Chapter 11 Standard costs for control: flexible budgets and manufacturing overhead Copyright ª 2006 McGraw­Hill Australia Pty Ltd 11­1 Flexible budgets • Used to control overheads • A detailed budget that is prepared for a range of levels of activities – Compared to a static budget which relates to one specific planned level of activity • Often restricted to the practice of flexing overhead costs to various levels of activity – Can be provided for any budgeted revenues or costs Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e By Kim Langfield-Smith 11-2 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e By Kim Langfield-Smith 11-3 Advantages of flexible budgets • Allow us to select the most appropriate benchmark for cost control • Provide a valid basis for comparing actual and expected costs, for the actual level of activity Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e By Kim Langfield-Smith 11-4 Input measures and output measures • Units of output are not usually a meaningful measure of the level of activity in a multi-product firm • Output can be measured as the standard quantity of input allowed, given actual output – Machine hours – Direct labour hours • The choice between input or output measures only becomes important when multiple products are being manufactured Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e By Kim Langfield-Smith 11-5 Flexible overhead budget • Flexible budget report: shows flexible overhead budgets at various levels of activity • Formula flexible budget: allows us to calculate total overhead at various levels of activity using a formula Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e By Kim Langfield-Smith 11-6 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e By Kim Langfield-Smith 11-7 Overhead application in a standard costing system • Overhead application is the method of allocating overhead cost to products – Recorded in the WIP inventory account • Overhead is applied to inventory using the standard overhead rate – Based on the standard quantity of input allowed, given actual output • The activity chosen for the standard overhead rate should be a cost driver – Any activity or factor that causes costs to be incurred Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e By Kim Langfield-Smith 11-8 Calculating overhead cost variances • The flexible budget provides a tool for controlling manufacturing overhead costs • At the end of an accounting period, the flexible budget can be used to calculate the amount of overhead cost that should have been incurred, given the actual level of activity • Four different overhead variances can be calculated to compare the actual overhead cost incurred with the flexible budget Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e By Kim Langfield-Smith 11-9 Calculating variable overhead cost variances • Variable overhead spending variance – Ameasure of the difference between the actual variable overhead and the standard variable overhead rate multiplied by actual activity =Actual variable overhead – (AH × SVR) Where AH = actual direct labour hours SVR = standard variable overhead rate continued Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e By Kim Langfield-Smith 11-10 Calculating variable overhead cost variances • Variable overhead efficiency variance – A measure of the difference between the actual activity and the standard activity allowed, given the actual output multiplied by the standard variable overhead rate = SVR(AH – SH) Where SH = standard direct labour hours allowed for actual output