Cornerstones of Managerial Accounting 2e Chapter Ten Flexible Budgets and Overhead Analysis Mowen/Hansen Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Prepare a flexible budget, and use it for performance reporting. Objective # 1 Prepare a flexible budget, and use it for performance reporting.

Performance Reports Compare actual costs with budgeted costs Two ways: Compare actual costs with budgeted costs for the budgeted level of activity Based on a static budget Compare actual costs with the actual level of activity Based on a flexible budget

Static Budget A budget for one particular level of activity Performance report will compare: Direct materials, direct labor, and overhead costs budgeted for the planned level of activity with Actual costs for the actual level of activity Resulting in unfavorable variances when actual production exceeds the planned level To create a meaningful performance report: Actual costs and expected costs must be compared at the same level of activity

Flexible Budget Enables a firm to compute expected costs for a range of activity levels Two types: Before-the-fact -- Allows managers to see the expected outcomes for a range of activity levels Used to generate financial results for a number of plausible scenarios After-the-fact -- Created for the actual level of activity Used to compute what costs should have been for the actual level of activity Expected costs are then compared with the actual costs in order to assess performance

Calculate the variable overhead variances and explain their meaning Objective # 2 Calculate the variable overhead variances and explain their meaning

Total Overhead Variance Difference between applied and actual overhead Broken down into: Total Variable Overhead Variance Broken further into: Variable Overhead Spending Variance Variable Overhead Efficiency Variance Total Fixed Overhead Variance Fixed Overhead Spending Variance Fixed Overhead Volume Variance

Total Variable Overhead Variance Actual Costs – Applied Costs = Total Variance (AH X AVOR) – (SH X SVOR) Actual Hours x Actual Variable Overhead Rate Hours allowed for production (SH) x Standard Variable Overhead Rate (SVOR)

Variable Overhead Spending Variance Measures the aggregate effect of the differences between Actual variable overhead rate (AVOR) Standard variable overhead rate (SVOR) Two ways to calculate: Three-pronged columnar approach Formula approach (AVOR – SVOR)AH

Variable Overhead Efficiency Variance Measures the change in variable overhead consumption that occurs because of efficient (or inefficient) use of direct labor Two ways to calculate: Three-pronged columnar approach Formula approach (AH – SH)SVOR

Example Formula Approach: VOH spending variance (AVOR – SVOR)AH

VOH efficiency variance Example Formula Approach: VOH efficiency variance (AH – SH) SVOR

Calculate the fixed overhead variances, and explain their meaning Objective # 3 Calculate the fixed overhead variances, and explain their meaning

Total Fixed Overhead Variance Difference between actual and applied fixed overhead When applied overhead = standard fixed overhead rate x standard hours allowed for the actual output Broken down into: Fixed Overhead Spending Variance Fixed Overhead Volume Variance

Fixed Overhead Spending Variance Difference between Actual fixed overhead rate (AFOH) Budgeted fixed overhead rate (BFOH) Two ways to calculate: Three-pronged columnar approach Formula approach AFOH – SFOH

Fixed Overhead Volume Variance Difference between Budgeted fixed overhead (BFOH) Applied fixed overhead (ApFOH) Two ways to calculate: Three-pronged columnar approach Formula approach (SHp – SH)SFOR

Example Information: Standard fixed overhead rate (SFOR) $10.00 per direct labor hour Budgeted fixed overhead (BFOH) $1,800 Number of tee shirts produced 1,200 units Hours allowed for production (SH) 144 hours

Fixed Overhead (FOH) Volume Variance Example Formulas: Fixed Overhead (FOH) Volume Variance AFOH – BFOH

Fixed Overhead (FOH) Efficiency Variance Example Formulas: Fixed Overhead (FOH) Efficiency Variance (SHp - SH) SFOR

Prepare an activity-based flexible budget. Objective # 4 Prepare an activity-based flexible budget.

Activity-Based Budgeting A powerful planning and control tool Can be used to emphasize cost reduction through the elimination of wasteful activities and improving efficiency of necessary activities Two types: Static activity budgets Activity-based flexible budget