Controlling overhead costs is a major preoccupation of managers in business, in government, and in not-for-profit organizations. Overhead is a major cost, if not the major cost, in many organizations. For example, it costs Microsoft very little to make copies of its software for sale to customers; almost all of Microsoft's costs are in research and development and marketing—elements of overhead. Or consider Disney World. The only direct cost of serving a particular guest is the cost of the food the guest consumes at the park; virtually all of the other costs of running the amusement park are overhead. Even Boeing, a manufacturer, has huge amounts of overhead in the form of engineering salaries, buildings, insurance, administrative salaries, and marketing costs.

LO1 Prepare a flexible budget and explain the advantages of the flexible budget approach over the static budget approach.
A flexible budget shows what costs should be as a function of the level of activity. A flexible budget provides a better benchmark for evaluating how well costs have been controlled than the static budget approved at the beginning of the period. Some costs should be different from the amounts budgeted at the beginning of the period simply because the level of activity is different from what was expected. The flexible budget takes this fact into account, whereas the static budget does not.

LO2 Prepare a performance report for both variable and fixed overhead costs using the flexible budget approach.
A flexible budget performance report compares actual costs to what the costs should have been, given the actual level of activity for the period. Variable costs are flexed (i.e., adjusted) for the actual level of activity. This is done by multiplying the cost per unit of activity by the actual level of activity. Fixed costs, at least within the relevant range, are not adjusted for the level of activity. The total cost for a fixed cost item is carried over from the static budget without adjustment.

LO3 Use a flexible budget to prepare a variable overhead performance report containing only a spending variance.
The spending variance for a variable overhead expense is computed by comparing the actual cost incurred to the amount that should have been spent, based on the actual direct labor-hours or machine-hours of the period.

LO4 Use a flexible budget to prepare a variable overhead performance report containing both a spending and an efficiency variance.
As stated above, the spending variance for a variable overhead expense is computed by comparing the actual cost incurred to the amount that should have been spent, based on the actual direct labor-hours or machine-hours of the period. The efficiency variance is computed by comparing the cost that should have been incurred for the actual direct labor-hours or machine-hours of the period to the cost that should have been incurred for the actual level of output of the period.

LO5 Compute the predetermined overhead rate and apply overhead to products in a standard cost system.
In a standard cost system, overhead is applied to products based on the standard hours allowed for the actual output of the period. This differs from a normal cost system in which overhead is applied to products based on the actual hours of the period.

LO6 Compute and interpret the fixed overhead budget and volume variances.
The fixed overhead budget variance is the difference between the actual total fixed overhead costs incurred for the period and the budgeted total fixed overhead costs. This variance measures how well fixed overhead costs were controlled.

The fixed overhead volume variance is the difference between the fixed overhead applied to production using the predetermined overhead rate and the budgeted total fixed overhead. A favorable variance occurs when the standard hours allowed for the actual output exceed the hours assumed when the predetermined overhead rate was computed. An unfavorable variance occurs when the standard hours allowed for the actual output are less than the hours assumed when the predetermined overhead rate was computed.

After studying Chapter 9, you should be able to:

L01 Prepare a flexible budget and explain the advantages of the flexible budget approach over the static budget approach.

L02 Prepare a performance report for both variable and fixed overhead costs using the flexible budget approach.

L03 Use a flexible budget to prepare a variable overhead performance report containing only a spending variance.

L04 Use a flexible budget to prepare a variable overhead performance report containing both a spending and an efficiency variance.

L05 Compute the predetermined overhead rate and apply overhead to products in a standard cost system.

L06 Compute and interpret thefixed overhead budget and volume variances.