1. Hilton Maher Selto

2. 17 Flexible Budgets, Overhead Cost Management, and Activity-Based Budgeting McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

3. 17-3 A flexible budget is valid for a range of activity A flexible budget is valid for a range of activity A static budget is based on a particular planned level of activity A static budget is based on a particular planned level of activity This range of activity is the relevant range This range of activity is the relevant range A flexible overhead budget is defined as a detailed plan for controlling overhead cost valid in the firm’s relevant range of activity A flexible overhead budget is defined as a detailed plan for controlling overhead cost valid in the firm’s relevant range of activity What Are Flexible Overhead Budgets?

4. 17-4 Based on planned June production of 4,000 tents, at 1.5 machine hours per tent. We cannot tell from this budget what it would cost to make 3,000 tents. Based on planned June production of 4,000 tents, at 1.5 machine hours per tent. We cannot tell from this budget what it would cost to make 3,000 tents. Based on only ONE anticipated activity level Based on only ONE anticipated activity level Includes several possible activity levels Static Budget Versus Flexible Budget Exh. 17-1

5. 17-5 Actual Electricity Cost Actual Electricity Cost Budgeted Electricity Cost (static budget) Budgeted Electricity Cost (static budget) $1,050 $1,200 The manager is comparing the electricity cost incurred at the ACTUAL activity level (3,000 tents) with the budgeted electricity cost at the PLANNED activity level (4,000 tents). These activity levels are different, therefore we would expect the electricity cost to be different Advantages Of Flexible Budgets Cost Variance $150 Favorable

6. 17-6 Actual Electricity Cost Actual Electricity Cost Budgeted Electricity Cost (flexible budget) Budgeted Electricity Cost (flexible budget) Cost Variance $1,050 $900 $150 Unfavorable The manager is comparing the electricity cost incurred at the ACTUAL activity level, 3,000 tents with the budgeted electricity cost at the ACTUAL activity level, (3,000 tents x 1.5 machine hours) = 4,500 machine hours Electrical cost was greater than it should have been, given the actual level of output Advantages Of Flexible Budgets

7. 17-7 Output measures require different inputs Output measures can be used if you only make one product Flexible budget must be based on outputs that can be compared Activity Measure: Based On Input Or Output

8. 17-8 1.5 standard allowed machine hours per tent 1.5 standard allowed machine hours per tent Usually not a meaningful measure in a multi-product firm because it would require us to add numbers of unlike products Usually not a meaningful measure in a multi-product firm because it would require us to add numbers of unlike products Output is measured in terms of the standard allowed input, given actual output Flexible Budgets: Inputs Versus Outputs

9. 17-9 If you recall, this is similar to the Predetermined Cost-Driver Rate discussed in Chapter 4.. EXAMPLE Assume that the company needs flexible budget numbers for three activity levels: 4,500 hours, 6,000 hours, and 7,500 hours. Also, assume that the Predetermined Budgeted Variable-Overhead Cost per Activity Unit is $6 per hour. Budgeted Fixed-Overhead Cost for the month is $30,000. EXAMPLE Assume that the company needs flexible budget numbers for three activity levels: 4,500 hours, 6,000 hours, and 7,500 hours. Also, assume that the Predetermined Budgeted Variable-Overhead Cost per Activity Unit is $6 per hour. Budgeted Fixed-Overhead Cost for the month is $30,000. Flexible Budget? Formula Flexible Budget

10. 17-10 The flexed total budgeted monthly overhead for each activity level can now be used effectively in planning and variance analysis. Formula Flexible Budget

11. 17-11 Manufacturing OverheadWork-in-Process Inventory Actual overhead Applied overhead Actual hours Predetermined overhead rate X Applied overhead Actual hours Predetermined overhead rate X Overhead Application - Normal Costing The Difference between Normal Costing and Standard Costing lies in the quantity of hours used The Difference between Normal Costing and Standard Costing lies in the quantity of hours used Exh. 17-4

12. 17-12 Manufacturing OverheadWork-in-Process Inventory Actual overhead Applied overhead Standard allowed hours Predetermined or standard overhead rate X Applied overhead Standard allowed hours Predetermined or standard overhead rate X Overhead Application - Standard Costing The Difference between Normal Costing and Standard Costing lies in the quantity of hours used The Difference between Normal Costing and Standard Costing lies in the quantity of hours used Exh. 17-4

13. 17-13 Both normal-costing and standard-costing systems use an overhead rate computed at the beginning of the accounting period (predetermined overhead rate) Computed annually Predetermined Overhead Rates Exh. 17-5

14. 17-14 Choice Of Activity Measure How should the cost manager select the activity measure for the flexible budget? The variable overhead cost and the activity measure should move together The variable overhead cost and the activity measure should move together Direct labor time has traditionally been the most popular activity measure in manufacturing firms Direct labor time has traditionally been the most popular activity measure in manufacturing firms As automation increases, more firms are switching to machine hours or process time As automation increases, more firms are switching to machine hours or process time Dollar measures, such as direct-labor or material costs can be misleading because they are subject to price-level changes and other fluctuations

15. 17-15 Koala manufactured 3,000 tree line tents X 1.5 machine hours per tent = standard allowed 4,500 machine hours Koala manufactured 3,000 tree line tents X 1.5 machine hours per tent = standard allowed 4,500 machine hours Actual machine hours for June = 4,800 Actual machine hours for June = 4,800 The total variable overhead variance for June = Actual variable overhead $30,480 Budget variable overhead $27,000 $ 3,480 F The total variable overhead variance for June = Actual variable overhead $30,480 Budget variable overhead $27,000 $ 3,480 F Overhead Cost Variances For standard allowed 4,500 machine hours the budget overhead (from Exhibit 17-3) for June = Variable overhead $27,000 Fixed overhead $30,000 For standard allowed 4,500 machine hours the budget overhead (from Exhibit 17-3) for June = Variable overhead $27,000 Fixed overhead $30,000 From the cost accounting records, the actual overhead for June = Variable overhead $30,480 Fixed overhead $32,500 $62,980 From the cost accounting records, the actual overhead for June = Variable overhead $30,480 Fixed overhead $32,500 $62,980

16. 17-16 The VARIABLE-OVERHEAD SPENDING VARIANCE is the difference between the actual variable overhead cost and the product of the standard variable -overhead rate and the actual hours of an activity base (or cost driver) The VARIABLE-OVERHEAD SPENDING VARIANCE is the difference between the actual variable overhead cost and the product of the standard variable -overhead rate and the actual hours of an activity base (or cost driver) Variable Overhead Variances Exh. 17-6???????? 4,800 machine hours 4,800 machine hours $6.35 per machine hour $6.35 per machine hour 4,800 machine hours 4,800 machine hours $6.00 per machine hour $6.00 per machine hour Actual variable overhead Actual machine hours (AH) Actual machine hours (AH) Actual rate (AVR) Actual rate (AVR) Actual machine hours (AH) Actual machine hours (AH) Standard rate (SVR) Standard rate (SVR) Actual machine hours × the standard rate $30,480 $28,800 $1,680 Unfavorable Variable-overhead spending variance $1,680 Unfavorable Variable-overhead spending variance

17. 17-17 $27,000 $28,800 ???? The VARIABLE-OVERHEAD EFFICIENCY VARIANCE is the difference between the actual and the standard hours of an activity base (or cost driver) multiplied by the standard variable overhead rate The VARIABLE-OVERHEAD EFFICIENCY VARIANCE is the difference between the actual and the standard hours of an activity base (or cost driver) multiplied by the standard variable overhead rate Flexible budget: variable overhead Flexible budget: variable overhead Standard allowed machine hours (SH) Standard allowed machine hours (SH) Standard rate (SVR) Standard rate (SVR) Actual machine hours (AH) Actual machine hours (AH) Standard rate (SVR) Standard rate (SVR) Actual machine hours times the standard rate Actual machine hours times the standard rate Variable Overhead Variances 4,500 machine hours 4,500 machine hours $6.00 per machine hour $6.00 per machine hour 4,800 machine hours 4,800 machine hours $6.00 per machine hour $6.00 per machine hour Exh. 17-6 $1,800 Unfavorable Variable-overhead efficiency variance $1,800 Unfavorable Variable-overhead efficiency variance

18. 17-18???? The flexible budget amount for variable overhead $27,000 is the amount that will be applied to Work-in-Process for product-costing purposes The flexible budget amount for variable overhead $27,000 is the amount that will be applied to Work-in-Process for product-costing purposes Flexible budget: variable overhead Flexible budget: variable overhead Standard allowed machine hours (SH) Standard allowed machine hours (SH) Standard rate (SVR) Standard rate (SVR) Variable overhead applied to work in process Variable overhead applied to work in process $27,000 Standard allowed machine hours (SH) Standard allowed machine hours (SH) Standard rate (SVR) Standard rate (SVR) 4,500 machine hours 4,500 machine hours $6.00 per machine hour $6.00 per machine hour 4,500 machine hours 4,500 machine hours $6.00 per machine hour $6.00 per machine hour No difference Variable Overhead Variances Exh. 17-6 $27,000

19. 17-19? The unfavorable variance resulting from using more machine hours than the standard quantity, given actual output The unfavorable variance resulting from using more machine hours than the standard quantity, given actual output The actual labor rate per hour differs from the standard rate The actual labor rate per hour differs from the standard rate Efficiency variance Spending variance The variable overhead efficiency variance has nothing to do with efficient or inefficient use of variable overhead items The variable overhead efficiency variance has nothing to do with efficient or inefficient use of variable overhead items An unfavorable variance means that the total actual cost of variable overhead is > expected, after adjusting for the actual quantity of machine hours used An unfavorable variance means that the total actual cost of variable overhead is > expected, after adjusting for the actual quantity of machine hours used The spending variance is the real control variance for variable overhead The spending variance is the real control variance for variable overhead How To Interpret The Variable Overhead Variances

20. 17-20 The FIXED-OVERHEAD BUDGET VARIANCE is the difference between actual fixed overhead and budgeted fixed overhead The FIXED-OVERHEAD BUDGET VARIANCE is the difference between actual fixed overhead and budgeted fixed overhead Fixed-overhead budget variance Actual Fixed overhead Budgeted fixed overhead =- Fixed-overhead budget variance Actual Fixed overhead = $32,500 Budgeted fixed overhead = $30,000 =- Unfavorable variance of $2,500, because we spent more than budgeted Unfavorable variance of $2,500, because we spent more than budgeted Fixed Overhead Budget Variance

21. 17-21 The FIXED-OVERHEAD VOLUME VARIANCE is the difference between budgeted fixed overhead and actual fixed overhead. Assume that the predetermined fixed overhead per machine hour = $5 and that it is based on 4,500 machine hours. The FIXED-OVERHEAD VOLUME VARIANCE is the difference between budgeted fixed overhead and actual fixed overhead. Assume that the predetermined fixed overhead per machine hour = $5 and that it is based on 4,500 machine hours. Fixed-overhead volume variance Budgeted fixed overhead Applied fixed overhead =- Applied fixed overhead = $22,500 Fixed-overhead volume variance Budgeted fixed overhead = $30,000 = - Variance = $7,500 U, because we produced less than budgeted. Fixed Overhead Volume Variance

22. 17-22 Budget Variance Volume Variance The real control variance for fixed overhead because it compares actual expenditures with budgeted fixed overhead costs The real control variance for fixed overhead because it compares actual expenditures with budgeted fixed overhead costs Reconciles the two different purposes of the cost accounting system Reconciles the two different purposes of the cost accounting system For cost-management purposes, the cost- accounting system recognizes that fixed overhead does not change as production activity varies For cost-management purposes, the cost- accounting system recognizes that fixed overhead does not change as production activity varies For product-costing purposes, budgeted fixed overhead is divided by planned activity to obtain a predetermined or standard fixed- overhead rate For product-costing purposes, budgeted fixed overhead is divided by planned activity to obtain a predetermined or standard fixed- overhead rate Managerial Interpretation Of Fixed-Overhead Variances

23. 17-23 (1) Actual fixed O/H (1) Actual fixed O/H (2) Budgeted fixed O/H (2) Budgeted fixed O/H (3) Fixed overhead applied to work in process (3) Fixed overhead applied to work in process Standard allowed machine hours Standard allowed machine hours Standard fixed overhead rate Standard fixed overhead rate X X 4,500 machine hrs $5.00 per machine hr $5.00 per machine hr X X $30,000$32,500 Fixed-overhead budget variance = $2,500 U Fixed-overhead volume variance = $7,500 U $22,500 Fixed Overhead Budget And Volume Variances Exh. 17-8

24. 17-24 Fixed overhead $30,000 $22,500 0 Applied fixed overhead ($5.00 per standard allowed machine hour) Budgeted fixed overhead Machine hours Volume variance $7,500 4,500 Standard allowed hours, given actual output 6,000 Planned monthly activity Applied fixed overhead in June Budgeted Versus Applied Fixed Overhead Exh. 17-9

25. 17-25 4-, 3-, & 2-way Variance Analysis Four-way analysis Three-way analysis Two-way analysis Variable- overhead spending variance Fixed- overhead budget variance Variable- overhead efficiency variance Fixed- overhead volume variance $1,680 U$2,500 U$1,800 U$7,500 U Combined spending variance $4,180 U$1,800 U$7,500 U $5,980 U Combined budget variance Underapplied overhead $7,500 U $62,980 actual overhead - overhead applied to WIP, 49,500 = $13,480 Exh. 17-10

26. 17-26 Using The Overhead Cost Performance Report In Cost Management An Overhead Cost Performance Report Shows the fixed overhead budget variance,along with the actual and budgeted cost for each fixed overhead item. Shows the variable overhead spending and efficiency variances, along with the actual and budgeted cost for each variable overhead item. The report would be used by management to exercise control over each of the overhead costs.

27. 17-27 Manufacturing Overhead Actual $62,980$49,500 Applied Credit: Indirect-material inventory Wages payable Utilities payable Accumulated depreciation Prepaid insurance and property taxes Engineering salaries payable 19,350 32,610 2,170 1,300 1,050 6,500 Debit: Work-in-process inventory Applied overhead: $11.00 (predetermined overhead rate) X 4,500 (standard allowed hours $49,500 $13,480 Debit: Cost of goods sold $13,480 Using Standard Costs In Product Costing

28. 17-28 An activity-based flexible budget may provide more useful cost management information than a conventional flexible budget An activity-based flexible budget may provide more useful cost management information than a conventional flexible budget The traditional budget Activity-based flexible budget Costs are categorized as variable based on volume measures Costs are categorized as variable based on volume measures Machine hours Machine hours Direct labor hours Direct labor hours Costs are categorized as variable based on several cost drivers Costs are categorized as variable based on several cost drivers Cost that may seem fixed with respect to a single volume-based cost driver may be variable with respect to other non-volume related cost drivers Cost that may seem fixed with respect to a single volume-based cost driver may be variable with respect to other non-volume related cost drivers Activity-Based Flexible Budget

29. 17-29 End of Chapter 17 I wish I could figure out how to …….. my paycheck!