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Overhead Budgets

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Overhead Budgets Most companies use flexible budgets to control overhead costs. A flexible budget is not based on only one level of activity but is valid for the firm ... – PowerPoint PPT presentation

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Title: Overhead Budgets


1
Overhead Budgets
  • Most companies use flexible budgets to control
    overhead costs.
  • A flexible budget is not based on only one level
    of activity but is valid for the firms relevant
    range of activity.
  • The flexible budget provides the correct basis
    for comparison between actual and expected costs.
  • The flexible overhead budget is based on a
    standard input measure (e.g. machine hours)

2
Flexible Budget Formula
  • The relationship between activity and total
    budgeted overhead is given by

Budgeted variable-overhead cost per activity unit
Budgeted fixed-overhead cost per month
Total budgeted monthly overhead cost
Total activity units



3
Standard Costing System
  • In a standard costing system, overhead
    application is based on standard hours allowed,
    given actual output.
  • The Manufacturing Overhead account is credited
    and the Work-In-Process Inventory is debited by
    the following amount
  • Standard allowed hours X Predetermined (Standard)
    rate

4
Variable-Overhead Spending Variance
  • Variable-overhead spending variance
  • Actual variable overhead - (AH x SVR)
  • or
  • (AH x AVR) - (AH x SVR)
  • AH x (AVR - SVR)

Notation AH actual machine hours AVR actual
variable-overhead rate actual variable
overhead ? AH SVR standard variable-overhead
rate
5
Variable-Overhead Efficiency Variance
  • Variable-Overhead Efficiency Variance
  • (AH x SVR) - (SH x SVR)
  • SVR x (AH - SH)

Notation AH actual machine hours SH standard
machine hours SVR standard variable-overhead
rate
6
Variance Analysis for Managerial ControlVariable
Overhead
Actual Costs Incurred (a)
Flexible Budget based on Actual Output (b)
Expected Costs based on Actual Output (c)
AQ AR
AQ SR
SQA SR
Variable-Overhead Spending Variance (b-a)
Variable-Overhead Efficiency Variance (c-b)
AQ(SR - AR)
SR(SQA - AQ)
Variable-Overhead Budget Variance (c-a)
(SQA SR) - (AQ AR)
7
Interpreting Variable Variance
  • The variable-overhead efficiency variance simply
    reflects an adjustment in the managerial
    accountants expectation about variable overhead
    cost.
  • It does not indicate inefficient use of
    variable-overhead.
  • An unfavorable variable-overhead spending
    variance simply means that the total actual cost
    of variable overhead is greater than expected.
  • The spending variance is the real control
    variance for variable overhead. The spending
    variance can alert managers if variable overhead
    costs are exceeding expectations.

8
Fixed-Overhead Variances
  • Fixed-Overhead Budget Variance
  • Actual fixed overhead - Budgeted fixed overhead
  • The budget variance is the real control variance
    for fixed overhead, because it compares actual
    expenditures with budgeted fixed-overhead costs.
  • Fixed-Overhead Volume Variance
  • Budgeted fixed overhead - Applied fixed overhead
  • Applied fixed overhead Predetermined fixed
    overhead rate x Standard allowed hours
  • A faulty interpretation of a positive volume
    variance is that it measures the cost of
    under-utilizing productive capacity. Perhaps
    under-utilizing capacity and reducing inventory
    may be the appropriate response to the current
    demand.

9
Variance Analysis for Managerial ControlFixed
Overhead
Actual Costs Incurred (a)
Flexible Budget based on Actual Output (b)
Expected Costs based on Actual Output (c)
AQ AR
AQ SR
SQA SR
Fixed-Overhead Spending Variance (b-a)
Fixed-Overhead Efficiency Variance (c-b)
AQ(SR - AR)
SR(SQA - AQ)
Fixed-Overhead Budget Variance (c-a)
(SQA SR) - (AQ AR)
10
Disposition of Variances
  • Variances are temporary accounts and most
    companies close them directly into Cost of Goods
    Sold at the end of each accounting period.
  • Debit Cost of Goods Sold
  • Credit Manufacturing Overhead
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