Flexible Budgets

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Static Budgets and Performance Reports

Hmm! Comparing
static budgets with
Static budgets actual costs is like
are prepared for comparing apples
a single, planned and oranges.
level of activity.
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.

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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 Actual activity is below
question using budgeted activity.
a static budget. So, shouldn’t variable costs
be lower if actual activity
is lower?

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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 isis
due
due to
to lower
lower activity,
activity, and
and how
how much
much isis 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 toto the
the
actual
actual level
level of
of activity.
activity.

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 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 ble
aria
unchanged within the V
relevant range. Fixed

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 Preparing a Flexible Budget

Let’s prepare
budgets
for CheeseCo.

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 Preparing a Flexible Budget

CheeseCo
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Variable costs are expressed as
Indirect labor $ 4.00 a constant amount per hour.
Indirect material 3.00
Power 0.50 $40,000 ÷ 10,000 hours is
Total variable cost $ 7.50 $4.00 per hour.
Fixed costs Fixed costs are
Depreciation $ 12,000
Insurance 2,000
expressed as a
Total fixed cost total amount.
Total overhead costs
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 Preparing a Flexible Budget

CheeseCo
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor $ 4.00 $ 32,000
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost $ 7.50 $ 60,000

Fixed costs $4.00 per hour × 8,000 hours = $32,000

Depreciation $ 12,000
Insurance 2,000
Total fixed cost
Total overhead costs
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 Preparing a Flexible Budget

CheeseCo
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor $ 4.00 $ 32,000
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost $ 7.50 $ 60,000

Fixed costs
Depreciation $ 12,000 $ 12,000
Insurance 2,000 2,000
Total fixed cost $ 14,000
Total overhead costs $ 74,000
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 Preparing a Flexible Budget

CheeseCo
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor $ 4.00 $ 32,000 $ 40,000
Indirect material 3.00 fixed costs
Total 24,000 30,000
Power 0.50
do not change in4,000 5,000
Total variable cost $ 7.50 $ 60,000 $ 75,000
the relevant range.
Fixed costs
Depreciation $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000
Total fixed cost $ 14,000 $ 14,000
Total overhead costs $ 74,000 $ 89,000 ?
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 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.

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 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
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 Preparing a Flexible Budget

Cost Total Flexible Budgets

Formula Fixed 8,000 10,000 12,000
per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor $ 4.00 $ 32,000 $ 40,000 $ 48,000
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost $ 7.50 $ 60,000 $ 75,000 $ 90,000

Fixed costs
Depreciation $ 12,000 $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000 2,000
Total fixed cost $ 14,000 $ 14,000 $ 14,000
Total overhead costs $ 74,000 $ 89,000 $ 104,000
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 Flexible Budget Performance Report

Let’s prepare a
budget performance
report
for CheeseCo.

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 Flexible Budget Performance Report
CheeseCo
Flexible budget Cost
is Total
prepared for the
Formula Fixed Flexible Actual
same activity level
per Hour Cost Budget Results Variances
(8,000
Machine hours) as
hours 8,000 8,000 0
actually achieved.
Variable costs
Indirect labor $ 4.00 $ 34,000
Indirect material 3.00 25,500
Power 0.50 3,800
Total variable cost $ 7.50 $ 63,300

Fixed costs
Depreciation $ 12,000 $ 12,000
Insurance 2,000 2,050
Total fixed cost $ 14,050
Total overhead costs $ 77,350
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 Quick Check 

What
What isis the
the variance
variance for
for indirect
indirect labor
labor when
when the
the
flexible
flexible budget
budget forfor 8,000
8,000 hours
hours is
is compared
compared toto 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

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 Quick Check 

What
What isis the
the variance
variance for
for indirect
indirect labor
labor when
when the
the
flexible
flexible budget
budget forfor 8,000
8,000 hours
hours is
is compared
compared toto 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

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 Flexible Budget Performance Report
CheeseCo
Cost Total
Formula Fixed Flexible Actual
per Hour Cost Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs
Indirect labor $ 4.00 $ 32,000 $ 34,000 $ 2,000 U
Indirect material 3.00 25,500
Power 0.50 3,800
Total variable cost $ 7.50 $ 63,300

Fixed costs
Depreciation $ 12,000 $ 12,000
Insurance 2,000 2,050
Total fixed cost $ 14,050
Total overhead costs $ 77,350
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 Quick Check 

What
What isis the
the variance
variance for
for indirect
indirect material
material when
when the
the
flexible
flexible budget
budget forfor 8,000
8,000 hours
hours is
is compared
compared to
to the
the
actual
actual results?
results?
a.
a. $1,500
$1,500 U U
b.
b. $1,500
$1,500 FF
c.
c. $4,500
$4,500 U U
d.
d. $4,500
$4,500 FF

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

 Quick Check 

What
What isis the
the variance
variance for
for indirect
indirect material
material when
when the
the
flexible
flexible budget
budget forfor 8,000
8,000 hours
hours is
is compared
compared to
to the
the
actual
actual results?
results?
a.
a. $1,500
$1,500 U U
b.
b. $1,500
$1,500 FF
c.
c. $4,500
$4,500 U U
d.
d. $4,500
$4,500 FF

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 Flexible Budget Performance Report
CheeseCo
Cost Total
Formula Fixed Flexible Actual
per Hour Cost Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs
Indirect labor $ 4.00 $ 32,000 $ 34,000 $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable cost $ 7.50 $ 60,000 $ 63,300 $ 3,300 U

Fixed costs
Depreciation $ 12,000 $ 12,000 $ 12,000 $ 0
Insurance 2,000 2,000 2,050 50 U
Total fixed cost $ 14,000 $ 14,050 50 U
Total overhead costs $ 74,000 $ 77,350 $ 3,350 U
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 Flexible Budget Performance Report

Remember the questi

on:
“How much of the to
tal
variance is due to lo
wer
activity and how mu
ch is
due to cost control?
”

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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 Let’s place Actual
Overhead the flexible Overhead
Budget at at
budget for
10,000 Hours 8,000 Hours
8,000 hours
$ 89,000 here. $ 77,350

Difference between original static budget

and actual overhead = $11,650 F.

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 Flexible Budget Performance Report

Overhead Variance Analysis

Static Flexible Actual
Overhead Overhead Overhead
Budget at Budget at at
10,000 Hours 8,000 Hours 8,000 Hours
$ 89,000 $ 74,000 $ 77,350

Activity Cost control

This $15,000F variance is This $3,350U

due to lower activity. variance is due
to poor cost control.

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