Principles of Managerial Accounting Chapter 11

Static Budget Set at the beginning of a budgeting period and that is geared to only one level of activity Weakness of the static budget: Does not allow for changes in level of activity which will cause variable expenses to be incorrect.

Why do actual costs deviate from budgeted costs? The actual level of activity differs from the budgeted level of activity The manager’s use of resources was more or less effective than assumed on the budget.

Flexible budget Geared to all levels of activity within the relevant range. Three factors should be considered in selecting an activity base: There should be causal relationship between the activity base and overhead costs—the activity measure should drive the overhead cost.

Flexible budget (cont.) The activity measure should not be stated in dollars—eg. Actual hours drives overhead costs. The activity base should be simple and easily understood.

Predetermined overhead rates Overhead from the flexible budget at the denominator level of activity/denominator level of activity. Separate predetermined rates can be computed for variable and fixed overhead by including only variable or fixed overhead costs in the numerator.

Fixed overhead variances in a standard cost system. Budget variance – the difference between the actual fixed overhead costs incurred during the period and the budgeted fixed overhead costs contained in the flexible budget Volume variance – the difference between the total budgeted fixed overhead and the fixed overhead applied to production. A measure of the utilization of plant facilities relative to the planned utilization.

Volume variance (cont) Formula: Fixed portion of the predetermined overhead rate(Denominator hours- Standard hours allowed for the actual output) A variance occurs because the denominator level of activity differs from the standard hours allowed for production.

Under and Overapplied overhead The sum of the four manufacturing overhead variances equal the under or overapplied overhead Variable overhead spending Variable overhead efficiency Fixed overhead budget Fixed overhead volume

If overhead is underapplied: More overhead cost is incurred than was applied to inventory. Therefore: More overhead cost was incurred than was allowed for the actual output. Consequently an underapplied overhead is unfavorable.