Cornerstones of Financial & Managerial Accounting

Cornerstones of Financial & Managerial Accounting

Rich/Jones/Heitger/Mowen/Hansen

Chapter 21

Learning Objectives

LO1. Prepare a flexible budget, and use it for performance reporting.

·  Static budgets provide expected cost for a given level of activity. If the actual level of activity differs from the level associated with the static budget level, then comparing actual costs with budgeted costs does not make any sense. The solution is flexible budgeting.

·  Flexible budgets divide costs into those that vary with units of production (or direct labor hours) and those that are fixed with respect to these unit-level drivers. These relationships allow the identification of a cost formula for each item in the budget.

·  Cost formulas are the means for calculating expected costs for various levels of activity. There are two applications of flexible budgets: before-the-fact and after-the-fact.

·  Before-the-fact applications allow managers to see what costs will be for different levels of activity, thus helping in planning.

·  After-the-fact applications allow managers to see what the cost should have been for the actual level of activity. Knowing these after-the-fact expected or budgeted costs then provides the opportunity to evaluate efficiency by comparing actual costs with budgeted costs.

LO2. Calculate the variable overhead variances, and explain their meaning.

·  Overhead costs are often a significant proportion of costs in a budget.

·  Comparing actual variable and fixed overhead costs with applied overhead costs yields a total overhead variance.

·  In a standard cost system, it is possible to break down these overhead variances into component variances.

·  For variable overhead, the two component variances are the spending variance and the efficiency variance.

·  The spending variance is the result of comparing the actual costs with budgeted costs.

·  The variable overhead efficiency variance is the result of efficient or inefficient use of labor because variable overhead is assumed to vary with direct labor hours.

LO3. Calculate the fixed overhead variances, and explain their meaning.

·  For fixed overhead, the two component variances are the spending variance and the volume variance.

·  The spending variance is the result of comparing the actual costs with budgeted costs.

·  The fixed overhead volume variance is the result of producing a level different than that used to calculate the predetermined fixed overhead rate. It can be interpreted as a measure of capacity utilization.

LO4. Prepare an activity-based flexible budget.

·  Activity-based budgeting (ABB) is done at the activity level.

·  First, demand for products is assessed.

·  Next, the level of activity output needed to support the expected production level is estimated.

·  Finally, the resources needed to support the required activity output are estimated. This then becomes the activity budget.

·  Activity flexible budgets differ from traditional flexible budgets because the cost formulas are based on the activity drivers for the respective activities rather than being based only on a single unit-based driver, such as direct labor hours.