Chapter 11 – Flexible Budgeting and Analysis of Overhead Costs
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CHAPTER 11
FLEXIBLE BUDGETING AND ANALYSIS OF
OVERHEAD COSTS
Learning Objectives
1. Distinguish between static and flexible budgets and explain the advantages of a
flexible overhead budget.
2. Prepare a flexible overhead budget, using both a formula and a columnar format.
4. Explain some important issues in choosing an activity measure for overhead
budgeting and application.
5. Compute and interpret the variable-overhead spending and efficiency variances
and the fixed-overhead budget and volume variances.
6. Prepare an overhead cost performance report.
8. Prepare journal entries to record manufacturing overhead under standard
costing (Appendix A).
Chapter 11 – Flexible Budgeting and Analysis of Overhead Costs
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Chapter Overview
I. Overhead Budgets
A. Flexible budgets
B. Advantages of flexible budgets
C. The activity measure
II. Flexible Overhead Budget Illustrated
A. Formula flexible budget
III. Overhead Application in a Standard-Costing System
IV. Choice of Activity Measure
A. Criteria for choosing the activity measure
V. Cost Management Using Overhead Cost Variances
A. Variable overhead
1. Spending and efficiency variances
2. Product costing versus cost management
3. Graphing variable-overhead variances
5. Management of variable overhead costs
B. Fixed overhead
2. Management interpretation of fixed-overhead variances
3. Capacity utilization
VI. Overhead Cost Performance Report
VII. Activity-Based Flexible Budgets
VIII. Flexible Budgeting in the Service Industry
IX. Appendix A: Standard Costs and Product Costing
X. Appendix B: Sales Variances
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Key Lecture Concepts
I. Overhead Budgets
• A flexible budget is a detailed plan for controlling overhead and other
costs. Most important, the flexible budget is prepared for different levels
of activity within a firm’s relevant range.
• The flexible budget results in improved performance evaluations. Actual
results at one activity level are compared against what should have
happened (i.e., budgeted costs) at the same level of output.
• As mentioned in previous chapters, when applying or budgeting
overhead, the activity base must be chosen carefully. It is typically an
input measure, namely, the standard hours allowed for the actual
production.
II. Flexible Overhead Budget Illustrated
• The flexible budget may be expressed as a formula:
Total budgeted overhead = (Budgeted variable cost per activity
unit x Number of activity units) + Budgeted fixed overhead
cost
III. Overhead Application in a Standard-Costing System
• Overhead application to Work-in-Process Inventory in a standard-costing
system is similar to the method demonstrated in Chapter 3 for normal
costing, with one important difference.
➢ Normal costing:
Overhead applied = Actual hours x Predetermined rate
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➢ Standard costing:
Overhead applied = Standard hours x Predetermined
rate (i.e., S x S)
• Predetermined overhead rates are calculated by dividing the overhead
dollars shown in the flexible budget by the most likely level of activity.
IV. Choice of Activity Measure
• The activity measure selected should be a cost driver for variable
overhead, with both of these items moving together as activity changes.
• Dollar measures, such as direct labor costs, should be avoided as these
have significant drawbacks.
V. Cost Management Using Overhead Cost Variances
• At the end of the period, actual overhead costs are compared against
amounts shown in the flexible budget. The difference, or variance, is
subdivided into two components for variable overhead and two for fixed
overhead.
• Variable-overhead variances are conceptually similar to variances for
direct material and direct labor. The variances may be expressed
algebraically as follows:
The result of taking (SH x SVR) is the amount of variable overhead
applied to production.
➢ The VOH spending variance is the result of comparing the amount
that was spent on variable overhead items at the actual level of
activity against the amount that should have been spent at that
level.
Chapter 11 – Flexible Budgeting and Analysis of Overhead Costs
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▪ The spending variance can arise from paying higher/lower
prices than expected and consuming larger/smaller
quantities than expected (e.g., energy, supplies), so it is not a
“pure” price/rate variance.
• Fixed overhead variances are calculated as follows:
FOH budget variance = Actual fixed overhead – Budgeted fixed
overhead
➢ The FOH budget variance is the result of comparing total actual
fixed-overhead expenditures with lump-sum, budgeted fixed
overhead costs.
➢ The volume variance occurs whenever the planned level of activity
and the standard level of activity differ.
▪ A common interpretation of a positive volume variance is
that a company has underutilized its facility. However, this
VI. Overhead Cost Performance Report
• An overhead cost performance report shows itemized variances along
with actual and budgeted costs for each overhead item.
Chapter 11 – Flexible Budgeting and Analysis of Overhead Costs
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VII. Activity-Based Flexible Budgets
• The basic difference between a conventional flexible budget and an
activity-based flexible budget is the use of additional cost pools and
additional cost drivers.
VIII. Flexible Budgeting in the Service Industry
• Service firms also incur overhead costs that vary with appropriately
chosen cost drivers. Therefore, these companies can benefit from the use
of flexible budgets.
IX. Appendix A: Standard Costs and Product Costing
• Journal entries are made to record overhead expenditures throughout the
period. Actual overhead amounts are recorded in the Manufacturing
X. Appendix B: Sales Variances
• The idea of variance analysis can be extended to areas other than
production, for example, an analysis of why actual contribution margin
differed from budgeted contribution margin.
• If unit variable costs do not change, two items will contribute to this
variance: the sales-price variance (SPV) and the sales-volume variance
(SVV).
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➢ The sales-volume variance (SVV), which arises from an increase or
decrease in units sold, is calculated as:
Teaching Overview
The two main concepts in Chapter 11 are (1) the construction and use of a flexible
budget and (2) the analysis of overhead variances. The construction of a flexible budget
presents little difficulty for students; however, overhead variance analysis is more
troublesome.
Be prepared to spend extra time in the area of variance computation. If this is the first
time that you have taught the course, you may be surprised at how easily students
calculate and interpret direct material and direct labor variances, and the great
difficulty they have in doing the same for overhead.
Fixed overhead is especially troublesome. I recommend emphasizing that fixed cost
items and variable cost items cannot be analyzed by using the same model. Even
students who remember this fact seem to experience “interference” from the variable
cost model and use an erroneous combination of the two.
Links to the Text
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Homework Grid – CHAPTER 11
Item No.
Learning
Objectives
Completion
Time (min.)
Special
Features*
Exercises:
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Problems:
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Learning
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Item No.
Objectives
Time (min.)
Features*
Cases:
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* W = Written response E = Ethical issue G = Group work
I = International C = Internet use S = Spreadsheet