acct2121 chapter8

Flexible Budgets,Overhead Cost Variances,andManagement Control

Explain the similarities and differences in planning variable and fixed overhead costsDevelop budgeted variable and fixed overhead cost ratesCompute the variable overhead flexible-budget variance, the variable overhead efficiency variance, and the variable overhead spending variance (slide 7)Compute the fixed overhead flexible-budget variance, the fixed overhead spending variance, and the fixed overhead production-volume variance8-*

Show how the 4-variance analysis approach reconciles the actual overhead incurred with the overhead amounts allocated during the periodExplain the relationship between the sales-volume variance and the production-volume varianceCalculate variances in activity-based costingExamine the use of overhead variances in nonmanufacturing settings8-*

To effectively plan variable overhead costs, managers should focus on activities that add value and eliminate those that do not.

Fixed overhead planning is similar ~ plan only for essential activities and plan to be as efficient as possible.

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is a costing system that

Traces direct costs to output by multiplying the standard prices or rate by the standard quantities of inputs allowed for actual outputs produced.

Allocates overhead costs on the basis of the standard overhead-cost rates times the standard quantities of the allocation bases allowed for the actual outputs produced.8-*

Choose the period to be used for the budget.Select the cost-allocation bases to use in allocating variable overhead costs to output produced.Identify the variable overhead costs associated with each cost-allocation base.Compute the rate per unit of each cost-allocation base used to allocate variable overhead costs to output produced.8-*

Variable overhead flexible-budget variance measures the difference between actual variable overhead costs incurred and flexible-budget variable overhead amounts.This variance can be further broken down into the Variable Overhead Efficiency Variance and the Variable Overhead Spending Variance.8-*

Sheet1

Variable Overhead=Actual Costs-Flexible-budget

flexible-budget varianceIncurredamount

Sheet2

Sheet3

As a reminder, the flexible-budget amount will be calculated by taking the budgeted input allowed per output unit x the budgeted variable overhead cost rate per input unit.If, for example, our actual output were 10,000 units, the budgeted machine hours were 4,000 and the budgeted variable overhead cost per machine-hour were $30, then the flexible budget would be calculated by taking 0.4 (= 4,000 / 10,000 to get machine hours per unit) x $30 x 10,000 actual units.8-*

Variable overhead efficiency variance is the difference between the actual quantity of the variable overhead cost-allocation base used and the budgeted quantity of the variable overhead cost-allocation base allowed for the actual output X the budgeted variable overhead cost per unit of the cost-allocation base.8-*

Sheet1



Sheet2

Variable{Actual quantity ofBudgeted quantity of}Budgeted variable

Overhead=variable overhead-variable overhead cost-Xoverhead cost

Efficiencycost-allocation baseallocation base allowedper unit of

Varianceused for actual outputfor actual outputcost-allocation base

Sheet3

If, for example, our cost-allocation base were machine hours and we actually had 4500, our budgeted machine hours were 4000, and the budgeted variable overhead cost per machine hour were $30, then the variable overhead efficiency variance by taking (4,500 4,000) x $30.8-*

Variable overhead spending variance is the difference between actual and budgeted variable overhead cost per unit of the cost-allocation base, multiplied by the actual quantity of variable overhead cost-allocation base used.8-*

simple



Fixed Overhead=Actual Costs-Flexible-budget


complex



Efficiencycost-allocation baseallocation based allowedper unit of


Variable{Actual variableBudgeted variable}Actual quantity of

Overhead=overhead cost-overhead costXvariable overhead

Spendingper unit ofper unit ofcost-allocation base

Variancecost-allocation basecost-allocation baseused

Sheet3

If, for example, the cost allocation base were machine hours and the actual variable overhead cost per machine hour were $29, the budgeted variable overhead cost per machine hour were $30 and the actual quantity of machine hours used were 4,500, then this variance by taking (29 30) x 4,500 resulting in a favorable variance (favorable because actual cost per hour was less than budgeted cost per hour) of $4,500.8-*

8-*This chart represents a summary of the variable overhead variances and their relationship. You can see that at Level 2 (Chapter 7), we have the flexible-budget variance which is broken down further in the Level 3 (Chapter 7) variances.

Fixed overhead costs are, by definition, a lump sum of costs that remain unchanged for a given period despite potentially wide changes in activity within the relevant range.

These costs are fixed in the sense that, unlike variable costs, fixed costs do not automatically increase or decrease with the level of activity within the relevant range.8-*

Choose the period to be used for the budget.Select the cost-allocation bases to use in allocating fixed overhead costs to output produced.Identify the fixed overhead costs associated with each cost-allocation base.Compute the rate per unit of each cost-allocation base used to allocate fixed overhead costs to output produced.8-*

Fixed overhead flexible-budget variance is the difference between actual fixed overhead costs and fixed overhead costs in the flexible budget.

The fixed overhead spending variance is the same variance as the Fixed Overhead Flexible-Budget Variance8-*

simple





complex





Sheet3

Production-volume variance is the difference between budgeted fixed overhead and fixed overhead allocated on the basis of actual output produced.This variance is also known as the denominator-level variance.8-*For example, if our budgeted fixed overhead were $276,000 with an allocation per output of $23/unit based on 12,000 units but we actually only produced 10,000 units, we would have allocated only $230,000 ($23/unit x 10,000) resulting in an unfavorable production volume variance of $46,000.The variance here is unfavorable because, due to lower than planned volume, we were unable to allocate the budgeted amount of fixed costs.

simple





Production-Volume=Budgeted-Fixed Overhead allocated

VarianceFixed Overheadfor actual output units

produced

complex





Variable{Actual variableBudgeted variable}Actual quantity of

Overhead=overhead cost-overhead costXvariable overhead

Spendingper unit ofper unit ofcost-allocation base

Variancecost-allocation basecost-allocation baseused for actual output

Sheet3

Interpretation of this variance is difficult due to the nature of the costs involved and how they are budgeted.Fixed costs are by definition somewhat inflexible. While market conditions may cause production to flex up or down, the associated fixed costs remain the same.Fixed costs may be set years in advance, and may be difficult to change quickly.Contradiction: Despite this, examination of the fixed overhead budget formulae reveals that it is budgeted similar to a variable cost.8-*

8-*

4-VARIANCE ANALYSISSPENDING VARIANCEEFFICIENCY VARIANCEPRODUCTION-VOLUME VARIANCEVARIABLE OVERHEADYESYESNEVER A VARIANCEFIXED OVERHEADYESNEVER A VARIANCEYES

You may recall from chapter 7 that the static budget variance (the difference between the static budget and the actual results) was $93,100 Unfavorable for Webb Company, our sample company.

The sales-volume variance (the difference between the flexible budget and the static budget) was $64,000 Unfavorable.

The sales-volume variance consists of two components: The operating-income volume variance and the production-volume variance.8-*

Activity-based costing systems focus on individual activities as the fundamental cost objects. Variances are calculated for each activity.

8-*

Nonmanufacturing companies can benefit from overhead variances just as manufacturing companies can.

Variance analysis can be used to examine overhead costs and make decisions about pricing, managing costs and the mix of products.

Output measures will be different and can be passenger-miles flown, patient days provided, rooms-days occupied, ton-miles of freight hauled, etc.8-*

8-*

TERMS TO LEARNPAGE NUMBER REFERENCEDenominator levelPage 292Denominator-level variancePage 298Fixed overhead flexible-budget variancePage 297Fixed overhead spending variancePage 297Operating-income volume variancePage 307Production-volume variancePage 298Standard costingPage 290

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TERMS TO LEARNPAGE NUMBER REFERENCETotal-overhead variancePage 305Variable overhead efficiency variancePage 293Variable overhead flexible-budget variancePage 293Variable overhead spending variancePage 295

*In Chapter 8, well be studying variances for variable and fixed costs.Here are the first 4 of our 8 learning objectives:Explain the similarities and differences in planning variable and fixed overhead costsDevelop budgeted variable and fixed overhead cost rates.Compute the variable overhead flexible-budget variance, the variable overhead efficiency variance and the variable overhead spending varianceCompute the fixed overhead flexible-budget variance, the fixed overhead spending variance and the fixed overhead production-volume variance

*Here are the final 4 of our 8 learning objectives:Show how the 4-variance analysis approach reconciles the actual overhead incurred with the overhead amounts allocated during the periodExplain the relationship between the sales-volume variance and the production-volume varianceCalculate variances in activity-based costingExamine the use of overhead variances in nonmanufacturing settings

*To effectively plan variable overhead costs, managers must focus on the activities that create a superior product or service for their customers and eliminate activities that do not add value.Planning fixed overhead costs is similar to planning variable overhead costs undertake only essential activities and then plan to be efficient in that undertaking.*Standard costing is a costing system that (1) traces direct costs to output produced by multiplying the standard prices or rates by the standard quantities of inputs allowed for actual outputs produced, and (2) allocated overhead costs on the basis of the standard overhead-cost rates times the standard quantities of the allocation bases allowed for the actual outputs produced.*The steps to follow in developing budgeted variable overhead rates are:Choose the period to be used for the budget.Select the cost-allocation bases to use in allocating variable overhead costs to output produced.Identify the variable overhead costs associated with each cost-allocation base.Compute the rate per unit of each cost-allocation base used to allocate variable overhead costs to output produced.

*As seen here, the variable overhead flexible-budget variance measures the difference between actual variable overhead costs incurred and flexible-budget variable overhead amounts.As a reminder, the flexible-budget amount will be calculated by taking the budgeted input allowed per output unit x the budgeted variable overhead cost rate per input unit.If, for example, our actual output were 10,000 units, the budgeted machine hours were 4,000 and the budgeted variable overhead cost per machine-hour were $30, the flexible budget would be calculated by taking .4 (4000/10000 to get machine hours per unit) x $30 x 10,000 actual units.The variable overhead flexible-budget variance can be further broken down into the Variable Overhead Efficiency Variance and the Variable Overhead Spending Variance.

*On this slide, we see the formula for the variable overhead efficiency variance which is the difference between the actual quantity of the variable overhead cost-allocation base used for actual output and the budgeted quantity of the variable overhead cost-allocation base allowed for the actual output X the budgeted variable overhead cost per unit of the cost-allocation base.If, for example, our cost-allocation base were machine hours and we actually had 4500, our budgeted machine hours were 4000, and the budgeted variable overhead cost per machine hour were $30, we would calculate the variable overhead efficiency variance by taking (4500-4000) x $30.*The variable overhead spending variance is the difference between actual and budgeted variable overhead cost per unit of the cost-allocation base, multiplied by the actual quantity of variable overhead cost-allocation base used for actual output.If, for example, the cost allocation base were machine hours and the actual variable overhead cost per machine hour were $29, the budgeted variable overhead cost per machine hour were $30 and the actual quantity of machine hours used were 4,500, we would calculate this variance by taking (29 30) x 4500 resulting in a favorable variance (favorable because actual cost per hour was less than budgeted cost per hour) of $4,500.*This chart represents a summary of the variable overhead variances and their relationship. You can see that at Level 2, we have the flexible-budget variance which is broken down further in the level 3 variances.Exhibit 8-1 page 294*Fixed overhead costs are, by definition, a lump sum of costs that remain unchanged for a given period despite potentially wide changes in activity within the relevant range. These costs are fixed in the sense that, unlike variable costs, fixed costs do not automatically increase or decrease with the level of activity within the relevant range.

*The process of developing the budgeted fixed overhead rate is the same as the one for calculating the budgeted variable overhead rate. The steps are as follows:Choose the period to be used for the budget.Select the cost-allocation bases to use in allocating fixed overhead costs to output produced.Identify the fixed overhead costs associated with each cost-allocation base.Compute the rate per unit of each cost-allocation base used to allocate fixed overhead costs to output produced.

*The fixed overhead flexible-budget variance is simply the difference between actual fixed overhead costs and fixed overhead costs in the flexible budget.Fixed Overhead Flexible Budget Variance = Fixed Overhead Spending Variance*The production-volume variance is the difference between budgeted fixed overhead and fixed overhead allocated on the basis of actual output produced. This variance is also known as the denominator-level variance or the output-level overhead variance because that is the basis of the variance.For example, if our budgeted fixed overhead were $276,000 with an allocation per output of $23/unit based on 12000 units but we actually only produced 10,000 units, we would have allocated only $230,000 ($23/unit x 10000) resulting in an unfavorable production volume variance of $46,000.The variance here is unfavorable because, due to lower than planned volume, we were unable to allocate the budgeted amount of fixed costs.*Lump-sum fixed costs represent the costs of acquiring capacity. An analysis of the production-volume variance should include questions like:Why did this overcapacity occur? Why were only 10,000 units produced? Is there a quality problem, etc.Fixed costs are by definition somewhat inflexible. While market conditions may cause production to flex up or down, the associated fixed costs remain the same.Fixed costs may be set years in advance, and may be difficult to change quickly.Contradiction: Despite this, examination of the fixed overhead budget formulae reveals that it is budgeted similar to a variable cost.

*This chart shows a summary of the fixed overhead variances with the flexible-budget variance at level 2 and the spending and production-volume variances at level 3. Exhibit 8-2 page 298*The chart represents what is called a 4-variance analysis. As with our other variances, they are not necessarily independent of each other. This is called a 4-variance analysis because there are a total of 4 variances:Variable SpendingFixed SpendingVariable EfficiencyFixed Production-VolumeExhibit 8-4 page 304*This second view of the 4-variance analysis indicates what kind of variances are expected for variable and fixed overhead.Variable overhead will never have a production-volume variance and fixed overhead will never have an efficiency variance.*You may recall from chapter 7 that the static budget variance (the difference between the static budget and the actual results) was $93,100 Unfavorable for Webb Company, our sample company.The sales-volume variance (the difference between the flexible budget and the static budget) was $64,000 Unfavorable.The sales-volume variance consists of two components: The operating-income volume variance and the production-volume variance.

*This chart provides a summary of the static budget variance the difference between the static-budget and actual performance based on what weve learned in chapters 7 and 8. Exhibit 8-5 page 307*Variance analysis can be performed in an activity-based costing system in a similar manner. Variances are calculated for each activity rather than for each type of cost.*Nonmanufacturing companies can benefit from overhead variances just as manufacturing companies can. The variance analysis can be used to examine overhead costs and make decisions about pricing, managing costs and the mix of products.Output measures for these companies will be different and can be passenger-miles flown, patient days provided, rooms-days occupied, ton-miles of freight hauled, etc.

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acct2121 chapter8

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