Transcript Variable Overhead Variances

Flexible Budgets and
Overhead Analysis
Chapter Eleven
McGraw-Hill/Irwin
Copyright © 2006, The McGraw-Hill Companies, Inc.
Static Budgets and Performance Reports
Static budgets
are prepared for
a single, planned
level of activity.
Hmm! Comparing
static budgets with
actual costs is like
comparing apples
and oranges.
Performance
evaluation is difficult
when actual activity
differs from the
planned level of
activity.
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Flexible Budgets
May be prepared for any activity
level in the relevant range.
Show costs that should have been
incurred at the actual level of
activity, enabling “apples to apples”
cost comparisons.
Reveal variances related to
cost control.
Improve performance evaluation.
Let’s look at CheeseCo.
McGraw-Hill/Irwin
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Static Budgets and Performance Reports
CheeseCo
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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 don’t think I
can answer the
question using
a static budget.
McGraw-Hill/Irwin
Actual activity is below
budgeted activity.
So, shouldn’t 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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Preparing a Flexible Budget
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Preparing a Flexible Budget
CheeseCo
Cost
Formula
per Hour
Total
Fixed
Cost
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
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
8,000
$
$
4.00
3.00
0.50
7.50
10,000
12,000
Variable costs are expressed as
a constant amount per hour.
$40,000 ÷ 10,000 hours is
$4.00 per hour.
$ 12,000
2,000
Fixed costs are
expressed as a
total amount.
Copyright © 2006. The McGraw-Hill Companies, Inc.
Preparing a Flexible Budget
CheeseCo
Cost
Formula
per Hour
Total
Fixed
Cost
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
8,000
$
$
4.00
3.00
0.50
7.50
Fixed costs
$4.00
Depreciation
Insurance
Total fixed cost
Total overhead costs
McGraw-Hill/Irwin
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
per hour × 8,000 hours = $32,000
$ 12,000
2,000
Copyright © 2006. The McGraw-Hill Companies, Inc.
Preparing a Flexible Budget
CheeseCo
Cost
Formula
per Hour
Total
Fixed
Cost
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
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000
$
$
4.00
3.00
0.50
7.50
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$ 12,000
2,000
$ 12,000
2,000
$ 14,000
$ 74,000
Copyright © 2006. The McGraw-Hill Companies, Inc.
Preparing a Flexible Budget
CheeseCo
Cost
Formula
per Hour
Total
Fixed
Cost
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
$
$
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000
10,000
4.00
$ 32,000
3.00 fixed costs
24,000
Total
0.50
do
not change in4,000
7.50
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
the relevant range.
$ 12,000
2,000
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 89,000
12,000
?
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Preparing a Flexible Budget
Cost
Formula
per Hour
Total
Fixed
Cost
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
$
$
4.00
3.00
0.50
7.50
$ 12,000
2,000
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$ 48,000
36,000
6,000
$ 90,000
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
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Flexible Budget Performance Report
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Flexible Budget Performance Report
CheeseCo
Flexible budget Cost
is
prepared for the
Formula
per Hour
same activity level
(8,000
hours) as
Machine
hours
actually achieved.
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
4.00
3.00
0.50
7.50
Flexible
Budget
Actual
Results
8,000
8,000
Variances
0
$ 34,000
25,500
3,800
$ 63,300
$ 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
Total
Fixed
Cost
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
$
$
4.00
3.00
0.50
7.50
$ 12,000
2,000
Flexible
Budget
Actual
Results
8,000
8,000
$ 32,000
$ 34,000
25,500
3,800
$ 63,300
Variances
0
$ 2,000 U
$ 12,000
2,050
$ 14,050
$ 77,350
Copyright © 2006. The McGraw-Hill Companies, Inc.
Flexible Budget Performance Report
CheeseCo
Cost
Formula
per Hour
Total
Fixed
Cost
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
$
$
4.00
3.00
0.50
7.50
$ 12,000
2,000
Flexible
Budget
Actual
Results
8,000
8,000
$ 32,000
24,000
4,000
$ 60,000
$ 34,000
25,500
3,800
$ 63,300
$ 2,000 U
1,500 U
200 F
$ 3,300 U
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,050
$ 14,050
$ 77,350
$
Variances
0
0
50 U
50 U
$ 3,350 U
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Flexible Budget Performance Report
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Static Budgets and Performance
How much of the $11,650 favorable variance is due to
lower activity and how much is due to cost control?
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Flexible Budget Performance Report
Overhead Variance Analysis
Static
Overhead
Budget at
10,000 Hours
$
89,000
Let’s 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.
McGraw-Hill/Irwin
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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
$
Activity
This $15,000F variance is
due to lower activity.
McGraw-Hill/Irwin
74,000
Actual
Overhead
at
8,000 Hours
$
77,350
Cost control
This $3,350U
variance is due
to poor cost control.
Copyright © 2006. The McGraw-Hill Companies, Inc.
Variable Overhead Variances –
A Closer Look
If flexible budget
is based on
actual hours
If flexible budget
is based on
standard hours
Only a spending
variance can be
computed.
Both spending
and efficiency
variances can be
computed.
McGraw-Hill/Irwin
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Variable Overhead Variances – Example
ColaCo’s actual production for the period required
3,200 standard machine hours. Actual variable
overhead incurred for the period was $6,740.
Actual machine hours worked were 3,300. The
standard variable overhead cost per machine hour
is $2.00.
Compute the variable overhead spending variance
first using actual hours. Then use standard hours
allowed to calculate the variable overhead
efficiency variance.
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Variable Overhead Variances
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
AH × AR
AH × SR
Spending
Variance
AH = Actual hours
AR = Actual variable
overhead rate
SR = Standard variable
overhead rate
Spending variance = AH(AR – SR)
McGraw-Hill/Irwin
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Variable Overhead Variances – Example
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
$6,740
3,300 hours
×
$2.00 per hour
= $6,600
Spending Variance
= $140 unfavorable
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Variable Overhead Variances –
A Closer Look
Spending Variance
Results from paying more
or less than expected for
overhead items and from
excessive usage of
overhead items.
McGraw-Hill/Irwin
Now, let’s use the
standard hours allowed,
along with the actual
hours, to compute the
efficiency variance.
Copyright © 2006. The McGraw-Hill Companies, Inc.
Variable Overhead Variances
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
AH × AR
AH × SR
Spending
Variance
Flexible Budget
for Variable
Overhead at
Standard Hours
SH × SR
Efficiency
Variance
Spending variance = AH(AR - SR)
Efficiency variance = SR(AH - SH)
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Variable Overhead Variances – Example
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
3,300 hours
×
$2.00 per hour
$6,740
Spending variance
$140 unfavorable
$6,600
Flexible Budget
for Variable
Overhead at
Standard Hours
3,200 hours
×
$2.00 per hour
$6,400
Efficiency variance
$200 unfavorable
$340 unfavorable flexible budget total variance
McGraw-Hill/Irwin
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Variable Overhead Variances –
A Closer Look
Efficiency Variance
Controlled by
managing the
overhead cost driver.
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Quick Check 
Yoder Enterprises’ actual production for the
period required 2,100 standard direct labor
hours. Actual variable overhead for the period
was $10,950. Actual direct labor hours worked
were 2,050. The predetermined variable
overhead rate is $5 per direct labor hour. What
was the spending variance?
a. $450 U
b. $450 F
c. $700 F
d. $700 U
McGraw-Hill/Irwin
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Quick Check 
Spending
variance = AH
(AR -production
SR)
Yoder Enterprises’
actual
for the
period=required
2,100overhead
standard
direct–labor
Actual variable
incurred
(AH  SR)
hours. Actual variable overhead for the period
= $10,950 – (2,050 hours  $5 per hour)
was $10,950. Actual direct labor hours worked
= $10,950
– $10,250
were 2,050.
The
predetermined variable
overhead
rate is $5 per direct labor hour. What
= $700 U
was the spending variance?
a. $450 U
b. $450 F
c. $700 F
d. $700 U
McGraw-Hill/Irwin
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Quick Check 
Yoder Enterprises’ actual production for the
period required 2,100 standard direct labor
hours. Actual variable overhead for the period
was $10,950. Actual direct labor hours worked
were 2,050. The predetermined variable
overhead rate is $5 per direct labor hour. What
was the efficiency variance?
a. $450 U
b. $450 F
c. $250 F
d. $250 U
McGraw-Hill/Irwin
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Quick Check 
Yoder Enterprises’ actual production for the
period required 2,100 standard direct labor
hours. Actual variable overhead for the period
Efficiency
variance
= SRdirect
(AH –labor
SH) hours worked
was
$10,950.
Actual
were 2,050.
variable
= $5 perThe
hourpredetermined
(2,050 hours – 2,100
hours)
overhead rate is $5 per direct labor hour. What
= $250
F
was the
efficiency
variance?
a. $450 U
b. $450 F
c. $250 F
d. $250 U
McGraw-Hill/Irwin
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Quick Check Summary
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
2,050 hours
×
$5 per hour
$10,950
Spending variance
$700 unfavorable
$10,250
Flexible Budget
for Variable
Overhead at
Standard Hours
2,100 hours
×
$5 per hour
$10,500
Efficiency variance
$250 favorable
$450 unfavorable flexible budget total variance
McGraw-Hill/Irwin
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Overhead Rates and Overhead Analysis
Recall that overhead costs are assigned to
products and services using a predetermined
overhead rate (POHR):
Assigned Overhead = POHR × Standard Activity
POHR
McGraw-Hill/Irwin
=
Overhead from the
flexible budget for the
denominator level of activity
Denominator level of activity
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Overhead Rates and Overhead Analysis
The predetermined overhead rate
can be broken down into fixed
and variable components.
The variable
component is useful
for preparing and analyzing
variable overhead
variances.
McGraw-Hill/Irwin
The fixed
component is useful
for preparing and analyzing
fixed overhead
variances.
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Normal versus Standard Cost Systems
In a normal cost
system, overhead is
applied to work in
process based on
the actual number
of hours worked
in the period.
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In a standard cost
system, overhead is
applied to work in
process based on
the standard hours
allowed for the output
of the period.
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Fixed Overhead Variances
Actual Fixed
Overhead
Incurred
Budget
Variance
Fixed
Overhead
Budget
DH × FR
Fixed
Overhead
Applied
SH × FR
Volume
Variance
FR = Standard Fixed Overhead Rate
SH = Standard Hours Allowed
DH = Denominator Hours
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Overhead Rates and Overhead
Analysis – Example
ColaCo prepared this budget for overhead:
Machine
Hours
3.000
Total
Variable
Total
Fixed
Variable Overhead Fixed Overhead
Overhead
Rate
Overhead
Rate
$6.000
?
$9.000
?
Let’s calculate overhead rates.
ColaCo applies overhead based
on machine-hour activity.
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Overhead Rates and Overhead
Analysis – Example
ColaCo prepared this budget for overhead:
Machine
Hours
3.000
Total
Variable
Total
Fixed
Variable Overhead Fixed Overhead
Overhead
Rate
Overhead
Rate
$6.000
$2,00
$9.000
$3,00
The total POHR is the sum of
the fixed and variable rates
for a given activity level.
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Fixed Overhead Variances – Example
ColaCo’s actual production required 3,200
standard machine hours. Actual fixed
overhead was $8,450. The predetermined
overhead rate is based on 3,000 machine
hours.
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Overhead Variances
Now let’s turn
our attention
to calculating
fixed overhead
variances.
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Fixed Overhead Variances – Example
Actual Fixed
Overhead
Incurred
Fixed
Overhead
Budget
$8,450
$9,000
Fixed
Overhead
Applied
Budget variance
$550 favorable
McGraw-Hill/Irwin
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Fixed Overhead Variances –
A Closer Look
Budget Variance
Results from spending
more or less than
expected for fixed
overhead items.
McGraw-Hill/Irwin
Now, let’s use the
standard hours allowed
to compute the fixed
overhead volume
variance.
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Fixed Overhead Variances – Example
Actual Fixed
Overhead
Incurred
Fixed
Overhead
Budget
Fixed
Overhead
Applied
SH × FR
3,200 hours
×
$3.00 per hour
$8,450
$9,000
$9,600
Budget variance
$550 favorable
McGraw-Hill/Irwin
Volume variance
$600 favorable
Copyright © 2006. The McGraw-Hill Companies, Inc.
Volume Variance – A Closer Look
Volume
Variance
Results when standard hours
allowed for actual output differs
from the denominator activity.
Unfavorable
when standard hours
< denominator hours
McGraw-Hill/Irwin
Favorable
when standard hours
> denominator hours
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Quick Check 
Yoder Enterprises’ actual production for the
period required 2,100 standard direct labor
hours. Actual fixed overhead for the period
was $14,800. The budgeted fixed overhead
was $14,450. The predetermined fixed
overhead rate was $7 per direct labor hour.
What was the budget variance?
a. $350 U
b. $350 F
c. $100 F
d. $100 U
McGraw-Hill/Irwin
Copyright © 2006. The McGraw-Hill Companies, Inc.
Quick Check 
Budget
Yoder variance
Enterprises’ actual
production for the
= Actual
fixed overhead
– Budgeteddirect
fixed overhead
period
required
2,100 standard
labor
hours.
Actual– $14,450
fixed overhead for the period
= $14,800
was $14,800. The budgeted fixed overhead
$350 U
was= $14,450.
The predetermined fixed
overhead rate was $7 per direct labor hour.
What was the budget variance?
a. $350 U
b. $350 F
c. $100 F
d. $100 U
McGraw-Hill/Irwin
Copyright © 2006. The McGraw-Hill Companies, Inc.
Quick Check 
Yoder Enterprises’ actual production for the
period required 2,100 standard direct labor
hours. Actual fixed overhead for the period
was $14,800. The budgeted fixed overhead
was $14,450. The predetermined fixed
overhead rate was $7 per direct labor hour.
What was the volume variance?
a. $250 U
b. $250 F
c. $100 F
d. $100 U
McGraw-Hill/Irwin
Copyright © 2006. The McGraw-Hill Companies, Inc.
Quick Check 
Volume variance
Yoder Enterprises’ actual production for
= Budgeted fixed overhead – (SH  FR)
the
period required 2,100 standard direct labor
$14,450
– (2,100
hours  $7
hours. =Actual
fixed
overhead
forper
thehour)
period
= $14,450The
– $14,700
was $14,800.
budgeted fixed overhead
= $250 F The predetermined fixed
was $14,450.
overhead rate was $7 per direct labor hour.
What was the volume variance?
a. $250 U
b. $250 F
c. $100 F
d. $100 U
McGraw-Hill/Irwin
Copyright © 2006. The McGraw-Hill Companies, Inc.
Quick Check Summary
Actual Fixed
Overhead
Incurred
Fixed
Overhead
Budget
$14,800
Budget variance
$350 unfavorable
McGraw-Hill/Irwin
$14,450
Fixed
Overhead
Applied
SH × FR
2,100 hours
×
$7.00 per hour
$14,700
Volume variance
$250 favorable
Copyright © 2006. The McGraw-Hill Companies, Inc.
Overhead Variances and Under- or
Overapplied Overhead Cost
In a standard
cost system:
Unfavorable
variances are equivalent
to underapplied overhead.
Favorable
variances are equivalent
to overapplied overhead.
The sum of the overhead variances
equals the under- or overapplied
overhead cost for a period.
McGraw-Hill/Irwin
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End of Chapter 11
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