changes in
  fashion.
• Where there are general changes in sales.
• Where the business units keep or introducing new
  product or make changes in the design of its
  products frequently.
• Where the industries are engaged in make to order
  business like ship-building.

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Needs of Flexible Budgeting

• Helps to obtain detailed information of cost,
  sales, output and profit at different level of
  operation, useful for analysis.
• Makes possible the comparison of actual
  performance and budgeted one for actual level of
  operation in a very easy and understanding way.
• Helps to attain the objective of cost reduction
  and better cost control.
• Helps to estimate the profit and cost of the
  products such as luxury goods, fashionable goods
  or soft drinks, whose production and sales are
  uncertain.
• Helps to present a monthly report based upon
  comparative analysis of budgeted and actual cost
  at given level of operation.
• Helps to measure the capacity utilization of
  plant or labour force, in term of level of
  activity.
• Helps on planning the expenditure of responsible
  centres, who care responsible for tactical profit
  plan.
• Helps to develop the labour oriented business
  sector, where labour are scare.
• Helps in taking localized decision, identifying
  the possible factors affection the cost and
  profit.

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Classification Of Costs

• Fixed Cost Fixed costs remain constant within
  the given range of activity in spite of change in
  volume of production. The unit fixed cost per
  unit decreases as the level of production
  increases within the volume. They are the period
  cost and capacity, should be incurred for a
  period of time.
• Variable Cost Those costs which increase
  directly and proportionately with the level of
  activity are called variable costs. Total cost
  increases or decreases towards the direction of
  production or sales units. Where as the variable
  cost per unit will remain constant, if other
  thing remaining the same.
• Semi-variable Cost (Mixed Cost) Composition of
  fixed and variable cost is the mixed cost or semi
  variable cost. Such costs increase with the level
  of activity, but by intermittent jumps than
  continuously. In other words the cost does not
  change proportionately with the level of output.

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Methods for flexible budgeting

• Formula Approach
• Columnar or Tabular Approach
• Graphical Approach

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Formula Approach

• Fixed cost and the variable cost per unit are
  found out
• BA FC (UVC Q)
• where,
• BA Budget Allowance
• FC Fixed Cost
• UVC Unit Variable Cost
• Q Output level, i.e. labour hour, machine
  hour, or units produced

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Example
Level of activity 50,000 hours 100,000 hours
Total Cost Rs. 500,000 Rs. 800,000
Variable Cost Difference in Cost / Difference
in activity level Rs.
(800,000 500,000)/(100,000-50,000)
Rs. 300,000/50,000
Rs.6 Fixed Cost Total Cost Variable
Cost Level of activity Rs.
500,000 Rs.6 50,000
Rs.(500,000 300,000) Rs.
200,000
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contd

• Therefore, the required formula is
• BA 200,000 6Q
• So using the formula the required budget for
  60,000 labor hours would be
• BA Rs. 200,000 (Rs. 6 60,000)
• Rs. (200,000 360,000)
• Rs. 560,000

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Activity level in units Flexible Formula 6,000 units 8,000 units
Variable Costs Direct material Direct labor Variable expenses Selling expenses (90) Distribution expenses (80) Total Variable Cost B. Fixed Costs Fixed Overheads Administrative Expenses Selling Expenses 10 of 6.5 10,000 Distribution Expenses 20 of 3.5 10,000 Total Fixed Cost C. Total Costs (A B) Rs. 35 Rs. 12.5 Rs. 10 Rs. 5.85 Rs. 2.8 50,000 25,000 6,500 7,000 88,500 210,000 75,000 60,000 35,100 16,800 396,900 50,000 25,000 6,500 7,000 88,500 485,400 280,000 100,000 80,000 46,800 22,400 529,200 50,000 25,000 6,500 7,000 88,500 617,700
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Columnar or Tabular Approach

• Example
• Cost of output levels of 10,000 units in a
  factory are as follows

Details Cost per unit
Direct Material Direct Labor Variable Overheads Fixed Overheads Rs.50,000 Selling expenses (10 fixed) Administrative expenses (100 fixed) Distribution expenses (20 fixed) Total Costs Rs. 35 2.5 10 5 6.5 2.5 3.5 75
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Preparation of Flexible Budget
Activity level in units 6,000 units 8,000 units
Variable Costs Direct material _at_ Rs. 35 Direct labor _at_ Rs. 12.5 Variable expenses _at_ Rs. 10 Selling expenses (90) _at_ Rs. 5.85 Distribution expenses (80) _at_ Rs. 2.8) Total Variable Cost B. Fixed Costs Fixed Overheads Administrative Expenses Selling Expenses 10 of 6.5 10,000 Distribution Expenses 20 of 3.5 10,000 Total Fixed Cost C. Total Costs (A B) 210,000 75,000 60,000 35,100 16,800 396,900 50,000 25,000 6,500 7,000 88,500 485,400 280,000 100,000 80,000 46,800 22,400 529,200 50,000 25,000 6,500 7,000 88,500 617,700
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Manufacturing Overhead Variance

• The total manufacturing overhead variance is
  equal to the difference between the actual
  manufacturing overhead costs incurred and the
  standard manufacturing overhead costs applied to
  production

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Types Of Overhead Variance

• Capacity or volume variance
• Spending variance
• Efficiency variance

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Calculation of Overhead Variance
Analytical Table Analytical Table
Overhead Applied (SOR x SLA) SORFORVOR, FORFO/NC xxx
Budget Allowance for Standard Level of Activities(SLA) (Fixed Overhead VOR x SLA) xxx
Budget Allowance for Actual Level of Activities (ALA) (Fixed Overhead VOR x Actual of Activities (hrs)) (FO VOR x ALA) xxx
Actual Overhead Incurred (Actual Fixed Overhead Actual Variable Overhead) xxx
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Variances

• Capacity variance (a-b)Overhead Applied-Budget
  Allowance for Standard Level of Activities (SLA)
• Efficiency variance(b-c)Budget Allowance for
  Actual Level of Activities (ALA)- Actual Overhead
  Incurred
• Spending variance (c-d)Budget Allowance for
  Standard Level of Activities (SLA)- Budget
  Allowance for Actual Level of Activities (ALA)

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The following are the data relating to overhead
expenses of a company

• BA Rs.400,000 Rs.5 x DLH
• Normal capacity 100,000DLH
• Standard time per unit of output 2 DLH
• Actual output 52,000 units
• Actual hours worked 98,000 DLH
• Actual overheads paid Rs.865,500
• Required The three overhead variances

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Solution
Analytical Table Analytical Table
a. Overhead Applied (SOR x SLA) (Rs.9x2x52,000) FORFO/NC400,000/100,0004 SORFORVOR459 936,000
b. Budget Allowance for Standard Level of Activities(SLA) (400,000Rs.5x2x52,000) 920,000
c. Budget Allowance for Actual Level of Activities (ALA) (400,000Rs.5x98,000) 890,000
d. Actual Overhead Paid 865,500
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Variances

• Capacity Variance (a-b) Rs.(936,000-920,000)
  Rs.16,000(F)
• Efficiency Variance (b-c) Rs.(920,000-890,000)
• Rs.30,000(F)
• Spending Variance (s-d) Rs.(890,000-865,500)
• Rs.24,500(F)