Chapter 9 - Outline

Chapter 9 - Outline - Chapter 9 Flexible Budgets &...

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Chapter 9 Key Concepts Flexible Budgets (Exhibit 9-3) Fixed Overhead Analysis o Denominator Activity o Normal Cost System vs. Standard Cost System (Exhibit 9-9) o Variance Analysis (Exhibit 9-10) Flexible Budgets – Introduction We have previously been dealing with static budgets (i.e. they represent costs at a single level of activity. Examples of static budgets would be the sales budget, the production budget and the cash budgets from Chapter 7. The problem with static budgets is that the actual activity level assumed in the static budget rarely coincides with the original activity level assumed in the static budget. As a result, static budgets should not be used to evaluate how well costs have been contained. For example, if the activity level is higher than was assumed in the original budget then variable costs should be higher than originally budgeted. Solution is the use of a Flexible Budget. What’s a Flexible Budget? A flexible budget is geared to a wide range of activity rather than to a single level of activity. Please review Exhibit 9-3 below: 1
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Exhibit 9-3 Flexible Budget The flexible budget incorporates a cost formula for the variable costs. Key Features of a Flexible Budget 1. The flexible budget is a dynamic tool. It can be used to quickly develop a budget for any level of activity within its relevant range. The variable costs are adjusted by multiplying the cost per unit by the activity level. Fixed costs remain unchanged within the relevant range. 2. The activity base underlying the flexible budget must be carefully chosen. There are three general criteria used for selecting an activity base: 2
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a. The flexible budget assumes that variable costs change in proportion to changes in the activity base, so the activity base should actually drive the variable costs. b. The activity base should not be expressed in dollars. For example, direct labor cost should not be used as an activity base. A change in the labor wage rate would change the measure of activity, but would have little real effect on variable costs such as the cost of supplies. c. The activity base should be simple and easy to understand. Flexible Budget Performance Report – The flexible budget performance report is used to evaluate how well costs were controlled. It consists of the following elements: 1. Compute the amount for each variable cost in the flexible budget by multiplying its cost per unit by the level of activity for the period. 2. If the actual activity is within the relevant range, the fixed cost amounts are constant and can be copied from the static budget. 3. Variances are computed for each of the costs. If the actual cost exceeds the flexible budget cost for the actual level of activity, the variance is unfavorable . If the actual cost is less than the flexible budget cost for the actual level of activity, the variance is favorable . 4.
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Chapter 9 - Outline - Chapter 9 Flexible Budgets &...

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