Chapter 11.ppt

Chapter Eleven Flexible Budgets and Overhead Analysis Learning Objective 1 Prepare a flexible budget and explain the advantages of the flexible budget approach over the static budget approach. Static Budgets and Performance Reports Static budgets are prepared for a single, planned level of activity. Performance evaluation is difficult when actual activity differs from the planned level of activity. Hmm! Comparing static budgets with actual costs is like comparing apples and oranges. Flexible Budgets Improve performance evaluation. 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. Let?s look at CheeseCo. Static Budgets and Performance Reports CheeseCo Static Budgets and Performance Reports CheeseCo Static Budgets and Performance Reports U = Unfavorable variance CheeseCo was unable to achieve the budgeted level of activity. CheeseCo Static Budgets and Performance Reports CheeseCo F = Favorable variance that occurs when actual costs are less than budgeted costs. Static Budgets and Performance Reports Since cost variances are favorable, have we done a good job controlling costs? CheeseCo Static Budgets and Performance Reports I don?t think I can answer the question using a static budget. Actual activity is below budgeted activity. So, shouldn?t variable costs be 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 must the budget to the actual level of activity. Preparing a Flexible Budget To a budget we need to know that: Total variable costs change in direct proportion to changes in activity. Total fixed costs remain unchanged within the relevant range. Fixed Variable Preparing a Flexible Budget Let?s prepare budgets for CheeseCo. Preparing a Flexible Budget Fixed costs are expressed as a total amount. Variable costs are expressed as a constant amount per hour. $40,000 ÷ 10,000 hours is $4.00 per hour. CheeseCo Preparing a Flexible Budget $4.00 per hour × 8,000 hours = $32,000 CheeseCo Preparing a Flexible Budget CheeseCo Preparing a Flexible Budget Total fixed costs do 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. 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 Preparing a Flexible Budget Learning Objective 2 Prepare a performance report for both variable and fixed overhead costs using the flexible budget approach. Flexible Budget Performance Report Let?s prepare a budget performance report for CheeseCo. Flexible Budget Performance Report CheeseCo Flexible budget is prepared for the same activity level (8,000 hours) as actually achieved. 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 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 Flexible Budget Performance Report CheeseCo 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 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 CheeseCo Flexible Budget Performance Report Flexible Budget Performance Report Remember the question: ?How much of the total variance is due to lower activity and how much is due to cost control?? 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? Flexible Budget Performance Report Difference between original static budget and actual overhead = $11,650 F. Overhead Variance Analysis 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 $3,350U variance is due to poor cost control. Cost control The Measure of Activity? A Critical Choice Three important factors in selecting an activity base for an overhead flexible budget Activity base and variable overhead should be causally related. Activity base should not be expressed in dollars or other currency. Activity base should be simple and easily understood. Variable Overhead Variances ? A Closer Look If flexible budget is based on actual hours If flexible budget is based on standard hours Only a spending variance can be computed. Both spending and efficiency variances can be computed. 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. Learning Objective 3 Use a flexible budget to prepare a variable overhead performance report containing only a spending variance. Variable Overhead Variances Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours AH × SR AH × AR Spending Variance Spending variance = AH(AR ? SR) AH = Actual hours AR = Actual variable overhead rate SR = Standard variable overhead rate Variable Overhead Variances ? Example Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours 3,300 hours × $2.00 per hour = $6,600 $6,740 Spending Variance = $140 unfavorable Variable Overhead Variances ? A Closer Look Spending Variance Results from paying more or less than expected for overhead items and from excessive usage of overhead items. Now, let?s use the standard hours allowed, along with the actual hours, to compute the efficiency variance. Learning Objective 4 Use a flexible budget to prepare a variable overhead performance report containing both a spending and an efficiency variance. Variable Overhead Variances AH × SR AH × AR Spending variance = AH(AR - SR) Efficiency variance = SR(AH - SH) SH × SR Spending Variance Efficiency Variance Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours Variable Overhead Variances ? Example 3,300 hours 3,200 hours × × $2.00 per hour $2.00 per hour $6,740 $6,600 $6,400 Spending variance $140 unfavorable Efficiency variance $200 unfavorable $340 unfavorable flexible budget total variance Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours Variable Overhead Variances ? A Closer Look Efficiency Variance Controlled by managing the overhead cost driver. 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 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 Spending variance = AH (AR - SR) = Actual variable overhead incurred ? (AH ? SR) = $10,950 ? (2,050 hours ? $5 per hour) = $10,950 ? $10,250 = $700 U 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 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 Efficiency variance = SR (AH ? SH) = $5 per hour (2,050 hours ? 2,100 hours) = $250 F Quick Check Summary 2,050 hours 2,100 hours × × $5 per hour $5 per hour Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours $10,950 $10,250 $10,500 Spending variance $700 unfavorable Efficiency variance $250 favorable $450 unfavorable flexible budget total variance Activity-based Costing and the Flexible Budget It is unlikely that all variable overhead will be driven by a single activity. Activity-based costing can be used when multiple activity bases drive variable overhead costs. Learning Objective 5 Compute the predetermined overhead rate and apply overhead to products in a standard cost system. Overhead Rates and Overhead Analysis Recall that overhead costs are assigned to products and services using a predetermined overhead rate (POHR): Overhead from the flexible budget for the denominator level of activity POHR = Assigned Overhead = POHR × Standard Activity Denominator level of activity Overhead Rates and Overhead Analysis The predetermined overhead rate can be broken down into fixed and variable components. The variable component is useful for preparing and analyzing variable overhead variances. The fixed component is useful for preparing and analyzing fixed overhead variances. Normal versus Standard Cost Systems In a normal cost system, overhead is applied to work in process based on the actual number of hours worked in the period. In a standard cost system, overhead is applied to work in process based on the standard hours allowed for the actual output of the period. Learning Objective 6 Compute and interpret the fixed overhead budget and volume variances. Budget Variance Volume Variance FR = Standard Fixed Overhead Rate SH = Standard Hours Allowed DH = Denominator Hours SH × FR Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied Fixed Overhead Variances DH × FR 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 ? ColaCo applies overhead based on machine-hour activity. Let?s calculate overhead rates. Overhead Rates and Overhead Analysis ? Example ColaCo prepared this budget for overhead: Rate = Total Variable Overhead ÷ Machine Hours This rate is constant at all levels of activity. 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 ? 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. 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. 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. Overhead Variances Now let?s turn our attention to calculating fixed overhead variances. Fixed Overhead Variances ? Example Budget variance $550 favorable $8,450 $9,000 Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied Fixed Overhead Variances ? A Closer Look Budget Variance Results from spending more or less than expected for fixed overhead items. Now, let?s use the standard hours allowed to compute the fixed overhead volume variance. Fixed Overhead Variances ? Example 3,200 hours × $3.00 per hour Budget variance $550 favorable $8,450 $9,000 $9,600 Volume variance $600 favorable SH × FR Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied Volume Variance ? A Closer Look Volume Variance Results when standard hours allowed for actual output differs from the denominator activity. Unfavorable when standard hours < denominator hours Favorable when standard hours > denominator hours Volume Variance ? A Closer Look Volume Variance Results when standard hours allowed for actual output differs from the denominator activity. Unfavorable when standard hours < denominator hours Favorable when standard hours > denominator hours Does not measure over- or under spending It results from treating fixed overhead as if it were a variable cost. 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 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 Budget variance = Actual fixed overhead ? Budgeted fixed overhead = $14,800 ? $14,450 = $350 U 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 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 Volume variance = Budgeted fixed overhead ? (SH ? FR) = $14,450 ? (2,100 hours ? $7 per hour) = $14,450 ? $14,700 = $250 F Quick Check Summary 2,100 hours × $7.00 per hour Budget variance $350 unfavorable $14,800 $14,450 $14,700 Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied Volume variance $250 favorable SH × FR Fixed Overhead Variances ? A Graphic Approach Let?s look at a graph showing fixed overhead variances. We will use ColaCo?s numbers from the previous example. Fixed Overhead Variances ? A Graphic Approach Activity Cost 3,000 Hours Expected Activity $9,000 budgeted fixed OH Fixed overhead applied to products Fixed Overhead Variances ? A Graphic Approach $8,450 actual fixed OH Activity Cost 3,000 Hours Expected Activity $9,000 budgeted fixed OH Fixed overhead applied to products $8,450 actual fixed OH $550 Favorable Budget Variance { Fixed Overhead Variances ? A Graphic Approach { $8,450 actual fixed OH 3,200 machine hours × $3.00 fixed overhead rate $600 Favorable Volume Variance $9,600 applied fixed OH 3,200 Standard Hours Activity Cost 3,000 Hours Expected Activity $9,000 budgeted fixed OH Fixed overhead applied to products $550 Favorable Budget Variance { $8,450 actual fixed OH Overhead Variances and Under- or Overapplied Overhead Cost In a standard cost system: Unfavorable variances are equivalent to underapplied overhead. Favorable variances are equivalent to overapplied overhead. The sum of the overhead variances equals the under- or overapplied overhead cost for a period. End of Chapter 11