flexible budgets and overhead analysis 11/30/04 chapter 11
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Flexible Budgets and Overhead Analysis
11/30/04
Chapter 11
© The McGraw-Hill Companies, Inc., 2003McGraw-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! Comparingstatic budgets withactual costs is likecomparing apples
and oranges.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Static Budgets and Performance Reports
CheeseCo
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Static Budgets and Performance Reports
CheeseCo
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Static Budgets and Performance Reports
U = Unfavorable variance CheeseCo was unable to achieve
the budgeted level of activity.
CheeseCo
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Static Budgets and Performance Reports
CheeseCo
F = Favorable variance that occurs when actual costs are less than budgeted costs.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Static Budgets and Performance Reports
Since cost variances are favorable, havewe done a good job controlling costs?
CheeseCo
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Static Budgets and Performance Reports
I don’t think Ican answer thequestion usinga static budget.
Actual activity is belowbudgeted activity.
So, shouldn’t variable costsbe lower if actual activity
is lower?
© The McGraw-Hill Companies, Inc., 2003McGraw-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 mustthe budget to theactual 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 mustthe budget to theactual level of activity.
Static Budgets and Performance Reports
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Flexible Budgets
Improve performance evaluation.
May be prepared for any activity level in the relevant range.
Show revenues and expensesthat should have occurred at theactual level of activity.
Reveal variances due to good costcontrol or lack of cost control.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Flexible Budgets
Central Concept
If you can tell me what your activity wasfor the period, I will tell you what your costs
and revenue should have been.
© The McGraw-Hill Companies, Inc., 2003McGraw-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 remainunchanged within therelevant range. Fixed
Variable
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Preparing a Flexible BudgetCheeseCo
Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ Indirect material 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$
Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs
Fixed costs areexpressed as atotal amount.
Variable costs are expressed as a constant amount per hour,
using static budget data.
$40,000 ÷ 10,000 hours is$4.00 per hour.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ Indirect material 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$
Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs
Preparing a Flexible Budget
$4.00 per hour × 8,000 hours = $32,000
CheeseCo
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Preparing a Flexible Budget
Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ Indirect material 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$
Fixed costs Depreciation 12,000$ 12,000$ Insurance 2,000 2,000 Total fixed cost 14,000$ Total overhead costs 74,000$ ?
CheeseCo
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Preparing a Flexible Budget
Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ 40,000$ Indirect material 3.00 24,000 30,000 Power 0.50 4,000 5,000 Total variable cost 7.50$ 60,000$ 75,000$
Fixed costs Depreciation 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$
CheeseCo
Total fixed costsdo not change in
the relevant range.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Preparing a Flexible Budget
Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ 40,000$ 48,000$ Indirect material 3.00 24,000 30,000 36,000 Power 0.50 4,000 5,000 6,000 Total variable cost 7.50$ 60,000$ 75,000$ 90,000$
Fixed costs Depreciation 12,000$ 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ 104,000$
CheeseCo
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Let’s prepare a budget performance report for CheeseCo.
Flexible BudgetPerformance Report
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Flexible BudgetPerformance Report
Cost TotalFormula Fixed Flexible ActualPer Hour Costs Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs Indirect labor 4.00$ 34,000$ Indirect material 3.00 25,500 Power 0.50 3,800 Total variable costs 7.50$ 63,300$ Fixed Expenses Depreciation 12,000$ 12,000$ Insurance 2,000 2,050 Total fixed costs 14,050$ Total overhead costs 77,350$
Flexible budget is prepared for the
same activity level (8,000 hours) as
actually achieved.
CheeseCo
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Cost TotalFormula Fixed Flexible ActualPer Hour Costs Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 24,000 25,500 1,500 U Power 0.50 4,000 3,800 200 FTotal variable costs 7.50$ 60,000$ 63,300$ $ 3,300 UFixed Expenses Depreciation 12,000$ 12,000$ 12,000$ 0 Insurance 2,000 2,000 2,050 50 UTotal fixed costs 14,000$ 14,050$ 50 UTotal overhead costs 74,000$ 77,350$ $ 3,350 U
Flexible BudgetPerformance Report
CheeseCo
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Static ActualBudget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs Ind irect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,050 50 U
Total overhead costs 89,000$ 77,350$ $11,650 F
Static Budgets and Performance How much of the $11,650 is due to activity
and how much is due to cost control?
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Flexible BudgetPerformance Report
Difference between original static budgetand actual overhead = $11,650 F.
Overhead Variance Analysis
Static ActualOverhead OverheadBudget at at
10,000 Hours 8,000 Hours
89,000$ 77,350$
Let’s place the flexible budget for
8,000 hours here.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Flexible BudgetPerformance Report
Overhead Variance Analysis
This $15,000F variance is due to lower activity.
Activity
This $3,350U flexiblebudget variance is dueto poor cost control.
Cost control
Static Flexible ActualOverhead Overhead OverheadBudget at Budget at at
10,000 Hours 8,000 Hours 8,000 Hours
89,000$ 74,000$ 77,350$
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Flexible BudgetPerformance Report
What causesthe cost
control variance?
There are two primaryreasons for unfavorablevariable overhead variances:
1. Spending too much for resources.
2. Using the resources inefficiently.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
End of Chapter 11