1. 1 Copyright © 2008 Cengage Learning South-Western. Heitger/Mowen/Hansen Flexible Budgets and Overhead Analysis Chapter Nine Cornerstones of Managerial Accounting 2e

2. 2 Objective # 1 Prepare a flexible budget, and use it for performance reporting.

3. 3 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

4. 4 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

5. 5 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

6. 6 Objective # 2 Calculate the variable overhead variances and explain their meaning

7. 7 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 ∙Broken further into: ▫Fixed Overhead Spending Variance ▫Fixed Overhead Volume Variance

8. 8 Total Variable Overhead Variance Actual CostsApplied CostsTotal Variance –= (AH X AVOR)–(SH X SVOR) Hours allowed for production (SH) x Standard Variable Overhead Rate (SVOR) Actual Hours x Actual Variable Overhead Rate

9. 9 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

10. 10 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

11. 11 Example VOH spending variance (AVOR – SVOR)AH Formula Approach:

12. 12 Example VOH efficiency variance (AH – SH) SVOR Formula Approach:

13. 13 Objective # 3 Calculate the fixed overhead variances, and explain their meaning

14. 14 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

15. 15 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

16. 16 Fixed Overhead Volume Variance Difference between ◦Budgeted fixed overhead (BFOH) ◦Applied fixed overhead (ApFOH) Two ways to calculate: ◦Three-pronged columnar approach ◦Formula approach ∙(SH p – SH)SFOR

17. 17 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

18. 18 Example Fixed Overhead (FOH) Volume Variance AFOH – BFOH Formulas:

19. 19 Example Fixed Overhead (FOH) Efficiency Variance (SH p - SH) SFOR Formulas:

20. 20 Objective # 4 Prepare an activity-based flexible budget.

21. 21 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