Chapter 11

Flexible Budgets and Overhead Analysis

11/24/03

Static Budgets and Performance Reports

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.
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Hmm! Comparing static budgets with actual costs is like comparing apples and oranges.

Lets look at CheeseCo.

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Static Budgets and Performance Reports

CheeseCo

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The McGraw-Hill Companies, Inc., 2003

Static Budgets and Performance Reports

CheeseCo

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Static Budgets and Performance Reports

CheeseCo

U = Unfavorable variance CheeseCo was unable to achieve the budgeted level of activity.

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Static Budgets and Performance Reports

CheeseCo

F = Favorable variance that occurs when actual costs are less than budgeted costs.

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Static Budgets and Performance Reports

CheeseCo

Since cost variances are favorable, have we done a good job controlling costs?

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Static Budgets and Performance Reports

I dont think I can answer the question using a static budget. Actual activity is below budgeted activity.

So, shouldnt variable costs be lower if actual activity is lower?

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Static Budgets and Performance Reports

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.
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Flexible Budgets
Show revenues and expenses that should have occurred at the actual level of activity. May be prepared for any activity level in the relevant range. Reveal variances due to good cost control or lack of cost control. Improve performance evaluation.

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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

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Preparing a Flexible Budget

CheeseCo
Cost Formula Per Hour Machine hours Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs
McGraw-Hill/Irwin

Total Fixed Cost

Flexible Budgets 8,000 10,000 Hours Hours 8,000 10,000

12,000 Hours 12,000

4.00 3.00 0.50 7.50

Variable costs are expressed as $ 32,000 amount per hour. a constant

24,000 $40,000 4,000 10,000 hours $ 60,000 $4.00 per hour. $12,000 2,000

is

Fixed costs are expressed as a total amount.

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Preparing a Flexible Budget

CheeseCo
Cost Formula Per Hour Machine hours Variable costs Indirect labor Indirect material Power Total variable cost 4.00 3.00 0.50 7.50 Total Fixed Cost Flexible Budgets 8,000 10,000 Hours Hours 8,000 $ 32,000 24,000 4,000 $ 60,000 10,000 12,000 Hours 12,000

Fixed costs Depreciation $4.00 Insurance Total fixed cost Total overhead costs
McGraw-Hill/Irwin

per hour 8,000 hours = $32,000 $12,000

2,000

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Preparing a Flexible Budget

CheeseCo
Cost Formula Per Hour Machine hours Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs
McGraw-Hill/Irwin

Total Fixed Cost

Flexible Budgets 8,000 10,000 Hours Hours 8,000 10,000

12,000 Hours 12,000

4.00 3.00 0.50 7.50 $12,000 2,000

$ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000

?
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Preparing a Flexible Budget

CheeseCo
Cost Formula Per Hour Machine hours Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs
McGraw-Hill/Irwin

Total Fixed Cost

Flexible Budgets 8,000 10,000 Hours Hours 8,000 10,000 $ 40,000 30,000 5,000 $ 75,000 $ 12,000 2,000 $ 14,000 $ 89,000

12,000 Hours 12,000

4.00 $ 32,000 3.00 fixed costs 24,000 Total 0.50 do not change 4,000 in $ 7.50 $ 60,000

the relevant range.

$12,000 2,000

$ 12,000 2,000 $ 14,000 $ 74,000

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Preparing a Flexible Budget

CheeseCo
Cost Formula Per Hour Machine hours Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs
McGraw-Hill/Irwin

Total Fixed Cost

Flexible Budgets 8,000 10,000 Hours Hours 8,000 10,000 $ 40,000 30,000 5,000 $ 75,000 $ 12,000 2,000 $ 14,000 $ 89,000

12,000 Hours 12,000 $ 48,000 36,000 6,000 $ 90,000 $ 12,000 2,000 $ 14,000 $ 104,000

4.00 3.00 0.50 7.50 $12,000 2,000

$ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000

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Flexible Budget Performance Report

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Flexible Budget Performance Report

CheeseCo Flexible budget is prepared for the Cost Total Formula Fixed Flexible same activity level Per Hour Costs Budget (8,000 hours) as Machine hours 8,000 actually achieved.
Variable costs Indirect labor Indirect material Power Total variable costs Fixed Expenses Depreciation Insurance Total fixed costs Total overhead costs
McGraw-Hill/Irwin

Actual Results 8,000 $ 34,000 25,500 3,800 $ 63,300

Variances 0

4.00 3.00 0.50 7.50 $ 12,000 2,000

$ 12,000 2,050 $ 14,050 $ 77,350

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Flexible Budget Performance Report

CheeseCo
Cost Formula Per Hour Machine hours Total Fixed Costs Flexible Budget 8,000 $ 4.00 3.00 0.50 7.50 $ 12,000 2,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000 Actual Results 8,000 $ 34,000 25,500 3,800 $ 63,300 $ 12,000 2,050 $ 14,050 $ 77,350 Variances 0 $ 2,000 U 1,500 U 200 F $ 3,300 U 0 50 U 50 U $ 3,350 U

Variable costs Indirect labor Indirect material Power Total variable costs Fixed Expenses Depreciation Insurance Total fixed costs Total overhead costs
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Flexible Budget Performance Report

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Static Budgets and Performance

How much of the $11,650 is due to activity and how much is due to cost control?
Static Budget Machine hours 10,000 $ 40,000 30,000 5,000 12,000 2,000 $ 89,000 Actual Results 8,000 $ 34,000 25,500 3,800 12,000 2,050 $ 77,350 Variances 2,000 U $6,000 F 4,500 F 1,200 F 0 50 U $11,650 F

Variable costs Ind irect labor Indirect materials Power

Fixed costs Depreciation Insurance Total overhead costs
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Flexible Budget Performance Report

Overhead Variance Analysis
Static Overhead Budget at 10,000 Hours $ 89,000

Lets place the flexible budget for 8,000 hours here.

Actual Overhead at 8,000 Hours $ 77,350

Difference between original static budget and actual overhead = $11,650 F.

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Flexible Budget Performance Report

Overhead Variance Analysis
Static Overhead Budget at 10,000 Hours $ 89,000 Flexible Overhead Budget at 8,000 Hours $ 74,000 Actual Overhead at 8,000 Hours $ 77,350

Activity This $15,000F variance is due to lower activity.

Cost control This $3,350U flexible budget variance is due to poor cost control.
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McGraw-Hill/Irwin

Flexible Budget Performance Report

There are two primary reasons for unfavorable variable overhead variances: What causes the cost control variance? 1. Spending too much for resources. 2. Using the resources inefficiently.

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End of Chapter 11

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