Flexible Budgeting and Analysis of Overhead Costs

Chapter 11
Flexible Budgeting
and Analysis of
Overhead Costs
Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
11-1
Learning Objective 11-1 – Distinguish between static and
flexible budgets and explain the advantages of a flexible
overhead budget.
11-2
Static v Flexible Budgets
Static budgets
are prepared for a Flexible budgets
single, planned cover a range of
level of activity. activity within
which the firm may
operate.
11-3
Flexible Budgets
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 adjust
the budget to the actual level of activity.
11-4
Advantages of Flexible Budgets
Provides the correct basis for comparison

between actual and expected costs, given
actual activity.
 May be prepared for any activity level in the relevant

range.
 Reveals variances due to good cost control or
lack of cost control.
 Improves performance evaluation.
11-5
Activity Measures
In a multiproduct firm output is measured in
terms of the standard allowed input, given
actual output. The flexible overhead budget is
then based on this standard input measure.
When only a single product is produced, it

makes no difference whether the flexible
budget is based on input or output.
11-6
Learning Objective 11-2 – Prepare a flexible overhead
budget, using both a formula and a columnar format.
11-7
Preparing a Flexible Budget – (columnar)
11-8
Preparing a Flexible Budget, formula
method (1 of 3)
The formula flexible budget is more

general than the columnar flexible
budget, because the formula allows
managers to compute budgeted
overhead costs at any activity level.
11-9
method (2 of 3)
11-10
method (3 of 3)
11-11
Learning Objective 11-3 – Explain how overhead is applied
to Work-in-Process Inventory under standard costing.
11-12
Overhead Application in a Standard
Costing System (1 of 2)
Normal Costing
Manufacturing Overhead Work-in-Process Inventory
Actual Applied Applied
overhead overhead: overhead:
Actual hours Actual hours
x x
Predetermined Predetermined
overhead rate overhead rate
Difference lies in the

quantity of hours used. Standard Costing
Manufacturing Overhead Work-in-Process Inventory
Actual Applied Applied
overhead overhead: overhead:
Standard Standard
allowed hours allowed hours
x x
Predetermined Predetermined
overhead rate overhead rate
11-13
Overhead Application in a Standard
Costing System (2 of 2)
11-14
Learning Objective 11-4 – Explain the important issues in
choosing an activity measure for overhead budgeting and
application.
11-15
Choice of Activity Measure (1 of 2)
Variable Dollar
Cost drivers overhead and measures
are the most the activity should be
significant measure avoided as
factor affecting should they are
overhead costs vary in a subject to
similar price-level
pattern. changes.
Examples:
machine hours,
labor hours,
process time.
11-16
Choice of Activity Measure (2 of 2)
Changing Manufacturing Technology
Machine hours and process time are

linked more closely than direct-labor
hours to the robotic technology and
computer-integrated manufacturing (CIM)
systems common in today’s
manufacturing environment.
11-17
Learning Objective 11-5 – Compute and interpret the
variable-overhead spending and efficiency variances and the
fixed-overhead budget and volume variances.
11-18
Variable Overhead Variances (1 of 2)
Actual Flexible Budget Flexible Budget
Variable for Variable for Variable
Overhead Overhead at Overhead at
Incurred Actual Hours Standard Hours
AQ × AVR AQ × SVR SQ × SVR
Spending Efficiency
Variance Variance
AQ = Actual Quantity of Activity
AVR = Actual Variable Overhead Rate
SVR = Standard Variable Overhead Rate
SQ = Standard Allowed
11-19
Variable Overhead Variances (2 of 2)
Actual Flexible Budget Flexible Budget
Variable for Variable for Variable
Overhead Overhead at Overhead at
Incurred Actual Hours Standard Hours
AQ × AVR AQ × SVR SQ × SVR
Spending Efficiency
Variance Variance
Spending variance = AQ(AVR − SVR)
Efficiency variance = SVR(AQ − SQ)
11-20
Variable Overhead Variances –
A Closer Look
Spending Variance Efficiency Variance
Results from paying more A function of the
or less than expected for selected cost driver.
overhead items and from It does not reflect
excessive usage of overhead control.
overhead items.
11-21
Fixed Overhead Variances
Actual Fixed Fixed Fixed

Overhead Overhead Overhead
Incurred Budget Applied
SH × AFOHR
Budget Volume
Variance Variance
AFOHR = Predetermined Fixed Overhead Rate
SH = Standard Allowed Activity
11-22
Fixed Overhead
Recall that fixed overhead costs are applied to

products and services using a predetermined
fixed overhead rate (PFOHR):
Applied Fixed Overhead = PFOHR × Standard Allowed
Budgeted Fixed Overhead

PFOHR =
Planned Activity in Hours
11-23
Fixed Overhead Variances –
A Closer Look
Budget Variance Volume Variance
Results from paying more Results from the inability
or less than expected for to operate at the activity
overhead items. level planned for the period.
Has no significance for
cost control.
11-24
Fixed Overhead Variances –
Capacity Utilization
Many managers interpret the fixed-
overhead volume variance merely as a way
.
of reconciling the two purposes of the
standard-costing system: cost application
and control. Frequently choosing not to
designate the volume variance as either
favorable or unfavorable, but view it as
more of a technical difference that is either
positive or negative in direction.
11-25
Overhead Variances –
Illustrated (1 of 5)
Actual production output 2,000

.
cakes
Standard allowed process hours per × 3
cake
Total standard allowed process hours 6,000
hours
11-26
The budgeted overhead

.
for September is
$45,000
11-27
Actual Overhead Cost for

.
September:
Variable overhead $34,650
Fixed overhead
16,100
Total overhead $50,750
Actual process hours for September
Standard allowed number of process 6,300
hours
11-28
Variable Overhead:
.
Actual variable overhead $34,650
Budgeted variable overhead 30,000
Total variable-overhead $ 4,650
variance Unfavorable
11-29
11-30
Variances
11-31
Learning Objective 11-6 – Prepare an overhead cost
performance report.
11-32
Overhead Cost
Performance Report (1 of 2)
11-33
Overhead Cost
Performance Report (2 of 2)
11-34
Learning Objective 11-7 – Explain how an activity-based
flexible budget differs from a conventional flexible budget.
11-35
Activity-Based Flexible Budget – Cost
Pool 1
11-36
Activity-Based Flexible Budget – Cost
Pools 2-5
11-37
Learning Objective 11-8 – Prepare journal entries to record
production overhead under standard costing (Appendix A).
11-38
Standard Costs and Product Costing
Disposition of Variances
Manufacturing Overhead Cost of Goods Sold
Actual Applied Balance (1) Balance (2)
overhead overhead: Actual Applied
Standard overhead overhead
allowed hours greater than greater than
x Applied Actual
Predetermined overhead overhead
overhead rate
Balance (1) Balance (2)
Balance (2) Balance (1)
11-39
Journal Entries (1 of 3)
11-40
The application of production overhead to Work-in-Process Inventory

is based on the predetermined overhead rate of $7.00 per process
hour (the total of the variable and the fixed rates) and 6,000 standard
allowed process hours, given an actual output of 2,000 multilayer
fancy cakes. The summary journal entry is as follows:
11-41
As explained in the preceding chapter, variances are temporary

accounts, and most companies close them directly into Cost of Goods
Sold at the end of each accounting period. The journal entry required
to close out DCdesserts.com’s underapplied overhead for September
is as follows:
11-42
Learning Objective 11-9 – Compute and interpret the sales-
price and sales-volume variances (Appendix B).
11-43
A General Model for Variance
Analysis
Actual Sales Volume Actual Sales Volume Budgeted Sales Volume
× × ×
Actual Sales Price Budgeted Sales Price Budgeted Sales Price
Sales Price Variance Sales Volume Variance
ASV(ASP − BSP) BSP(ASV − BSV)

ASV = Actual Sales Volume BSP = Budgeted Sales Price
ASP = Actual Sales Price BSV = Budgeted Sales Volume
11-44
End Chapter 11
11-45

Flexible Budgeting and Analysis of Overhead Costs

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Chapter 11

Provides the correct basis for comparison

 May be prepared for any activity level in the relevant

When only a single product is produced, it

The formula flexible budget is more

Difference lies in the

Changing Manufacturing Technology

Machine hours and process time are

Actual Fixed Fixed Fixed

Recall that fixed overhead costs are applied to

Applied Fixed Overhead = PFOHR × Standard Allowed

Budgeted Fixed Overhead

Actual production output 2,000

The budgeted overhead

Actual Overhead Cost for

The application of production overhead to Work-in-Process Inventory

As explained in the preceding chapter, variances are temporary

Sales Price Variance Sales Volume Variance

ASV(ASP − BSP) BSP(ASV − BSV)

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