FLEXIBLE BUDGETS, OVERHEAD COST VARIANCES, AND
Effective planning of variable overhead costs involves:
Planning to undertake only those variable overhead activities that add value for
customers using the product or service, and
Planning to use the drivers of costs in those activities in the most efficient way.
At the start of an accounting period, a larger percentage of fixed overhead costs are
locked-in than is the case with variable overhead costs. When planning fixed overhead costs, a
company must choose the appropriate level of capacity or investment that will benefit the
company over a long time. This is a strategic decision.
The key differences are how direct costs are traced to a cost object and how indirect costs
are allocated to a cost object:
× Actual inputs used
× Standard inputs allowed for actual output
Actual indirect rate
× Actual inputs used
Standard indirect cost-allocation rate
× Standard quantity of cost-allocation base
allowed for actual output
Steps in developing a budgeted variable-overhead cost rate are:
Choose the period to be used for the budget,
Select the cost-allocation bases to use in allocating variable overhead costs to the
Identify the variable overhead costs associated with each cost-allocation base, and
Compute the rate per unit of each cost-allocation base used to allocate variable
overhead costs to output produced.
Two factors affecting the spending variance for variable manufacturing overhead are:
a. Price changes of individual inputs (such as energy and indirect materials) included in
variable overhead relative to budgeted prices.
b. Percentage change in the actual quantity used of individual items included in variable
overhead cost pool, relative to the percentage change in the quantity of the cost driver
of the variable overhead cost pool.
Possible reasons for a favorable variable-overhead efficiency variance are:
Workers more skillful in using machines than budgeted,
Production scheduler was able to schedule jobs better than budgeted, resulting in
Machines operated with fewer slowdowns than budgeted, and
Machine time standards were overly lenient.