A note on "flexible budgets, variances and management control” terms (II)

A note on "flexible budgets, variances and management control” terms (II)

Briefly describe the following “flexible budgets, variances and management control” terms (II) in advanced management accounting study

(Terms used in Chapter 16)

 

1.    Planning of variable- and fixed-overhead costs

2.    Developing budgeted variable-overhead rates

3.    Variable-overhead cost variances

4.    Developing budgeted fixed-overhead rates

5.    Engineering, discretionary and infrastructure costs

6.    Financial and non-financial performance measures

7.    Actual, normal and standard costing

8.    Activity-based costing and variance analysis

 

These terms explain how managers plan overhead costs, convert plans into cost rates, analyse deviations from plan, and use the results for operational control. A flexible budget restates expected costs at the actual activity level, so it separates genuine cost-control issues from differences caused merely by output volume.

1–4. Overhead planning and rates

1.    Planning of variable- and fixed-overhead costs
Variable overheads—such as indirect materials, power, or machine supplies—are planned as a cost per activity unit (for example, per machine-hour). Fixed overheads—such as factory rent, supervisor salaries, and depreciation—are planned as a total amount for a period, normally unchanged within the relevant range of activity. This cost-behaviour distinction enables a budget to be flexed fairly to actual output.

2.    Developing budgeted variable-overhead rates
Estimate total variable overhead for the planning period and divide by the expected quantity of an appropriate allocation base, such as direct-labour hours or machine-hours:

Budgeted VOH rate=Budgeted variable overhead / Budgeted activity base

The resulting standard rate is used to calculate the variable overhead allowed for actual production.

3.    Variable-overhead cost variances
Variable overhead variance compares actual variable overhead with the amount that should have been incurred for actual output. It is commonly split into:

o   Spending (rate) variance: whether the business paid more or less than the standard variable-overhead rate for the actual activity used.

o   Efficiency variance: whether it used more or fewer activity-base hours than the standard hours allowed for actual output.

Thus,

VOH flexible-budget variance = Spending variance + Efficiency variance

An unfavourable variance signals higher-than-expected cost; a favourable variance signals lower-than-expected cost, though managers should investigate quality, capacity, and operational consequences before judging performance.

4.    Developing budgeted fixed-overhead rates
Divide total budgeted fixed manufacturing overhead by the budgeted quantity of the allocation base:

Budgeted FOH rate = Budgeted fixed overhead / Budgeted activity base

This predetermined rate applies fixed overhead to output for inventory costing and performance analysis. Because total fixed cost does not ordinarily change with short-run activity, a lower output level raises fixed cost per unit—not necessarily total fixed cost.

5–6. Cost types and control measures

5.    Engineering, discretionary and infrastructure costs
This classification helps determine how controllable a cost is and how it should be budgeted.

Cost type	Meaning	Examples	Management-control implication
Engineering costs	Costs with a clear, measurable physical or technical cause-and-effect relationship	Energy per machine-hour; materials per unit	Use standards, technical specifications, and efficiency variances
Discretionary costs	Costs set through managerial judgement rather than a precise short-run input–output formula	Advertising, training, R&D	Evaluate against objectives, milestones, and benefits—not only a spending variance
Infrastructure costs	Costs of maintaining organisational capacity and support systems	IT platforms, HR, facilities, senior management	Often committed in the short run; manage through periodic capacity and strategic reviews

6.    Financial and non-financial performance measures
Financial measures assess monetary results: profit, contribution margin, cost variances, ROI, residual income, cash flow, and revenue growth. Non-financial measures capture operational drivers of future financial results: defect rates, on-time delivery, customer satisfaction, employee turnover, cycle time, safety, and innovation. Good management control combines both: a unit can meet its cost target while harming quality or customer retention, which financial measures alone may miss.

7–8. Costing approaches and ABC

7.    Actual, normal and standard costing

Approach	Direct costs	Manufacturing overhead	Main use
Actual costing	Actual	Actual overhead rate	Historical reporting; limited timeliness
Normal costing	Actual	Predetermined overhead rate × actual activity	Timely product costing during the period
Standard costing	Standard quantities × standard prices/ rates	Standard overhead applied to standard activity allowed for actual output	Budgetary control and variance analysis

 

Under standard costing, actual costs are compared with standard costs, and the difference is reported as a variance. It is especially useful for diagnosing price/rate and efficiency/usage effects.

8.    Activity-based costing and variance analysis
Activity-based costing (ABC) assigns overhead through multiple activity cost pools and cost drivers—such as purchase orders, setups, inspections, or deliveries—rather than relying on one broad base such as labour-hours. In ABC variance analysis, managers calculate spending and efficiency variances for each activity, making the analysis more precise and revealing which operational process drives the deviation. For example, purchasing cost may be unfavourable because the firm processed more purchase orders than the standard allowed, even if labour-hours were on target.