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How to Implement a Flexible Budget

To compute variances that can help you understand why actual results differed from your expectations, creating a
flexible budget is helpful. A flexible budget adjusts the master budget for your actual sales or production volume.
For example, your master budget may have assumed that you’d produce 5,000 units; however, you actually produce
5,100 units. The flexible budget rearranges the master budget to reflect this new number, making all the appropriate
adjustments to sales and expenses based on the unexpected change in volume.
To prepare a flexible budget, you need to have a master budget, really understand cost behavior, and know the actual
volume of goods produced and sold.
Consider Kira, president of the fictional Skate Company, which manufactures roller skates. Kira’s accountant, Steve,
prepared the overhead budget shown.

Skate had a great year; actual sales came to 125,000 units. However, much to the disappointment of Steve and Kira,
the overhead budget report reported major overruns. For each category of overhead, Steve computed a variance,
identifying unfavorable variances in indirect materials, indirect labor, supervisory salaries, and utilities.

000 units to the $50. In other words. assuming that the company makes 130. such as indirect materials.000.000 units to 125. On the other hand. rent. and utilities are variable costs. the more materials you need.000 units.Skate’s total overhead exceeded budget by $25. some overhead costs. no matter how many units you make. Steve made the elementary mistake of treating variable costs as fixed.000 actual cost of making 125. . these variable costs should also increase. appear to be variable costs. an analysis indicates that indirect materials. You’re comparing apples and oranges.000 units. such as rent.000 budgeted cost of making just 100. Separate fixed and variable costs Some costs are variable — they change in response to activity levels — while other costs are fixed and remain the same. portions of overhead. are fixed. comparing the $60. indirect labor.000 units makes no sense. On the other hand. For Skate. supervisory salaries.000 units. Steve recomputes variable costs with the assumption that the company makes 125. think about the nature of the cost. these costs stay the same. If Skate increased production from 100. and depreciation are fixed. To determine whether a cost is variable or fixed. For example. Instead. direct materials are variable costs because the more goods you make. Steve should flex the budget to determine how much overhead he should have. After all.

$0. Dividing total cost of each category by the budgeted production level results in variable cost per unit of $0. Compare the flexible budget to actual results The next step is to combine the variable and fixed costs in order to prepare a new overhead budget report. multiply the variable cost per unit by the actual production volume. .000.In the original budget.000 units x $1.500 (125.000 units resulted in total variable costs of $130. and $0.000 should total $162.40 for indirect labor.40 for utilities.50 for indirect materials. To compute the value of the flexible budget. inserting the new flexible budget results into the overhead budget report. Here. the figure indicates that the variable costs of producing 125. making 100.30).

What Is Overhead Variance? . Skate’s variance is suddenly favorable. Actual overhead of $355.500 flexible budget.Look at that! After you adjust for the change in production level.000 was $7.500 less than the $362.

such as targeted profits. It is favorable when the actual units produced are more than the budgeted units and adverse when the number of units produced are less than the budgeted.Managers acknowledge that it is impossible to exactly attain budgeted estimates. Actual overhead variances are those that have been incurred and can be known at the end of a particular accounting period after the accounts have been prepared. The variance can be favorable or adverse. Fixed Volume Overhead Variance It measures the difference between the budgeted and the actual level of activity valued at the standard fixed cost per unit. A variance is a difference between the actual figures and budgeted estimates. The fixed overhead volume variance is obtained by subtracting actual units produced from budgeted units and then multiplying the result with standard fixed cost per unit. Overhead variance arises due to the differences between actual overhead variances and the budgeted or the absorbed variances. which is the standard overhead absorption rate. It can also be obtained by subtracting actual hours incurred in production from the budgeted hours and then multiplying the result with the standard fixed cost per hour. Absorbed overheads are overheads charged to a product based on a predetermined overhead rate. The standard fixed cost per unit is obtained by dividing the budgeted fixed overhead by the budgeted production. .

. It is calculated by deducting the actual variable overhead incurred from a product of standard variable overhead rate and actual hours incurred. It arises due to changes in the cost of fixed overhead during the period. efficiency or inefficiency in the use of the variable overhead.Fixed Expenditure Overhead Variance This is the difference between the budgeted fixed overhead expenditure and the actual fixed overhead incurred. and then multiplying the result with the standard variable overhead rate. Fixed overhead expenditure variance is calculated by subtracting the actual fixed overhead cost from the budgeted fixed overhead cost. Variable overhead efficiency variance is calculated by subtracting the standard budgeted hours from the actual hours incurred. It arises due to a fall or rise in overhead spending due to unexpected changes in prices. It can be favorable when the budgeted fixed overhead is less than the actual fixed overhead or adverse when the actual costs are more than the budgeted. Variable Efficiency Overhead Variance  This is the difference between the actual and budgeted variable overhead costs that result from inefficient use of indirect materials and indirect labor. A favorable variance results when the actual hours used are less than the budgeted while an adverse variance results from use of more hours than the budgeted. inaccurate estimates of one or more items containing variable overhead and inadequate control of an item of an overhead cost.  Variable Overhead Expenditure Variance  This compares the actual variable overhead for production achieved with the budgeted.