Chapter 16 - Flexible budgets, variances and management control II

Question 1

What is a value-added cost?

Answer 1

A value-added cost is one that, if eliminated, would reduce the value customers obtain from using the product or service. A non-value-added cost is one that, if eliminated, would not reduce the value customers obtain from using the product or service. Consider it a continuum, many costs are in a grey area.

Question 2

1 What are the differences in the planning of variable-overhead costs and the planning of fixed-overhead costs?

Answer 2

Planning and control of variable manufacturing overhead costs has both a long-run and a short-run focus. It involves the company planning to undertake only value added overhead activities (a long-run view) and then managing the cost drivers of those activities in the most efficient way (a short-run view).

Planning and control of fixed manufacturing overhead costs has primarily a long-run focus. Planning of fixed-overhead costs includes undertaking only value-added fixed-cost activities and then determining the appropriate level of those activities, given the expected demand and the level of uncertainty pertaining to that demand

Question 3

How do we develop budgeted variable-overhead rates?

Answer 3

Step 1: Identify the costs to include in the variable-overhead cost pool(s)
Step 2: Select the cost allocation base(s)
Step 3: Estimate the budgeted variable-overhead rate(s)
Several approaches can be used in this step. One approach is to adjust the past actual variable-overhead cost rate per unit of the allocation base (e.g. adjust to take inflation into account). A second approach is to use standard costing.

Question 4

2 What is the spending and efficiency variances for variable overhead?

Answer 4

When the flexible budget for variable overhead is developed, a spending overhead variance and an efficiency variance can be calculated.
The variable-overhead spending variance is the difference between the actual amount of variable overhead incurred and the budgeted amount that is allowed for the actual quantity of the variable- overhead allocation base used for the actual output units achieved.
The variable-overhead efficiency variance measures the efficiency with which the cost-allocation base is used; this is a different type of efficiency variance from that calculated in Chapter 15 for direct-cost items, such as direct materials.

Question 5

2 Explain the computation of spending and efficiency variances for variable overhead

Answer 5

Variable-overhead efficiency variance = (actual units of variable-overhead cost allocation base used for actual output units achieved - budgeted units of variable-overhead cost allocation base allowed for actual output units achieved) * budgeted variable-overhead cost allocation rate
Variable-overhead spending variance = (actual variable-overhead cost per unit of cost allocation base - budgeted variable-overhead cost per unit of cost allocation base) * actual quantity of variable-overhead cost allocation base used for actual output units achieved

Question 6

3 How can we compute the budgeted fixed-overhead rate?

Answer 6

The budgeted fixed-overhead rate is calculated by dividing the budgeted fixed-overhead costs by the budgeted quantity of allocation base units.

Question 7

Why is the fixed-overhead flexible budget variance the same as the fixed-overhead static-budget variance and why is there no efficiency variance (level 3) and sales-volume variance (level 2)?

Answer 7

There is no ‘flexing’ of fixed costs.
For level 3 analysis, all of the flexible-budget variance is attributed to the spending variance because this is precisely why this variance arises for fixed costs. A manager cannot be more or less efficient in dealing with a given amount of fixed costs.
Budgeted fixed costs are, by definition, unaffected by sales-volume changes.
The amount of variable overhead allocated is always the same as the flexible-budget amount.

Question 8

What is the production volume variance and how does it arise?

Answer 8

The production volume variance is the difference between budgeted fixed overhead and the fixed overhead allocated. Fixed overhead is allocated based on the budgeted fixed overhead rate times the budgeted quantity of the fixed-overhead allocation base of the actual output units achieved. Also called denominator-level variance and output-level variance.
The production-volume variance arises whenever actual production differs from the denominator level used to calculate the budgeted fixed-overhead rate. We calculate this rate because stock costing and some types of contract require fixed-overhead costs to be expressed on a unit-of-output basis. The production-volume variance results from ‘unitising’ fixed costs. Be careful not to attribute much economic significance to this variance.

Question 9

How do we calculate the production-volume variance?

Answer 9

Production volume variance = budgeted fixed overhead - (budgeted quantity of fixed OH allocation base allowed for actual output units * budgeted fixed overhead rate)

Question 10

4 Give two reasons why the production-volume variance may not be a good measure of the opportunity cost of unused capacity

Answer 10

Production-volume variances are rarely a good measure of the opportunity cost of unused capacity. For example, the plant capacity level may exceed the budgeted level, hence some unused capacity may not be included in the denominator. Moreover, the production-volume variance focuses only on costs. It does not take into account any price changes necessary to spur extra demand that would in turn make use of any idle capacity.

Question 11

5 Explain how a 4-variance analysis can provide an integrated overview of overhead cost variances

Answer 11

A 4-variance analysis presents spending and efficiency variances for variable-overhead costs and spending and production-volume variances for fixed-overhead costs. By analysing these four variances together, managers can consider possible interrelationships among them. These variances collectively measure differences between actual and budgeted amounts for output level, selling prices, variable costs and fixed costs.

Question 12

What is a 3-variance analysis?

Answer 12

The two spending variances from the 4-variance analysis have been combined in the 3-variance analysis. The only loss of information in the 3-variance analysis is the overhead spending variance area – only one spending variance is reported instead of separate variable- and fixed-overhead spending variances. 3-Variance analysis is sometimes called combined variance analysis, because it combines variable- and fixed-cost variances when reporting overhead cost variances.

Question 13

What is a 2-variance and a 1-variance analysis?

Answer 13

The spending and efficiency variances from the 3-variance analysis have been combined under the 2-variance analysis. Hence, the two variances are the flexible-budget variance and the production-volume variance.
The single variance analysis is the sum of the flexible-budget variance and the production-volume variance i.e. total overhead variance.

Question 14

6 Explain the differing roles of cost allocation bases for fixed manufacturing overhead when (a) planning and controlling, and (b) valuing stock for financial reporting purposes

Answer 14

For planning and control, fixed manufacturing overhead is a lump sum that is unaffected by the budgeted quantity of the fixed-overhead allocation base. In contrast, for stock costing the unitised fixed manufacturing overhead rate will be affected by the budgeted quantity of the fixed-overhead allocation base.

Question 15

7 How can we prepare journal entries for variable- and fixed-overhead variances (and adjust for variances at the end of the accounting period)?

Answer 15

The separate analysis of variable- and fixed-overhead costs requires the use of separate variable- and fixed-overhead control accounts and separate variable- and fixed-overhead allocated accounts. At the end of each accounting period, any variances for variable- or fixed-overhead costs can be disposed as illustrated in Chapter 5 (adjusted allocation rate approach and the proration approach).
During the accounting period, actual variable-overhead and actual fixed-overhead costs are accumulated in separate control accounts. As each unit is manufactured, the budgeted variable- and fixed-overhead rates are used to record the amounts in the respective overhead allocated accounts.

Question 16

What three categories do managers often find it useful to classify costs into, from a planning and control standpoint?

Answer 16

Engineered costs - result specifically from a clear cause-and-effect relationship between costs and output. Each of these costs increase in a specific way as units manufactured increase. Can be variable of fixed costs (e.g. leasing a machine may be fixed in the short run)
Discretionary costs - have two important features: (1) they arise from periodic (usually yearly) decisions regarding the maximum outlay to be incurred, and (2) they have no clearly measurable cause-and-effect relationship between costs and outputs. There is often a delay between the acquisition of a resource and its eventual use. E.g. R&D, marketing, training… managers are seldom confident the ‘correct’ amounts are being spent.
Infrastructure costs - arise from having property, plant and equipment, and a functioning organisation. E.g. depreciation, long-run lease rental and the acquisition of long-run technical capabilities. The period between when infrastructure costs are committed to and acquired and when they are eventually used is very long. Careful long-range planning, rather than day-to-day monitoring, is the key to managing infrastructure costs. Frequently, there is also a high level of uncertainty about the outputs (cash inflows) resulting from the capital expenditure decisions.

Question 17

8 Explain how the flexible-budget variance approach can be used in activity-based costing

Answer 17

Flexible budgeting in activity-based costing systems enables insight into why activity costs differ from those budgeted.
ABC systems classify costs of various activities into a cost hierarchy – output-unit level, batch level, product sustaining, and facility sustaining. The basic principles and concepts for variable and fixed manufacturing overhead costs presented earlier in the chapter can be extended to ABC systems.

Question 18

What are three steps to calculating flexible budget and variance analysis for variable set-up overhead costs (ABC costing)?

Answer 18

Using batch-level costs in this example, variable set-up overhead costs.
Step 1: Using the budgeted batch size, calculate the number of batches that should have been used to produce the actual output
Step 2: Using budgeted set-up-hours per batch, calculate the number of set-up hours that should have been used
Step 3: Using the budgeted variable cost per set-up-hour, calculate the flexible budget for variable set-up overhead costs

Question 19

How do we calculate the flexible budget and variance analysis for fixed set-up overhead costs (ABC)?

Answer 19

For fixed overhead costs, the flexible-budget amount equals the static-budget amount. Hence, the fixed overhead spending variance is the same amount as the fixed over-head flexible-budget variance.
To calculate the production-volume variance, there are four steps.
Step 1: Choose the time period used to calculate the budget
Step 2: Select the cost-allocation base to use in allocating fixed overhead costs to the cost object(s)
Step 3: Identify the fixed overhead costs associated with the cost-allocation base
Step 4: Calculate the rate per unit of the cost-allocation base used to allocate fixed overhead costs to the cost object(s)

Question 20

How do we calculate the spending variance for variable manufacturing overhead?

Answer 20

(Actual variable-OH cost per unit of cost allocation base - Budgeted variable-OH cost per unit of cost allocation base)*Actual quantity of variable-OH cost allocation base used for actual output units