The factory overhead budget is based on a flexible budget calculation as described in Exhibit 9-3. More specifically, the calculation is as follows: a. Budgeted Factory Overhead Costs = Budgeted Fixed Overhead + (Budgeted Variable Overhead Rate)(D.L. Hours needed for Production from 4a) This is a cumulative equation that combines the equations for the company's various types of indirect resources. This same idea was illustrated in Chapter 4 when introducing predetermined overhead rates. The predetermined overhead rates developed in Chapter 4 and the budgeted overhead rates discussed in this chapter are conceptually the same. A plant wide rate based on direct labor hours is used as the overhead allocation basis in this chapter and subsequent chapters mainly to simplify the illustrations. Keep in mind however, that although many companies are still using a single production volume based measurement for overhead allocations, most companies use departmental rates and many companies are now using activity based rates. The calculation for cash payments reflects one of the differences between cash flows and accrual accounting. Since some costs, like depreciation, do not involve cash payments in the current period, these costs must be subtracted from the total overhead costs to determine the appropriate amount. b. Cash Payments for Overhead = Budgeted Factory Overhead Cost - Depreciation and other costs that do not require cash payments Alternative Calculation for Budgeted Factory Overhead Costs Although budgeted factory overhead costs can be calculated in the manner presented above, there is an alternative approach that illustrates the difference between budgeted and standard costs. Budgeted factory overhead costs can be calculated by determining the standard factory overhead costs and then adjusting for the planned production volume variance. The planned production volume variance is similar to the capacity (or idle capacity) variance illustrated in Chapter 4. It is the difference between the denominator inputs used to calculate the overhead rates, i.e., direct labor hours in our example, and the budgeted direct labor hours needed for production, multiplied by the budgeted fixed overhead rate. The alternative calculation for factory overhead costs is: Budgeted factory overhead costs = (Total budgeted overhead rate per hour)(D.L. hours needed for production from 4a) + Unfavorable planned production volume variance or - Favorable planned production volume variance Multiplying the total overhead rate by the number of direct labor hours needed for production provides the standard or applied overhead costs. However, if the number of direct labor hours needed for planned production (i.e., budgeted hours) is not equal to the number of hours used to calculate the overhead rates (i.e., denominator hours), then standard fixed overhead costs will not be equal to budgeted fixed overhead costs. The difference is the planned production volume variance. This is illustrated graphically in Figure 9-1. Since the difference is caused by the way fixed overhead costs are treated, it can be illustrated by comparing standard fixed overhead costs with budgeted fixed overhead costs. Figure 9-1 shows that if planned or budgeted hours (BH1) are less than denominator hours (DH), the planned production volume variance (PPVV) is unfavorable and represents underapplied fixed overhead. However, if planned or budgeted hours (BH2) are greater than denominator hours (DH), then the planned production volume variance (PPVV) is favorable and represents overapplied fixed overhead. The difference between budgeted and standard total factory overhead costs can be illustrated by simply adding variable overhead costs to the graph. Since budgeted and standard variable overhead costs are always equal at any level of production, the difference between standard and budgeted total overhead costs is the same as the difference between standard and budgeted fixed overhead costs. The difference is the planned production volume variance. This is illustrated in Figure 9-2 Summary of the PPVV Concept At any particular level of production, e.g., 1,000 hours, budgeted and standard variable overhead costs are always equal. However, budgeted and standard fixed overhead costs are only equal when the budgeted hours planned for the month are equal to the denominator hours used to calculate the overhead rates. The difference between the budgeted hours planned and the denominator hours, multiplied by the fixed overhead rate is the difference between budgeted and standard fixed overhead costs as well as the difference between budgeted and standard total overhead costs. When working with a budget this difference is referred to as the planned production volume variance. 6. ENDING INVENTORY BUDGET The dollar amount for the ending inventory of finished goods is needed below to determine cost of goods sold. The dollar amounts for ending direct materials and finished goods are needed for the balance sheet. a. Ending Direct Materials = (Desired Ending Materials from 3b)(Budgeted Prices) b. Budgeted or Standard Unit Cost = (Quantity of D.M. required per Unit)(Budgeted Prices) + (D.L. Hours required per Unit)(Budgeted Rate) + (Total Overhead Rate)(D.L. Hours required per Unit) The budgeted or standard unit cost can be calculated at any time after the budgeted quantities per unit and input prices are obtained. The calculation is placed here because it is needed for 6c. c. Ending Finished Goods = (Desired Ending Finished Goods from 2)(Budgeted Unit Cost) 7. COST OF GOODS SOLD BUDGET Cost of goods sold is needed for the income statement. One method of determining budgeted COGS involves accumulating the amounts from the previous sub-budgets as follows. a. Budgeted Total Manufacturing Cost = Cost of Direct Material Used (from 3d.) + Cost of Direct Labor Used (from 4b.) + Total Factory Overhead Costs (from 5a.) b. Budgeted Cost of Goods Sold = Budgeted Total Manufacturing Cost (from 7a.) + Beginning Finished Goods (from previous ending or calculate from 2 and 6b) - Ending Finished Goods (from 6c or calculate from 2 and 6b) This is the same approach used in Chapter 2 to determine cost of goods sold, but when developing a budget we typically assume no change in Work in Process. Therefore, budgeted cost of goods manufactured is equal to budgeted cost of goods sold. Alternative Calculation for Budgeted Cost of Goods Sold Budgeted cost of goods sold can also be calculated by determining standard cost of goods sold, and then adjusting for the planned production volume variance. The alternative calculation for cost of goods sold is: Budgeted Cost of Goods Sold = (Budgeted unit sales)(Budgeted unit cost) + Unfavorable planned production volume variance or - Favorable planned production volume variance Although budgeted unit cost equals standard unit cost, budgeted cost of goods sold is not equal to standard cost of goods sold. Again, the difference between standard and budgeted costs is the production volume variance. There are two reasons to become familiar with this alternative. First, it helps strengthen your understanding an important concept that appears again in subsequent chapters, e.g., Chapters 10 and 12. A second reason is that the alternative approach provides a much faster way to calculate budgeted cost of goods sold. Therefore it can be used as a stand alone method, or as a way to check the accuracy of your calculations in 7a and b. You may wonder why a company would plan a production volume variance in the budget. This occurs because the denominator activity for a particular month is normally the average monthly production based on one twelfth of the planned production for the entire year. The denominator may also be an average based on normal, practical, or theoretical maximum capacity for the year. When the planned production for a particular month is higher or lower than the monthly average, a planned production volume variance results. Actual production volume variances also occur as we shall see in the next chapter. 8. SELLING & ADMINISTRATIVE EXPENSE BUDGET The preparation of the selling and administrative expense budgets is very similar to the approach used for factory overhead. a. Budgeted Selling and Administrative Expenses = Budgeted Fixed Selling & Administrative Expenses + (Bud Variable Rate as a Proportion of Sales $)(Budgeted Sales $) b. Cash Payments for Selling & Administrative Expenses = Budgeted Selling & Administrative Expenses - Depreciation and other cost which do not require cash payments Although we will place less emphasis on this part of the master budget, (mainly to simplify the illustrations) these costs are usually significant. Also remember that many appropriation budgets (treated as fixed costs) may be included, particularly for certain administrative costs. In addition, as pointed out earlier in the text, a more precise traceable costing approach might be used for management purposes where some selling and administrative costs are allocated (i.e., traced to products) in determining a more precise product cost. Remember however, that selling and administrative costs are treated as expenses (period costs) in the conventional inventory valuation methods. Manufacturing overhead budget | Overhead budget Manufacturing Overhead Budget Definition The manufacturing overhead budget contains all manufacturing costs other than the costs of direct materials and direct labor (which are itemized separately in the direct materials budget and the direct labor budget). The information in the manufacturing overhead budget becomes part of the cost of goods sold line item in the master budget. Also, the total of all costs in this overhead budget are converted into a per-unit overhead allocation, which is used to derive the cost of ending finished goods inventory, and which in turn is listed on the budgeted balance sheet. The information in this budget is among the most important of the various departmental budget models, since it may contain a large proportion of the total amount of a company's expenditures. This budget is typically presented in either a monthly or quarterly format. Example of the Manufacturing Overhead Budget Delphi Furniture produces Greek-style furniture. It budgets the wood raw materials and cost of its artisans in the direct materials budget and direct labor budget, respectively. Its manufacturing overhead costs are outlined as follows: Delphi Furniture Manufacturing Overhead Budget For the Year Ended December 31, 20XX
Quarter 1 Quarter 2 Quarter 3 Quarter 4
Administrative salaries $142,000 $143,000 $144,000 $145,000 Administrative payroll taxes 10,000 10,000 11,000 11,000 Depreciation 27,000 27,000 29,000 29,000 Freight in and out 8,000 7,000 10,000 9,000 Rent 32,000 32,000 32,000 34,000 Supplies 6,000 5,000 7,000 6,000 Travel and entertainment 3,000 3,000 3,000 3,000 Utilities 10,000 10,000 10,000 12,000 Total manufacturing overhead $238,000 $237,000 $236,000 $237,000 The administrative salaries line item contains the wages paid to manufacturing supervisors, the purchasing staff, production clerks, and logistics planning staff, and gradually increases over time to reflect changes in pay rates. The depreciation expense is relatively fixed, though there is an increase in the third quarter that reflects the purchase of new equipment. Both the freight and supplies expenses are closely linked to actual production volume, and so their amounts fluctuate in conjunction with planned production levels. The rent expense is a fixed cost, but does increase in the fourth quarter to reflect a scheduled rent increase. The budget could also include a calculation of the overhead rate. For example, direct labor hours could be included at the bottom of the budget, which are divided into the total manufacturing overhead cost per quarter to arrive at the allocation rate per direct labor hour. Much of the information in this budget can be estimated from historical results, if the types of products manufactured and production volumes do not vary significantly from prior periods. Other Manufacturing Overhead Budget Issues A less-common format for the overhead budget is to group the line items into fixed and variable expense classifications. It can be difficult to determine the fixed or variable status of a cost, in which case you can add a third cost grouping for mixed costs that contain both fixed and variable cost characteristics. Separate treatment of variable expenses is useful if you want to create a flexible budget, where the budgeted amount of variable costs change to match the amount of actual revenues earned. In a simplified budgeting environment, the overhead budget may be as simple as an overhead rate that is multiplied by some form of activity, such as direct labor hours or machine time used. This approach is generally not recommended, since it does not reveal the precise nature of the various types of expenses incorporated into the overhead rate, and could even be used by a less ethical manager to increase his manufacturing budget without making it visible to the rest of the management team. Given the considerable size of the expenditures in this budget, one must guard against the inclusion of an incorrect figure, since the result could be a seriously incorrect overall budget. One way to spot incorrect numbers is to match the budgeted totals by period against the actual amounts incurred for the same periods in the immediately preceding year, for reasonableness. It is not customary to include a cash requirements calculation as part of the manufacturing overhead budget. Instead, the cash requirements are calculated for all of the revenues and expenditures of a business as a whole, and are then summarized on a separate page of the budget. Similar Terms The manufacturing overhead budget is also known as the manufacturing budget, the factory overhead budget, and the overhead budget.
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