2. Flexible Budgets and Overhead Analysis 11/30/04 Chapter 11

3. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Static Budgets and Performance Reports Let’s look at CheeseCo. 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.

4. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Static Budgets and Performance Reports CheeseCo

5. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Static Budgets and Performance Reports CheeseCo

6. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Static Budgets and Performance Reports U = Unfavorable variance CheeseCo was unable to achieve the budgeted level of activity. CheeseCo

7. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Static Budgets and Performance Reports CheeseCo F = Favorable variance that occurs when actual costs are less than budgeted costs.

8. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Static Budgets and Performance Reports Since cost variances are favorable, have we done a good job controlling costs? CheeseCo

9. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin 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?

10. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin 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. 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. Static Budgets and Performance Reports

11. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Flexible Budgets Improve performance evaluation. May be prepared for any activity level in the relevant range. Show revenues and expenses that should have occurred at the actual level of activity. Reveal variances due to good cost control or lack of cost control.

12. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Flexible Budgets Central Concept If you can tell me what your activity was for the period, I will tell you what your costs and revenue should have been.

13. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin 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

14. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Preparing a Flexible Budget CheeseCo Fixed costs are expressed as a total amount. Variable costs are expressed as a constant amount per hour, using static budget data. $40,000 ÷ 10,000 hours is $4.00 per hour.

15. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Preparing a Flexible Budget $4.00 per hour × 8,000 hours = $32,000 CheeseCo

16. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Preparing a Flexible Budget CostTotal Flexible Budgets FormulaFixed8,00010,00012,000 Per HourCostHours Machine hours8,000 10,000 12,000 Variable costs Indirect labor4.00 32,000$ Indirect material3.00 24,000 Power0.50 4,000 Total variable cost7.50$ 60,000$ Fixed costs Depreciation12,000$ $ Insurance2,000 Total fixed cost14,000$ Total overhead costs74,000$ ? CheeseCo

17. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Preparing a Flexible Budget CostTotal Flexible Budgets FormulaFixed8,00010,00012,000 Per HourCostHours Machine hours8,000 10,000 12,000 Variable costs Indirect labor4.00 32,000$ 40,000$ Indirect material3.00 24,000 30,000 Power0.50 4,000 5,000 Total variable cost7.50$ 60,000$ 75,000$ Fixed costs Depreciation12,000$ $ $ Insurance2,000 Total fixed cost14,000$ $ Total overhead costs74,000$ 89,000$ CheeseCo Total fixed costs do not change in the relevant range.

18. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Preparing a Flexible Budget CostTotal Flexible Budgets FormulaFixed8,00010,00012,000 Per HourCostHours Machine hours8,000 10,000 12,000 Variable costs Indirect labor4.00 32,000$ 40,000$ 48,000$ Indirect material3.00 24,000 30,000 36,000 Power0.50 4,000 5,000 6,000 Total variable cost7.50$ 60,000$ 75,000$ 90,000$ Fixed costs Depreciation12,000$ $ $ $ Insurance2,000 Total fixed cost14,000$ $ $ Total overhead costs74,000$ 89,000$ 104,000$ CheeseCo

19. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Let’s prepare a budget performance report for CheeseCo. Flexible Budget Performance Report

20. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Flexible Budget Performance Report

21. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Flexible Budget Performance Report CheeseCo

22. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Static Budgets and Performance How much of the $11,650 is due to activity and how much is due to cost control?

23. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin 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.

24. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Flexible Budget Performance Report Overhead Variance Analysis This $15,000F variance is due to lower activity. Activity This $3,350U flexible budget variance is due to poor cost control. Cost control

25. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Flexible Budget Performance Report What causes the cost control variance? There are two primary reasons for unfavorable variable overhead variances: 1. Spending too much for resources. 2. Using the resources inefficiently.

26. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin End of Chapter 11