Cornerstones

of Managerial Accounting 3e
MOWEN / HANSEN / HEITGER
COPYRIGHT 2009 South-Western/Cengage Learning

Chapter Eleven Flexible Budgets and Overhead Analysis

Learning Objectives
1. Prepare a flexible budget, and use it for performance reporting. 2. Calculate the variable overhead variances, and explain their meaning. 3. Calculate the fixed overhead variances, and explain their meaning. 4. Prepare an activity-based flexible budget.
3

OBJECTIVE 1
Prepare a flexible budget, and use it for performance reporting.

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

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

Cornerstone 11-1
HOW TO Prepare a Performance Report Based on a Static Budget (Using Budgeted Production)

Example
Information:
From the Master Budget Production for Quarter 1: 1,060 Materials: 1 plain t-shirt @ $3.00 5 ounces of ink @ $0.20 Labor: 0.12 hours @ $10.00 Variable overhead: Maintenance: 0.12 hour @ $3.75 Power: 0.12 hour @ $1.25 Fixed overhead: Grounds keeping: $1,200 per qtr Depreciation: $600 per quarter Actual Data for Quarter 1 Production: 1,200 units Materials cost: $4,380 Labor cost: $1,500 Maintenance cost: $535 Power cost: $170 Grounds keeping: $1,050 Depreciation: $600

Example
Required: Prepare a performance report using a budget based on expected production.

Performance Report Example

Budgeted
Units produced 1,060

The plan is to produce 1,060 units. All budgeted costs will be based on 1,060 units.

Performance Report Example

Budgeted
Units produced Direct materials cost 1,060 $4,240

($3.00 t-shirt + $1.00 ink) x 1,060 units

Performance Report Example

Budgeted
Units produced Direct materials cost Direct labor cost 1,060 $4,240 1,272

(0.12 hours x $10.00 per hour) x 1,060 units

Performance Report Example

Budgeted
Units produced Direct materials cost Direct labor cost Variable overhead: Maintenance 1,060 $4,240 1,272

477

(0.12 hours x $3.75 per hour) x 1,060 units

Performance Report Example

Budgeted
Units produced Direct materials cost Direct labor cost Variable overhead: Maintenance Power 1,060 $4,240 1,272

477 159

(0.12 hours x $1.25 per hour) x 1,060 units

Performance Report Example

Budgeted
Units produced Direct materials cost Direct labor cost Variable overhead: Maintenance Power Fixed overhead: Grounds keeping Depreciation 1,060 $4,240 1,272
Grounds keeping and depreciation are both fixed costs. They will be $1,200 and $600 regardless of the number of units produced.

477 159
1,200 600

Performance Report Example

Budgeted
Units produced Direct materials cost Direct labor cost Variable overhead: Maintenance Power Fixed overhead: Grounds keeping Depreciation Total 1,060 $4,240 1,272

477 159
1,200 600 $7,948

Total budgeted costs for 1,060 units

Performance Report Example

Actual
Units produced Direct materials cost Direct labor cost Variable overhead: Maintenance Power Fixed overhead: Grounds keeping Depreciation Total 1,200

Budgeted
1,060 $4,240 1,272

Variance
140 F

477 159
1,200 600 $7,948

140 more units were produced than originally budgeted

Performance Report Example

Actual
Units produced Direct materials cost Direct labor cost Variable overhead: Maintenance Power Fixed overhead: Grounds keeping Depreciation Total 1,200 $4,830 1,500 535 170 1,050

Budgeted
1,060 $4,240 1,272

Variance
140 F $590 U 228 U 58 U 11 U (150) F
Grounds keeping costs were lower than predicteda favorable variance!

477 159
1,200 600 $7,948

Performance Report Example

Actual
Units produced Direct materials cost Direct labor cost Variable overhead: Maintenance Power Fixed overhead: Grounds keeping Depreciation Total 1,050 600 1,200 600 $7,948 535 170 477 159 58 U Budgeted 1,060 $4,240 1,272 Variance 140 F $590 U 228 U

1,200
$4,830 1,500

11 U

(150) F
0 $737 U

$8,685

Overall, actual costs exceeded budgeted costs by $737. Budgeted costs were based on 1,060 units and 1,200 units were actually produced.

Flexible Budget
Enables a firm to compete 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

Cornerstone 11-2
HOW TO Prepare a Flexible Production Budget

21

Example
Information: Levels of output: 1,000, 1,200 and 1,400 Materials (1 plain t-shirt @ $3.00 & 5 ounces of ink
@ $0.20)

Labor: 0.12 hour @ $10.00 per hour Variable overhead:

Maintenance: 0.12 hours @ $3.75 per hour Power: 0.12 hours @ $1.25 per hour

Fixed overhead: Grounds keeping: $1,200 per

quarter & Depreciation: $600 per quarter

Example
Required: Prepare a budget for three levels of output: 1,000, 1,200 and 1,400 units

Flexible Budget
Variable cost Range of Production (units) Production per unit 1,400 costs 1,200 1,000 Variable: $4.00 Direct materials

$3.00 t-shirt and $1.00 of ink

Flexible Budget
Variable cost Range of Production (units) Production per unit 1,400 costs 1,200 1,000 Variable: $4.00 $4,000 $4,800 $5,600 Direct materials

$4 x # of units

Flexible Budget
Variable cost Range of Production (units) Production per unit 1,400 costs 1,200 1,000 Variable: $4.00 $4,000 $4,800 $5,600 Direct materials 1.20 Direct labor

0.12 hours $10 per hour

Flexible Budget
Variable cost Range of Production (units) Production per unit 1,400 costs 1,200 1,000 Variable: $4.00 $4,000 $4,800 $5,600 Direct materials 1,200 1,440 1,680 1.20 Direct labor

$1.20 # of units

Flexible Budget
Variable cost Range of Production (units) Production per unit 1,400 costs 1,200 1,000 Variable: $4.00 $4,000 $4,800 $5,600 Direct materials 1,200 1,440 1,680 1.20 Direct labor Variable overhead: 540 630 0.45 450 Maintenance 0.12 hours $3.75 per hour

Flexible Budget
Variable cost Range of Production (units) Production per unit 1,400 costs 1,200 1,000 Variable: $4.00 $4,000 $4,800 $5,600 Direct materials 1,200 1,440 1,680 1.20 Direct labor Variable overhead: 540 630 0.45 450 Maintenance 210 0.15 150 Power 180 0.12 hours $1.25 per hour

Flexible Budget
Variable cost Range of Production (units) Production per unit 1,400 costs 1,200 1,000 Variable: $4.00 $4,000 $4,800 $5,600 Direct materials 1.20 Direct labor 1,200 1,440 1,680 Variable overhead: 630 540 0.45 450 Maintenance 210 0.15 150 Power 180 $5,800 $6,960 $8,120 $5.80 Total variable costs Fixed overhead: 1,200 Grounds keeping 1,200 1,200 Depreciation 600 600 600
Fixed costs do no change when levels of output change

Flexible Budget continued

Variable cost Range of Production (units) Production per unit 1,400 costs 1,200 1,000 Fixed overhead: Grounds keeping 1,200 1,200 1,200 Depreciation 600 600 600 Total fixed costs $1,800 $1,800 $1,800 Total production costs $7,600 $8,760 $9,920

Cornerstone 11-3
HOW TO Prepare a Performance Report using a Flexible Budget

32

Example
Information:
Budgeted Costs
Direct Materials: $4 per unit Direct Labor: $1.20 per unit Variable overhead: Maintenance: $0.45 per unit Power: $0.15 per unit Fixed overhead: Grounds keeping: $1,200 per qtr Depreciation: $600 per quarter Grounds keeping: $1,050 Depreciation: $600 Maintenance cost: $535 Power cost: $170

Actual Costs @ 1200 units

Direct Materials: $4,830 Direct Labor: $1,500

Example
Required: Prepare a performance report using budgeted costs for the actual level of activity.

Performance Report Example

Actual
Units produced 1,200

Budgeted
1,200

Variance

Budgeted costs are based on actual units produced

Performance Report Example

Actual
Units produced Direct materials 1,200 $4,830

Budgeted
1,200 $4,800

Variance
$ 30 U

Direct materials costs to produce 1,200 units were $30 higher than expected

Performance Report Example

Actual
Units produced Direct materials cost Direct labor cost Variable overhead: Maintenance Power Total variable costs Fixed overhead: Grounds keeping Depreciation Total fixed costs Total production costs 1,200 $4,830 1,500 535 170 $7,035 $1,050 600 $1,650 $8,685

Budgeted
1,200 $4,800 1,440

Variance
$30 U 60 U (5) U (10) U $ 75 U $(150) F 0 $(150) F $ (75) F

540 180 $6,960

$1,200 600 $1,800 $7,948

OBJECTIVE 2
Calculate the variable overhead variances and explain their meaning.

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

Cornerstone 11-4
HOW TO Calculate the Total Variable Overhead Variance

40

Example
Information: Standard variable overhead rate (SVOR) $5.00 per direct labor hour Actual variable overhead costs
Actual direct labor hours (AH) = 150 hours Actual Variable Overhead Rate (AVOR) $4.70 per hour

Standard hours (SH) allowed per unit 0.12 hour Actual production 1,200 units

Example
Required:

Calculate the total variable overhead variance.

Total Variable Overhead Variance

Actual Costs (AH AVOR)
Actual Hours Actual Variable Overhead Rate

Applied Costs = Total Variance

Total Variable Overhead Variance

Actual Costs (AH AVOR) Applied Costs = Total Variance

$705
150 hours $4.70

Total Variable Overhead Variance

Actual Costs Applied Costs = Total Variance (AH AVOR) (SH SVOR)

$705

Hours allowed for production (SH) Standard Variable Overhead Rate (SVOR)

Total Variable Overhead Variance

Actual Costs Applied Costs = Total Variance (AH AVOR) (SH SVOR)

$705

$720

144 hours $5.00

Total Variable Overhead Variance

Actual Costs Applied Costs = Total Variance (AH AVOR) (SH SVOR)

$705

$720

$15

This is a favorable variance since actual costs were less than expected

Variable Overhead Spending Variance

Measures the aggregate effect of the differences between
Actual variable overhead (AVOR) Standard variable overhead rate (SVOR)

Two ways to calculate:

Three-pronged columnar approach Formula approach
(AVOR SVOR) AH

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

Cornerstone 11-5
HOW TO Calculate Variable Overhead Variances: Columnar and Formula Approaches

50

Example
Information:

Standard variable overhead rate (SVOR) $5.00 per direct labor hour Actual variable overhead rate (AVOR) $4.70 Actual hours worked (AH) 150 hours Number of tee shirts produced 1,200 units Hours allowed for production (SH) 144 hours

Example
Required: Calculate the variable overhead spending and efficiency variances.

Example
Columnar Approach
1. AH AVOR 150 $4.70 $705 Spending Variance (1 2) $45 F This is a favorable variance since the actual variable overhead rate was less than the expected rate 2. AH SVOR 150 $5.00 $750 3. SH SVOR 144 $5.00 $720

Example
Columnar Approach
1. AH AVOR 150 $4.70 $705 Spending Variance (1 2) $45 F 2. AH 3. SH SVOR SVOR 144 $5.00 $720 150 $5.00 $750 Efficiency Variance (2 3) $30 U

This is an unfavorable variance since the actual hours exceeded budgeted hours

Example
Columnar Approach
1. AH AVOR 150 $4.70 $705 Spending Variance (1 2) $45 F
Total Variance (1 3) $15 F

2. AH x SVOR 150 x $5.00 $750

3. SH x SVOR 144 x $5.00 $720

Efficiency Variance (2 3) $30 U

Example
Formula Approach VOH spending variance

(AVOR

SVOR) AH

($4.70 - $5.00) 150

$45 Favorable

Example
Formula Approach VOH efficiency variance

(AH - SH) SVOR

(150 - 144) $5.00

$30 Unfavorable

Cornerstone 11-6
HOW TO Performance Report for the Variable Overhead Variances

58

Example
Information:

Standard variable overhead rate (SVOR) $5.00 per direct labor hour Actual costs: Maintenance $535 & Power $170 Actual hours worked (AH) 150 hours Number of t-shirts produced 1,200 units Hours allowed for production (SH) 144 hours Variable overhead: Maintenance 0.12 hour @
$3.75 & Power 0.12 hour @ $1.25

Example
Required: Prepare a performance report that shows the variances on an item-by-item basis.

Performance Report For the Quarter Ended March 31, 2010

Budget for Actual Spending Hours Variance
$562.50

Cost

Cost Formula $3.75

Actual Costs

Maintenance

$535

150 hours $3.75

Performance Report For the Quarter Ended March 31, 2010

Budget for Actual Spending Hours Variance
$562.50 $27.50 F

Cost

Cost Formula $3.75

Actual Costs

Maintenance

$535

$535 - $562.50

Performance Report (continued) For the Quarter Ended March 31, 2010
Budget for Actual Spending Hours Variance $27.50 F Budget for Standard Efficiency Hours Variance $540

Cost

Maintenance $562.50

144 $3.75

Performance Report (continued) For the Quarter Ended March 31, 2010
Budget for Actual Spending Hours Variance $27.50 F Budget for Standard Efficiency Hours Variance $540 $22.50 U

Cost

Maintenance $562.50

$562.50 - $540

Performance Report For the Quarter Ended March 31, 2010

Budget for Actual Spending Hours Variance
$562.50 187.50 $1.25 150 $27.50 U

Cost

Cost Formula $3.75 1.25

Actual Costs

Maintenance Power

$535 170

Performance Report For the Quarter Ended March 31, 2010

Budget for Actual Spending Hours Variance
$562.50 187.50 $170 - $187.50 $27.50 F 17.50 F

Cost

Cost Formula $3.75 1.25

Actual Costs

Maintenance Power

$535 170

Performance Report (continued) For the Quarter Ended March 31, 2010
Budget for Actual Spending Hours Variance $27.50 F 17.50 F Budget for Standard Efficiency Hours Variance $540 $22.50 U

Cost

Maintenance $562.50 Power 187.50

180

7.50 U

Performance Report For the Quarter Ended March 31, 2010

Budget for Actual Spending Hours Variance
$562.50 187.50 $750.00 $27.50 F 17.50 F $45.00 F

Cost

Cost Formula $3.75

Actual Costs

Maintenance Power

$535 170 $705

Total

1.25 $5.00

Performance Report (continued) For the Quarter Ended March 31, 2010
Budget for Actual Spending Hours Variance $27.50 F 17.50 F $45.00 F Budget for Standard Efficiency Hours Variance $540 180 $720 $22.50 U

Cost

Maintenance $562.50 Power

Total

187.50 $750.00

7.50 U $30.00 U

OBJECTIVE 3
Calculate the fixed overhead variances, and explain their meaning.

Total Fixed Overhead Variance

Difference between actual and applied fixed overhead
When applied overhead = standard fixed overhead rate standard hours allowed for the actual output

Broken down into:

Fixed Overhead Spending Variance Fixed Overhead Volume Variance

Cornerstone 11-7
HOW TO Calculate the Total Fixed Overhead Variance

72

Example
Information:

Standard fixed overhead rate (SFOR) $10.00 per direct labor hour Actual fixed overhead costs $1,650 Standard hours allowed per unit 0.12 hours Actual production 1,200 units

Example
Required:

Calculate the total fixed overhead variance.

Total Fixed Overhead Variance

Actual Costs AFOH Applied Costs = Total Variance (SH X SFOR)

$1605

$1,440

$210 U

This is an unfavorable variance since actual costs exceeded applied costs.

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

Fixed Overhead Volume Variance

Difference between
Budgeted fixed overhead (BFOH) Applied fixed overhead (ApFOH)

Two ways to calculate:

Three-pronged columnar approach Formula approach
(SHp SH) SFOR

Cornerstone 11-8
HOW TO Calculate Fixed Overhead Variances: Columnar and Formula Approaches

78

Example
Information:

Standard fixed overhead rate (SFOR) $10.00 per direct labor hour Budgeted fixed overhead (BFOH) $1,800 Number of t-shirts produced 1,200 units Hours allowed for production (SH) 144 hours

Example
Required:

Calculate the fixed overhead spending and volume variances.

Fixed Overhead Variances

Columnar Approach
1. Actual Fixed Overhead $1,650 Spending Variance (1 2) $150 F Total Variance (1 3) $210 U 2. SH SFOR 180 $10 $1,800 Volume Variance (2 3) $360 U 3. SHp SFOR 144 $10 $1,440

Example
Formula Approach Fixed Overhead (FOH) Volume Variance

AFOH

BFOH

$1,650 - $1,800

$150 Favorable

Example
Formula Approach Fixed Overhead (FOH) Efficiency Variance

(SHp SH) SFOR

(180 144) $10.00

$360 Unfavorable

OBJECTIVE 4
Prepare an activitybased flexible budget.

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

Cornerstone 11-9
HOW TO Prepare Static Budget for an Activity

86

Example
Information:

Demand for purchase orders based on materials requirements: 15,000 purchase orders Resources needed:
Five purchasing agents, each capable of processing 3,000 orders per year, salary, $40,000 each Supplies projected to cost $1.00 per purchase order Desks and computers: depreciation, $5,000 per year Office space, rent, and utilities, $6,000

Example
Required:

Prepare a budget for the purchasing activity.

Purchasing Budget
Salaries

$200,000

5 agents $40,000 per agent per year

Purchasing Budget
Salaries Depreciation Supplies

$200,000 5,000
15,000

$1.00 per purchase order 15,000 purchase orders

Purchasing Budget
Salaries Depreciation Supplies Occupancy Total

$200,000 5,000
15,000 6,000 $226,000

Cornerstone 11-10
HOW TO Prepare an Activity Flexible Budget

92

Example
Information:

The individual activities, drivers, their cost formulas, and the output levels are the inputs needed to prepare the budget. For example:
Activity: Maintenance Driver: Machine hours Fixed activity cost: $20,000 Variable activity rate: $5.50 per machine hour

Example
Required:

Prepare an activity-based flexible budget.

Activity-Based Flexible Budget

Formula Fixed Variable Driver: Direct Labor Hours Direct materials Level of Activity 20,000 10,000

Direct labor Subtotal

Driver: Machine Hours

$ ----$ 0

$ 10 8 $ 18

$100,000 $200,000 80,000 160,000 $180,000 $360,000

Fixed Maintenance Machining Subtotal

Variable

8,000

16,000

$20,000 15,000 $35,000

$ 5.50 2.00 $ 7.50

$64,000 $108,000 31,000 47,000 $95,000 $155,000

Activity-Based Flexible Budget continued

Formula Driver: Number of Setups Fixed Setups Inspections Subtotal Driver: Number of Orders Fixed Purchasing Variable 15,000 30,000 Variable 25 30 Level of Activity

$ ---$ 1,800 2,100 80,000 $80,000 $3,900

$ 45,000 $ 54,000 132,500 143,000 $177,500 $197,000

$211,500

$226,000 $236,000

Cornerstone 11-11
HOW TO Prepare an Activity-Based Performance Report

97

Example
Information: Actual Costs Actual Activity Level Direct materials Direct labor Maintenance Machining Inspections Setups Purchasing $101,000 $80,000 $55,000 $29,000 $125,500 $46,500 $220,000 10,000 10,000 8,000 8,000 25 25 15,000

Example
Required:

Prepare an activity-based performance report.

Activity-Based Performance Report

Actual Costs Budgeted Costs Budget Variance

Direct materials $101,000 $100,000 $ 1,000 U 80,000 80,000 Direct labor ---55,000 64,000 9,000 F Maintenance Machining 29,000 2,000 F 31,000 Inspections 132,500 125,500 7,000 F 1,500 U 46,500 45,000 Setups 226,000 6,000 F Purchasing 220,000 $657,000 $678,500 $21,500 F Total