Manerial accounting 11e garrison noreen brewer chap011

11th Edition
Chapter 11

McGraw-Hill/Irwin

Copyright © 2006. The McGraw-Hill Companies, Inc.


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.
McGraw-Hill/Irwin

Copyright © 2006. The McGraw-Hill Companies, Inc.


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

Copyright © 2006. The McGraw-Hill Companies, Inc.


Static Budgets and Performance Reports
CheeseCo
Static

Budget
Machine hours
Variable costs
Indirect labor
Indirect materials
Power
Fixed costs
Depreciation
Insurance
Total overhead costs
McGraw-Hill/Irwin

Actual
Results

Variances

10,000
$ 40,000
30,000
5,000
12,000
2,000
$ 89,000
Copyright © 2006. The McGraw-Hill Companies, Inc.


Static Budgets and Performance Reports
CheeseCo
Static

Budget
Machine hours
Variable costs
Indirect labor
Indirect materials
Power
Fixed costs
Depreciation
Insurance
Total overhead costs
McGraw-Hill/Irwin

Actual
Results

10,000

8,000

$ 40,000
30,000
5,000

$ 34,000
25,500
3,800

12,000
2,000

12,000
2,050

$ 89,000

$ 77,350

Variances

Copyright © 2006. The McGraw-Hill Companies, Inc.


Static Budgets and Performance Reports
CheeseCo
Static
Budget
Machine hours

10,000

Actual
Results

Variances

8,000

2,000 U

Variable costs

U = Unfavorable variance
Indirect labor
$ 40,000
$ 34,000
CheeseCo was30,000
unable to achieve
Indirect materials
25,500
level of activity.
Power the budgeted 5,000
3,800
Fixed costs
Depreciation
Insurance
Total overhead costs
McGraw-Hill/Irwin

$6,000 F
4,500 F
1,200 F

12,000
2,000

12,000
2,050

0
50 U

$ 89,000

$ 77,350

$11,650 F

Copyright © 2006. The McGraw-Hill Companies, Inc.


Static Budgets and Performance Reports
CheeseCo
Static
Budget
Machine hours
Variable costs
Indirect labor
Indirect materials
Power

Actual
Results

Variances

10,000

8,000

2,000 U

$ 40,000
30,000
5,000

$ 34,000
25,500
3,800

$6,000 F
4,500 F
1,200 F

F = Favorable
variance that occurs when
Fixed
costs
actual
costs are less than
budgeted12,000
costs.
Depreciation
12,000
Insurance
2,000
2,050
Total overhead costs
McGraw-Hill/Irwin

$ 89,000

$ 77,350

0
50 U
$11,650 F

Copyright © 2006. The McGraw-Hill Companies, Inc.


Static Budgets and Performance Reports
CheeseCo
Static
Budget
Machine hours
Variable costs
Indirect labor
Indirect materials
Power

Actual
Results

Variances

10,000

8,000

2,000 U

$ 40,000
30,000
5,000

$ 34,000
25,500
3,800

$6,000 F
4,500 F
1,200 F

Since
cost variances are favorable, have
Fixed
costs
we
done a good job controlling
costs?
Depreciation
12,000
12,000
Insurance
2,000
2,050
Total overhead costs
McGraw-Hill/Irwin

$ 89,000

$ 77,350

0
50 U
$11,650 F

Copyright © 2006. The McGraw-Hill Companies, Inc.


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?

Copyright © 2006. The McGraw-Hill Companies, Inc.


Static Budgets and Performance Reports

The

The relevant
relevant question
question is
is .. .. ..
“How
“How much
much of
of the
the favorable
favorable cost
cost variance
variance is
is
due
due to
to lower
lower activity,
activity, and
and how
how much
much is
is due
due to
to
good
good cost
cost control?”
control?”

To

To answer
answer the
the question,
question,
we
we must
must
the
the budget
budget to
to the
the
actual
actual level
level of
of activity.
activity.
McGraw-Hill/Irwin

Copyright © 2006. The McGraw-Hill Companies, Inc.


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 remain
unchanged within the
relevant range.

McGraw-Hill/Irwin

le
b
ria
a
V
Fixed

Copyright © 2006. The McGraw-Hill Companies, Inc.


Preparing a Flexible Budget

Let’s prepare
budgets
for CheeseCo.

McGraw-Hill/Irwin

Copyright © 2006. The McGraw-Hill Companies, Inc.


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
$

$

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

4.00
3.00
0.50
7.50

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

?

Copyright © 2006. The McGraw-Hill Companies, Inc.


Quick Check 
What
What should
should be
be the
the total
total overhead
overhead costs
costs for
for the
the
Flexible
Flexible Budget
Budget at
at 12,000
12,000 hours?
hours?
a.
a. $92,500.
$92,500.
b.

b. $89,000.
$89,000.
c.
c. $106,800.
$106,800.
d.
d. $104,000.
$104,000.

McGraw-Hill/Irwin

Copyright © 2006. The McGraw-Hill Companies, Inc.


Quick Check 
What
What should
should be
be the
the total
total overhead
overhead costs
costs for
for the
the
Flexible
Flexible Budget
Budget at
at 12,000
12,000 hours?

hours?
a.
a. $92,500.
$92,500.
b.
b. $89,000.
$89,000.
c.
c. $106,800.
$106,800.
d.
d. $104,000.
$104,000.
Total overhead cost
= $14,000 + $7.50 per hour × 12,000 hours
= $14,000 + $90,000 = $104,000
McGraw-Hill/Irwin

Copyright © 2006. The McGraw-Hill Companies, Inc.


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

Copyright © 2006. The McGraw-Hill Companies, Inc.


Flexible Budget Performance Report

Let’s prepare a
budget performance
report
for CheeseCo.

McGraw-Hill/Irwin

Copyright © 2006. The McGraw-Hill Companies, Inc.


Flexible Budget Performance Report
CheeseCo

Flexible budget is
Cost
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
Copyright © 2006. The McGraw-Hill Companies, Inc.


Quick Check 

What
What is
is the
the variance
variance for
for indirect
indirect labor
labor when
when the
the
flexible
flexible budget
budget for
for 8,000
8,000 hours
hours is
is compared
compared to
to the
the
actual
actual results?
results?
a.
a. $2,000
$2,000 U
U
b.
b. $2,000
$2,000 FF

c.
c. $6,000
$6,000 U
U
d.
d. $6,000
$6,000 FF

McGraw-Hill/Irwin

Copyright © 2006. The McGraw-Hill Companies, Inc.


Quick Check 

What
What is
is the
the variance
variance for
for indirect
indirect labor
labor when
when the
the
flexible
flexible budget
budget for
for 8,000
8,000 hours

hours is
is compared
compared to
to the
the
actual
actual results?
results?
a.
a. $2,000
$2,000 U
U
b.
b. $2,000
$2,000 FF
c.
c. $6,000
$6,000 U
U
d.
d. $6,000
$6,000 FF

McGraw-Hill/Irwin

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

$ 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.