flexible budget, overhead cost variances and management control lecture 18 1 readings chapter 8,cost...
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Chapter 8Flexible Budget,
Overhead Cost Variances and Management Control
Lecture 18
1
ReadingsChapter 8,Cost Accounting, Managerial Emphasis, 14th edition by HorengrenChapter 11, Managerial Accounting 12th edition by Garrison, Noreen, BrewerChapter 11, Managerial Accounting 6th edition by Weygandt, kimmel, kieso
Learning ObjectivesPrepare a flexible budget and explain the advantages of the
flexible budget approach over the static budget approach.Prepare a performance report for both variable and fixed
overhead costs using the flexible budget approach.Use a flexible budget to prepare a variable overhead
performance report containing onlya spending variance
Use a flexible budget to prepare a variable overhead performance report containing both a spending and an efficiency variance.
Compute the predetermined overhead rate and apply overhead to products in a standard cost system.
Compute and interpret the fixed overhead budget and volume variances.
Planning and OverheadVariable Overhead: as efficiently as possible,
plan only essential activitiesFixed Overhead: as efficiently as possible,
plan only essential activities, especially since fixed costs are predetermined well before the budget period begins
Standard CostingTraces 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 time the standard quantities of the allocation bases allowed for the actual outputs produced
A Roadmap: Variable OverheadActual Costs
Incurred:Actual Input
XActual Rate
Flexible Budget:Budgeted Input
Allowed forActual Output
XBudgeted Rate
Actual InputsX
Budgeted Rate
Allocated:Budgeted
Input Allowed forActual Output
XBudgeted Rate
SpendingVariance
EfficiencyVariance
Never aVariance
Never aVariance
Flexible-BudgetVariance
Total Variable Overhead VarianceOver/Under Allocated Variable Overhead
A Roadmap: Fixed OverheadActual Costs
Incurred
Flexible Budget:Same Budgeted Lump Sum (as in
Static Budget)Regardless of Output Level
Same BudgetedLump Sum(as in Static
Budget)Regardless of Output Level
Allocated:Budgeted
Input Allowed forActual Output
XBudgeted Rate
SpendingVariance
Flexible-BudgetVariance
Total Fixed Overhead VarianceOver/Under Allocated Fixed Overhead
Never aVariance
Production-Volume
Variance
Production-Volume
Variance
Overhead VariancesOverhead is the most difficult cost to
manage, and is the least understoodOverhead variances involve taking
differences between equations as the analysis moves back and forth between actual results and budgeted amounts
Developing Budgeted Variable Overhead Cost Rates1. Choose the period to be used for the
budget2. Select the cost-allocation bases to use in
allocating variable overhead costs to output produced
3. Identify the variable overhead costs associated with each cost-allocation base
4. Compute the rate per unit of each cost-allocation base used to allocate variable overhead costs to output produced
The Details: Variable OH VariancesVariable Overhead Flexible-Budget
Variance measures the difference between actual variable overhead costs incurred and flexible-budget variable overhead amounts
Variable Overhead Actual Costs Flexible-budgetflexible-budget variance Incurred amount= -
The Details: Variable OH VariancesVariable Overhead Efficiency Variance is
the difference between actual quantity of the cost-allocation base used and budgeted quantity of the cost per unit of the cost-allocation base
Variable Actual quantity of Budgeted quantity of Budgeted variableOverhead variable overhead variable overhead cost- overhead costEfficiency cost-allocation base allocation based allowed per unit ofVariance used for actual output for actual output cost-allocation base
} X= { -
The Details: Variable OH VariancesVariable Overhead Spending Variance is
the difference between actual and budgeted variable overhead cost per unit of the cost-allocation base, multiplied by actual quantity of variable overhead cost-allocation based used for actual output
Variable Actual variable Budgeted variable Actual quantity ofOverhead overhead cost overhead cost variable overheadSpending per unit of per unit of cost-allocation baseVariance cost-allocation base cost-allocation base used for actual output
{ }- X=
Developing Budgeted Fixed Overhead Cost Rates1. Choose the period to be used for the
budget2. Select the cost-allocation bases to use in
allocating fixed overhead costs to output produced
3. Identify the fixed overhead costs associated with each cost-allocation base
4. Compute the rate per unit of each cost-allocation base used to allocate fixed overhead costs to output produced
The Details: Fixed OH VariancesFixed Overhead Flexible-Budget Variance is
the difference between actual fixed overhead costs and fixed overhead costs in the flexible budget
This is the same amount for the Fixed Overhead Spending Variance
Fixed Overhead Actual Costs Flexible-budgetflexible-budget variance Incurred amount= -
The Details: Fixed OH VariancesProduction-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
Production-Volume Budgeted Fixed Overhead allocated usingVariance Fixed Overhead budgeted input allowed for
actual output units produced
= -
Production-Volume VarianceInterpretation 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
Variable Overhead Variance Analysis Illustrated
Fixed Overhead Variance Analysis Illustrated
Fixed Overhead Behavior
Integrated Variance Analysis Illustrated
20
Static Budgets and Performance Reports
Static budgetsare prepared fora single, plannedlevel of activity.
Performance evaluation is difficult when actual activity
differs from the planned level of
activity.
Hmm! Comparingstatic budgets withactual costs is likecomparing apples
and oranges.
Flexible Budgets
Improve performance evaluation.
May be prepared for any activity level in the relevant range.
Show costs that should have beenincurred at the actual level ofactivity, enabling “apples to apples”cost comparisons.
Reveal variances related tocost control.
Let’s look at CheeseCo.
CheeseCoStatic Actual
Budget Results Variances
Machine hours 10,000
Variable costs Indirect labor 40,000$ Indirect materials 30,000 Power 5,000
Fixed costs Depreciation 12,000 Insurance 2,000
Total overhead costs 89,000$
Static Budgets and Performance Reports
CheeseCoStatic Actual
Budget Results 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$
Static Budgets and Performance Reports
Static ActualBudget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,050 50 U
Total overhead costs 89,000$ 77,350$ $11,650 F
U = Unfavorable variance CheeseCo was unable to achieve
the budgeted level of activity.
CheeseCo
Static Budgets and Performance Reports
Static ActualBudget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,050 50 U
Total overhead costs 89,000$ 77,350$ $11,650 F
CheeseCo
F = Favorable variance that occurs when actual costs are less than budgeted costs.
Static Budgets and Performance Reports
Static ActualBudget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,050 50 U
Total overhead costs 89,000$ 77,350$ $11,650 F
Since cost variances are favorable, havewe done a good job controlling costs?
CheeseCo
Static Budgets and Performance Reports
I don’t think Ican answer thequestion usinga static budget.
Actual activity is belowbudgeted activity.
So, shouldn’t variable costsbe lower if actual activity
is lower?
Static Budgets and Performance Reports
The relevant question is . . .“How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?”
To answer the question,we mustthe budget to theactual level of activity.
The relevant question is . . .“How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?”
To answer the question,we mustthe budget to theactual level of activity.
Static Budgets and Performance Reports
Preparing a Flexible Budget To a budget we need to know that:
Total variable costs changein direct proportion to changes in activity.
Total fixed costs remainunchanged within therelevant range.
FixedVaria
ble
Preparing a Flexible Budget
Let’s prepare budgets for CheeseCo.
Cost Total Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00$ Indirect material 3.00 Power 0.50 Total variable cost 7.50$
Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs
Flexible Budgets
Preparing a Flexible Budget
Fixed costs areexpressed as atotal amount.
Variable costs are expressed as a constant amount per hour.
$40,000 ÷ 10,000 hours is$4.00 per hour.
CheeseCo
Cost Total Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00$ 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$ Insurance 2,000 Total fixed costTotal overhead costs
Flexible Budgets
Preparing a Flexible Budget
$4.00 per hour × 8,000 hours = $32,000
CheeseCo
Preparing a Flexible BudgetCheeseCo
Cost Total Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00$ 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 14,000$ Total overhead costs 74,000$
Flexible Budgets
Cost Total Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00$ 32,000$ 40,000$ Indirect material 3.00 24,000 30,000 Power 0.50 4,000 5,000 Total variable cost 7.50$ 60,000$ 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$ ?
Flexible Budgets
Preparing a Flexible Budget
Total fixed costsdo not change in
the relevant range.
CheeseCo
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.
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.
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.
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.
Quick Check
Total overhead cost
= $14,000 + $7.50 per hour 12,000 hours
= $14,000 + $90,000 = $104,000
Preparing a Flexible Budget
Cost Total Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00$ 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 14,000$ 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ 104,000$
Flexible Budgets
Let’s prepare a budget performance report for CheeseCo.
Flexible Budget Performance Report
Cost Total Formula Fixed Flexible Actualper Hour Cost Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs Indirect labor 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$
CheeseCoFlexible budget is prepared for the
same activity level (8,000 hours) as
actually achieved.
Flexible Budget Performance Report
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 Ub. $2,000 Fc. $6,000 Ud. $6,000 F
What is the variance for indirect labor when the flexible budget for 8,000 hours is compared to the actual results?a. $2,000 Ub. $2,000 Fc. $6,000 Ud. $6,000 F
What is the variance for indirect labor when the flexible budget for 8,000 hours is compared to the actual results?a. $2,000 Ub. $2,000 Fc. $6,000 Ud. $6,000 F
What is the variance for indirect labor when the flexible budget for 8,000 hours is compared to the actual results?a. $2,000 Ub. $2,000 Fc. $6,000 Ud. $6,000 F
Quick Check
Cost Total Formula Fixed Flexible Actualper Hour Cost Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs Indirect labor 4.00$ 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$
CheeseCo
Flexible Budget Performance Report
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 Ub. $1,500 Fc. $4,500 Ud. $4,500 F
What is the variance for indirect material when the flexible budget for 8,000 hours is compared to the actual results?a. $1,500 Ub. $1,500 Fc. $4,500 Ud. $4,500 F
What is the variance for indirect material when the flexible budget for 8,000 hours is compared to the actual results?a. $1,500 Ub. $1,500 Fc. $4,500 Ud. $4,500 F
What is the variance for indirect material when the flexible budget for 8,000 hours is compared to the actual results?a. $1,500 Ub. $1,500 Fc. $4,500 Ud. $4,500 F
Quick Check
Cost Total
Formula Fixed Flexible Actualper Hour Cost Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs Indirect labor 4.00$ 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 FTotal 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 UTotal fixed cost 14,000$ 14,050$ 50 UTotal overhead costs 74,000$ 77,350$ $ 3,350 U
CheeseCo
Flexible Budget Performance Report
47
Remember the question: “How much of the total variance is due to lower activity and how much isdue to cost control?”
Flexible Budget Performance Report
Static ActualBudget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,050 50 U
Total overhead costs 89,000$ 77,350$ $11,650 F
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?
Difference between original static budgetand actual overhead = $11,650 F.
Overhead Variance Analysis
Static ActualOverhead OverheadBudget at at
10,000 Hours 8,000 Hours
89,000$ 77,350$
Let’s place the flexible budget for
8,000 hours here.
Flexible Budget Performance Report
Overhead Variance Analysis
This $15,000F variance is due to lower activity.
Activity
This $3,350Uvariance is due
to poor cost control.
Cost control
Static Flexible ActualOverhead Overhead OverheadBudget at Budget at at
10,000 Hours 8,000 Hours 8,000 Hours
89,000$ 74,000$ 77,350$
Flexible Budget Performance Report
The Measure of Activity– A Critical Choice
Three importantfactors in selecting an
activity base for an overheadflexible budget
Activity base andvariable overhead
should becausally related.
Activity base andvariable overhead
should becausally related.
Activity base shouldnot be expressed
in dollars orother currency.
Activity base shouldnot be expressed
in dollars orother currency.
Activity base shouldbe simple and
easily understood.
Activity base shouldbe simple and
easily understood.
End of Lecture 18