Chapter 14: The Flexible Budget and Factory Overhead
CHAPTER 14: FLEXIBLE-BUDGETSFACTORY OVERHEAD
QUESTIONS
14-1a.Yes, the factory manager has done a good job in
controlling factory overhead costs if all factory overhead costs
are fixed. Even though the actual production is only at the 85
percent level of the budgeted production level, the total fixed
factory overhead should remain unchanged as long as the operation
falls within the relevant range of operations.
b. No, the total factory overhead cost incurred during the
period should have been less than the budgeted amount. The variable
factory overhead cost should have been approximately 85 percent of
the budgeted variable factory overhead, or $51,000, and the total
factory overhead around $71,000.
14-2Both the variable factory overhead efficiency variance and
the direct labor efficiency variance will be in the same direction.
The variable factory overhead efficiency variance will be favorable
if the firm has a favorable direct labor efficiency variance and
unfavorable if its direct labor efficiency variance is
unfavorable.
Furthermore, the relative amount of the variable factory
overhead efficiency variance to the direct labor efficiency
variance will be the same as the ratio of the variable factory
overhead rate per direct labor hour to the standard hourly wage
rate per direct labor hour.
14-3The total factory overhead spending variance is a term used
in a 3-variance analysis of the total overhead variance to
represent the sum of the variable overhead spending variance and
the fixed overhead spending variance.
The determination of the variable factory overhead efficiency
variance is independent of the procedure or factors involved in
determining any of the factory overhead spending variances.
14-4 A factory overhead flexible-budget variance is the
difference between the amount of factory overhead incurred in a
period and the flexible-budget for factory overhead based on output
(i.e., based on units produced or, equivalently, based on standard
activity units allowed for the output of the period). This variance
is also referred to as the controllable (overhead) variance. This
variance can be decomposed into three variances: fixed overhead
spending variance; variable overhead spending variance; and,
variable overhead efficiency variance.
14-5Any significant variance, be it favorable or unfavorable,
should be investigated. It might be argued that significant
favorable variances should not be investigated since such variances
serve to increase operating income for the period. Nonetheless, an
organization would be more likely to benefit from the good fortune
in the future if it knows the factors that led to the favorable
variance. Thus, managers should also investigate the cause or
causes that led to all significant variances, whether they are
favorable or unfavorable.14-6The total factory overhead can be the
same as the standard amount allowed for the current periods output
while one or more of the components of the total factory overhead
have significant variances. For example, a firm can have a
substantial unfavorable factory overhead flexible-budget variance
and an approximately equal favorable production volume variance.
The contributing factors to the unfavorable factory overhead
flexible-budget variance and to the favorable production volume
variance are likely to be different. Unless corrected, factors that
led to the significant unfavorable overhead flexible-budget
variance of a period may continue into the future with the
consequence that the organization continues to suffer from
unfavorable flexible-budget variances.
14-7Among reasons that a firm may use a 2-variance instead of
3-variance or 4-variance analysis of overhead variances are:
Information provided by the simpler 2-variance analysis is
thought to meet the needs of management, that is, the information
is thought to be good enough.
The firms accounting system does not support the detailed data
needed for a 3-variance or 4-variance analysis.
It is too costly to generate additional data needed for a more
detailed analysis.
A more detailed analysis confuses users of accounting
reports.
Total overhead costs are not significant in a relative
sense.
14-8This question pertains to text Exhibits 14.1 and 14.3. As
indicated in Exhibit 14.1, the amount of variable overhead applied
to production for a period (product-costing purpose) is exactly
equal to the amount of variable overhead in the flexible-budget
based on outputs (control purpose). In short, there is no
difference between the total variable factory overhead applied to
the units manufactured and the total standard variable factory
overhead in the control budget for the period.
However, as indicated in Exhibit 14.3, the amount of fixed
factory overhead in the flexible-budget is likely to be different
from the amount of fixed factory overhead assigned to production
for the period. The flexible-budget for fixed overhead includes a
lump-sum amount (control purpose) while the amount of fixed
overhead applied to production is equal to the product of a
predetermined (i.e., standard) fixed overhead allocation rate and
the standard allowed activity units for the production in the
period. The difference is a result of the discrepancy between the
activity units assumed when the fixed overhead application rate was
determined, what we call the denominator activity level, and the
number of units actually manufactured during the period. In short,
when dealing with fixed factory overhead, the (lump-sum) amount
used for control purposes and the amount applied to production will
be identical only if the actual output of the period exactly equals
the denominator activity level. 14-9Even though the denominator
level a firm selected determined the fixed factory overhead
application rate, the selected denominator level has no effect on
either the amount or the direction of the fixed factory overhead
flexible-budget variance for the operation. The fixed factory
overhead flexible-budget variance for a period is the difference
between the actual fixed factory overhead cost and the budgeted
fixed factory overhead cost for the period. Neither of these
amounts is affected by the fixed factory overhead application rate
for the period; both can be thought of as being lump-sum
amounts.
The production volume variance of a period is the difference
between the budgeted fixed factory overhead (lump-sum amount) and
the total fixed factory overhead applied to production of the
period based on the fixed factory overhead application rate.
Consequently, the production volume variance is directly a function
of the selected denominator level assumed when the application rate
was developed. A high denominator level increases an otherwise
unfavorable production volume variance (or decreases an otherwise
favorable volume variance). On the other hand, a low denominator
level increases an otherwise favorable production volume variance
(or decreases an otherwise unfavorable production volume
variance).
14-10A price variance is the difference between the actual price
paid to acquire a resource and the standard cost for the resource.
The standard costs to acquire factory overhead items are not used
in calculating factory overhead variances. In its place, one or
more activity measures such as direct labor hours, machine hours,
number of set-ups, and number of orders are used in the
calculations of factory overhead variances. These costs are not
standard costs for the acquisitions of the factory overhead items.
It is precisely because of this reason that we refer to overhead
spending, and not overhead cost, variances. If spending on variable
overhead cost is different from planned, the accountant can perform
an analysis for individual variable overhead costs, such as
electricity. Note, however, that this would require more detailed
information: standard electricity cost per kilowatt hour and
standard number of kilowatts per unit produced.
The variable overhead efficiency variance, a component of the
total overhead variance for the period, is the result of
inefficient (or efficient) uses of the activity measure used to
construct the flexible (control) budget for the period for the
factory overhead; it is not a result of using more (or less) than
the standard amount of individual factory overhead costs. That is,
the variable overhead efficiency variance is controlled by
controlling the use of the activity variable, not individual
variable overhead components. Finally, note that the variable
overhead efficiency variance each period is likely attributed in
part to the imperfect relationship between the activity variable
chosen and the incurrence of variable overhead costs.
14-11Possible contributing factors to a variable overhead
spending variance include:
Prices paid to acquire one or more variable factory overhead
items differ from those specified as standard prices.
Quantities of one or more factory overhead items used in the
operation differ from the standard quantity as determined by the
activity measure for applying factory overhead.
14-12Because an alternative activity measure usually is used as
the basis for applying factory overhead to production, a variable
factory overhead efficiency variance can be a result of
efficiencies or inefficiencies regarding the use of this activity
measure. For example, a favorable factory overhead efficiency
variance for a firm that uses machine hours to apply factory
overhead can be a result of the firms use of fewer machine hours
than the standard machine hours for the units manufactured. In
short, the variable overhead efficiency variance does not measure
efficiency regarding consumption of variable overhead costs
(electricity, indirect labor, etc.); it represents an impact on
variable overhead cost of efficiency or inefficiency in the use of
the activity measure used to construct the flexible-budget.
14-13A fixed factory overhead spending variance is defined as
the difference between the actual fixed factory overhead and the
budgeted fixed factory overhead for the period. A fixed factory
overhead spending variance can be a result of unanticipated changes
in spending, for example: A factory manager was given a bonus or
raise that was not in the original budget.
New machinery and equipment, with attendant depreciation
charges, was acquired during the period but not envisioned in the
original budget for the period.
Clean-up fees or expenses for an unexpected accident.
Failure to properly forecast property taxes for the year (such
forecasts are embodied in the fixed overhead budget for the coming
year).
Insurance premiums for factory and equipment were different than
anticipated.
Additional salaried employees, not envisioned when the original
budget was prepared, were added during the period.
14-14A production volume variance results when actual output
differs from the output level assumed when the fixed overhead
application rate was developed. Among reasons for this discrepancy
are:
Unexpected stoppage or slowdown of operations because of
unscheduled equipment maintenance, strike, or workers
slow-down.
Changes in market demand for the products of the firm.
Lost (decreased) production traceable to poor-quality materials
purchased and used in production during the period.
Poor production scheduling.
Choice of denominator activity level (e.g., if budgeted
activity, rather than practical capacity, is used, the amount of
the production volume variance will likely be smallerin the
extreme, it would be zero).
14-15The denominator activity level refers to the size of the
denominator when determining the standard fixed overhead
application rate for product-costing purposes. Various options for
the volume of the denominator are possible, including budgeted
volume, practical capacity, and theoretical capacity. Most writers
today recommend the use of practical capacity for at least two
reasons:
logical consistency between the numerator and denominator in the
determination of the fixed overhead allocation ratethe numerator
represents spending for the amount of capacity (resources)
available while the denominator represents, in practical terms, the
amount of capacity available.
The resulting volume variance for a period can be thought of as
a measure of capacity utilization and, as such, can be used to
inform managerial judgments regarding the spending on and
utilization of manufacturing support resources (i.e., overhead
items).
14-16Among characteristics that distinguish service firms from
manufacturing firms are:
1. Absence of output inventory
2. Predominance of fixed costs
3. Labor-intensiveness, and
4. Lack of a common measure for outputs
The production volume of a service firm always equals its sales
volume because it has no output inventory. A production volume
variance is not a result of changes in inventory levels as in the
case of some manufacturing firms. The production volume variance of
a service firm measures direct effects that deviations from the
planned activity have on the revenue and operating income of the
period.
Predominance of fixed costs in the total cost structure of many
service firms makes fixed overhead variances important variances
for managers to monitor. Improvements or deteriorations in
operating results often are the result of productive or
unproductive uses of resources whose costs are fixed in the short
run.
Labor-intensiveness increases the importance of labor-related
measures such as labor rate and efficiency variances. Many service
firms do not measure materials variances because of the relative
insignificance of materials in their operations.
Lack of a common measure for the output of a service firm often
leads management of the firm to rely primarily on input-based
performance measures. With each patient requiring different care,
for example, hospitals often use one or more input measures such as
number of patient-days, number of admissions/discharges, and number
of procedures performed as the basis for activity analysis and
construction of flexible (control) budgets.
14-17Many firms no longer track and report direct materials
price variances because of the importance and advantages of
maintaining long-term relationships with suppliers. Long-term
contractual agreements with suppliers stress reliability of on-time
delivery of quality materials or components at an agreed-upon price
structure. Thus, price variances for material purchases should be
small in amount.
Furthermore, favorable price variances often result from
purchasing materials either in large quantities or of low quality.
A favorable price variance obtained through either practice can
substantially increase the total costs to the firm.
14-18If a standard cost system is used, variances related to
overhead costs can be recorded formally in the accounting records.
Such variances, however, are considered temporary accounts, which
at the end of the year must be closed out. There are two primary
methods for doing this at the end of the year:
(1)Closing the net variance to cost of goods sold (for example,
if the net overhead variance is favorable, then the CGS account
would be decreased, that is credited, at the end of the year). This
practice can be defended for several reasons. One, it is the most
expedient (and therefore least costly) method to use. Two, one can
argue that the incremental information that results from the
more-complicated proration (allocation) method is small relative to
cost involved. Three, some accountants would argue that variances
inherently represent inefficiencies and, as such, should not be
carried forward on the balance sheet (through adjustment to
inventory accounts). Four, when companies maintain minimal
inventories, the bulk of the adjustment for the period under the
proration method would go to the CGS account anyway.
(2)Prorating (allocating) the variance among accounts that
contain standard manufacturing costs. For factory overhead costs,
this means that the net variance can be allocated among WIP
inventory, Finished Goods Inventory, and Cost of Goods Sold (CGS)
based on the amount of the current periods standard overhead costs
contained in the end-of-period balance in these accounts. Note that
when we expand the analysis to include direct materials, any price
variance that occurs during the period should be allocated to the
materials inventory account, the materials quantity (efficiency)
variance, the WIP Inventory account, the Finished Goods Inventory
account, and CGS. Similarly, any fixed overhead spending variance
should, in theory, be partially allocated to the production volume
variance for the period. The proration method is required in some
contexts (e.g., any government contract work for which the
contractor must comply to the standards set by the Cost Accounting
Standards Board [CASB]). Others would defend this approach because
the resulting data approximate actual-cost results.
One variation of the allocation method is to use the total
end-of-period dollar balance (not standard costs from this period)
in relevant accounts to determine allocation percentages. This
method is simpler to implement, but would result in a different
end-of-year allocation of the net manufacturing cost variance for
the year compared to the conceptually correct method noted
above.
14-19Factors that need be considered include:
Magnitude of the variance
Trend of the variance over time
Likelihood that an investigation will eliminate future
occurrences of the variance
Cost and benefit of investigating the variance
BRIEF EXERCISES
14-20The budgeted supervisory salary per month is:
Thus, the flexible-budget variance for the production
supervisory salaries in August is:
$29,000 $30,000 = $1,000 favorable14-21Standard indirect labor
cost per unit:
Total actual indirect labor cost incurred in April
$10,100
Total standard indirect labor cost for the 4,500 units
manufactured in April: 4,500 units x $2.40/units =
10,800Indirect labor flexible-budget variance
$ 700 F14-22Fixed overhead variances for the year:
(a) Spending Variance = Actual fixed overhead costs Budgeted
fixed overhead
= $245,000 $250,000 = $5,000F(b) Production Volume Variance =
Budgeted fixed overhead Applied fixed overhead
= $250,000 (20,000 units x 2 hrs./unit x $5/hr.)
= $250,000 $200,000 = $50,000U
or, = (denominator activity volume SQ) x fixed overhead
rate/machine hr.
= (50,000 hrs. 40,000 hrs.) x $5.00/hour = $50,000U
or, = (denominator output volume actual units produced) x fixed
overhead rate/unit produced
= (25,000 units 20,000 units) x $10.00/unit = $50,000U
That is, fixed overhead was underapplied by $50,000 during the
period.
14-23Variable overhead variances for the year:
(a) Spending variance = Actual variable overhead -
Flexible-budget based on Inputs
= ($3.90/unit x 20,000 units) (41,000 hours. x $2.00/hr.)
= $78,000 $82,000
= $4,000F
or, = AQ x (AP SP)
= 41,000 hrs. x ($1.90244 $2.00)/hr.
= $4,000F (rounded)
(b) Efficiency variance = Flexible-budget based on Inputs
Flexible-budget based on output
= $82,000 (20,000 units x 2 hrs./unit x $2.00/hr.)
= $82,000 $80,000
= $2,000U
or,= SP x (AQ SQ)
= $2.00/hr. x (41,000 40,000)
= $2,000U14-24Summary journal entries for the year:
Actual Overhead Costs
Dr. Factory Overhead
$323,000
Cr. Accumulated DepreciationFactory
$150,000
Cr. Salaries Payable
$ 95,000
Cr. Utilities Payable
$ 78,000
Overhead Costs Applied to Production
Dr. WIP Inventory (20,000 units x 2 hrs. x
$7.00/hr.)$280,000
Cr. Factory Overhead
$280,000
14-25To Record Factory Overhead Variances
Dr. Production Volume Variance
$50,000
Dr. Variable Overhead Efficiency Variance
$ 2,000
Cr. Variable Overhead Spending Variance
$ 4,000
Cr. Fixed Overhead Spending Variance
$ 5,000
Cr. Factory Overhead
$43,000
14-25 (Continued)
To Close the Net Overhead Variance to CGS at Year-End
Dr. CGS
$43,000
Dr. Variable Overhead Spending Variance
$ 4,000
Dr. Fixed Overhead Spending Variance
$ 5,000
Cr. Production Volume Variance
$50,000
Cr. Variable Overhead Efficiency Variance
$ 2,000
14-26To Allocate the Net Factory Overhead Variance at
Year-End
Dr. WIP Inventory (10% of $43,000)
$ 4,300
Dr. Finished Goods Inventory (20% of $43,000)$ 8,600
Dr.CGS (70% x $43,000)
$30,100
Dr. Variable Overhead Spending Variance
$ 4,000
Dr. Fixed Overhead Spending Variance
$ 5,000
Cr. Production Volume Variance
$50,000
Cr. Variable Overhead Efficiency Variance
$ 2,000
14-27 Factory Overhead Variance: Two-Variance Decomposition
(a) Total Overhead Variance = actual overhead - overhead applied
to production
= $323,000 (20,000 units x 2 hrs./unit x $7.00/hr.)
= $323,000 $280,000
= $43,000U
(b) Total Flexible-budget Variance = Actual overhead
Flexible-budget for Overhead based on Output
= $323,000 [($2/hr. x 2hrs./unit x 20,000 units) + $250,000]
= $323,000 $330,000= $7,000F
or, = Variable overhead flexible-budget variance + fixed
overhead flexible-budget variance
= [$78,000 (20,000 x $2 x 2)] + [$245,000 $250,000]
= $2,000F + $5,000F = $7,000F
(c) Production Volume variance = budgeted fixed overhead -
applied fixed overhead
= $250,000 (20,000 units x 2 hrs./unit x $5.00/hr.)
= $250,000 $200,000
= $50,000U (i.e., fixed overhead was underapplied by $50,000
during the year)
14-28 Summary Journal Entries
(a)Actual Overhead Costs
Dr. Factory Overhead
$323,000
Cr. Accumulated DepreciationFactory
$150,000
Cr. Salaries Payable
$ 95,000
Cr. Utilities Payable
$ 78,000
Overhead Costs Applied to Production
Dr. WIP Inventory (20,000 units x 2 hrs. x
$7.00/hr.)$280,000
Cr. Factory Overhead
$280,000
(b) To Record Overhead Variances Using a Two-Variance
Approach
Dr. Production Volume Variance
$50,000
Cr. Total Flexible-Budget Variance
$ 7,000
Cr. Factory Overhead
$ 43,000
14-29 End-of-Year Journal Entry to Close Out Variance
Accounts
(a) Net Variance Closed to CGS:
Dr. CGS
$43,000
Dr. Total Flexible-Budget Variance
$ 7,000
Cr. Production Volume Variance
$50,000
(b) Net Variance Allocated to Ending Inventories and CGS:
Dr. WIP Inventory (10% x $43,000)
$ 4,300
Dr. Finished Goods Inventory (20% x $43,000)
$ 8,600
Dr. CGS (70% x $43,000)
$30,100
Dr. Total Flexible-Budget Variance
$ 7,000
Cr. Production Volume Variance
$50,000
EXERCISES
14-30Variable Factory Overhead Variances (2025 minutes)
1.Standard Variable factory overhead rate per direct labor
hour:
= $15,000/2,500 hours = $6.00 per direct-labor hour
Standard direct-labor hours per unit:
= 2,500 hours/5,000 units = 0.50 hours/unit
Variable Overhead Variance Analysis FB Based on FB Based on
Actual Cost Inputs
Output
(AQ x AP)(AQ x SP) (SQ x SP)
2,700 hrs. x $5.7777/hr. 2,700 x $6.00/hr.
(4,800 x 0.5) x $6.00/hr.
= $15,600 = $16,200 = $14,400
Spending varianceEfficiency variance
= $600 F= $1,800 U
or, = AQ x (AP SP)or,= (AH SH) x SR
= 2,700 x ($5.7777 - $6.00) = (2,700 2,400) x $6.00/hr.
= $600F
= $1,800U
Flexible Budget
Actual Cost
Based on Output
$15,600
$14,400
Flexible-budget variance = $15,600 $14,400
= $1,200U14-30 (Continued)
2. To Record Favorable Variable Overhead Spending Variance:
Dr. Factory Overhead (or, Variable Factory
Overhead)
$ 600
Cr. Variable Overhead Spending Variance
$ 600
To Record Unfavorable Variable Overhead Efficiency Variance:
Dr. Variable Overhead Efficiency Variance
$1,800
Cr. Factory Overhead (or, Variable Factory Overhead)
$1,800
3.The factory had a favorable variable factory overhead spending
variance. This could be a result of conscientious efforts of
workers and the manager of the factory in conserving uses of
variable factory items. Alternatively, it could have been due, at
least in part, to the use of an inappropriate activity measure
(direct labor-hours) for assigning variable factory overhead
costs.
The $1,800 unfavorable variable overhead efficiency variance is
a result of using more direct labor hours to manufacture the output
of the period (2,700 hours to make 4,800 units of output) than the
standard labor hours allowed (2,400 hours) for this level of
output. As long as direct labor hours worked is related to variable
overhead costs incurred, then the efficiency variance indicates the
cost to the company (in terms of variable overhead) of using 300
extra labor hours this period.
The $1,200 unfavorable flexible-budget variance indicates that
the firm did not exercise good overall control regarding variable
factory overhead costs. Again, this is a valid conclusion provided
that direct labor-hour is a reasonably good activity measure for
the consumption of variable factory overhead cost.
14-31Fixed Factory Overhead Variances (2025 minutes)
1.Standard Fixed factory overhead application rate per direct
labor hour (DLH):
= $90,000/2,500 hours = $36.00 per DLH
Standard direct-labor hours (DLH) per unit:
= 2,500 hours/5,000 units = 0.5 DLHs per unit
Fixed Overhead Variance Analysis
Applied
Actual Cost Budget (SQ x SP)
4,800 units x 0.5 hrs. x $36/hr.
$92,000$90,000 = $86,400
Spending varianceProduction Volume variance
= $92,000 $90,000= $90,000 $86,400
= $2,000U= $3,600U
or, = SP x (Denominator Volume SQ)
= $36/hr. (2,500 hrs. 2,400 hrs.)
= $36/hr. x 100 hrs. = $3,600U2.Fixed factory overhead (FOH)
flexible-budget variance
= FOH spending variance = $2,000U
3. To Record Unfavorable Fixed Overhead Spending Variance
Dr. Fixed Overhead Spending Variance
$ 2,000
Cr. Factory Overhead (or, Fixed Factory Overhead)
$2,000
14-31 (Continued)
To Record Unfavorable Production Volume Variance:
Dr. Production Volume Variance
$ 3,600
Cr. Factory Overhead (or, Fixed Factory Overhead)
$ 3,600
4.The $2,000 unfavorable fixed factory overhead spending
variance could be a result of unexpected fluctuations,
overspending, or budgeting errors in one or more fixed overhead
items. However, since the amount is small (2.22% of the budget
amount), it is unlikely that the management needs to spend any time
or resources to investigate this variance.
The $3,600 unfavorable production volume variance is a result of
the lower output for the period (4,800 units) as compared to the
volume of output (5,000 units) assumed when the fixed overhead
allocation rate was determined. The production manager is
responsible for the unfavorable variance if the reason for the
lower output is a result of activities or events in the factory
such as equipment failure, inefficient workers, or high defective
rates. However, the factory is doing its job if the lower
production is a result of the decreased demand for its product. As
indicated in the text, this variance generally has shared
responsibility (with marketing, purchasing, etc.).
Note that when the denominator activity level is set at
practical capacity, then resulting production volume variances can
be interpreted as the cost of unused capacity. The disclosure of
this information over time can help managers make better decisions
regarding capacity-related spending.
14-32 Three-Variance Factory Overhead Analysis (2025
minutes)
1.Standard Variable factory overhead rate per direct labor
hour:
= $15,000/2,500 hours = $6.00/DLH
Standard fixed factory overhead rate per direct labor hour:
= $90,000/2,500 hrs. =
$36.00/DLHStandard factory overhead rate per direct labor hour
(DLH)
$42.00/DLH
Standard direct-labor hours (DLH) per unit:
Three-Variance Overhead Analysis
Flexible Budget Flexible Budget
Based on Inputs Based on Output Applied
Actual Cost AQ x SP (SQ x SP) (SQ x SP)
$ 15,6002,700 x $6 =$ 16,2002,400 x $6 = $14,400
+ 92,000+ 90,000+ 90,000
2,400 x $42
$107,600$106,200$104,400
= $100,800
Spending variance Efficiency Variance Production Volume
Variance
= $107,600 $106,200= $106,200 $104,400= $104,400 $100,800
= $1,400U
= $1,800 U
= $3,600U14-32 (Continued)
2. Total overhead spending variance = variable overhead spending
variance + fixed overhead spending variance
= $600F + $2,000U = $1,400U
Total overhead efficiency variance = variable overhead
efficiency variance
= $1,800U (that is, there is no fixed overhead efficiency
variance)
Production Volume Variance = $3,600U (the same as under the
four-way analysis of the overhead variance)
In sum, the only difference between the three-way and four-way
analysis is that in the former, the spending variances for fixed
and for variable overhead (reported in the latter) are combined
into a single overhead spending variance. Three- and Four-Variance
Factory Overhead Analysis: Summary Factory overhead spending
variance:
Variable overhead spending variance $ 600F
Fixed overhead spending variance 2,000U $1,400U
Factory overhead efficiency variance:
Variable overhead efficiency variance $1,800U
Factory overhead production volume variance:
Fixed overhead production volume variance $3,600U
Total Overhead Variance = $6,800U14-33 Two-Variance Analysis of
the Total Overhead Variance (2025 minutes)1.Standard variable
factory overhead rate per direct labor hour
$ 6.00
Standard fixed factory overhead rate per direct labor hour
36.00
Standard factory overhead rate per direct labor hour
$42.00
Standard direct-labor hours per unit = 0.5 DLH
Two-Variance Overhead Analysis Flexible Budget Based
Overhead
Actual Cost
on Output Applied
$ 15,600
2,400 x $6 = $14,400
+ 92,000
+ 90,000
2,400 x $42
$107,600
$104,400
= $100,800
Spending variance
Production Volume Variance
= $107,600 $104,400
= $104,400 $100,800
= $3,200U
= $3,600U2. Total Controllable (Flexible) Budget Variance for
Overhead:
a) Variable Overhead Spending Variance$ 600F
b) Variable Overhead Efficiency Variance$1,800U
c) Fixed Overhead Spending Variance $2,000U
$3,200U
Production Volume Variance
3,600U
Total Overhead Variance
$6,800U
That is, three items from the four-variance analysis (viz.,
variable overhead spending variance, variable overhead efficiency
variance, and fixed overhead spending variance) are combined into
one variance, the Total Controllable (Flexible) Budget Variance,
under the two-variance analysis. The production volume variance
component is the same in the two-variance, the three-variance, and
the four-variance breakdown of the total overhead variance.
3.The two-variance breakdown of the total overhead variance
reports two important factors concerning overhead costs. The
flexible-budget (controllable) variance measures the difference
between the actual overhead incurred and the overhead that should
have been incurred based on the actual output of the period. (This
latter term is referred to as the Flexible-budget Based on Output.)
To motivate cost-control on the part of managers, the total
Flexible-budget Variance is sometimes (as in this exercise)
referred to as the total controllable overhead varianceit signals
to managers the need to control costs vis--vis the amounts
reflected in the flexible-budget based on outputs for the
period.
14-33 (Continued)
The production volume variance, when the fixed overhead
application rate is based on practical capacity, reports the
effectiveness of the organization in using available capacity. Over
time, this variance can signal to managers the existence of excess
capacity or the need for capacity expansion. In short, this
variance helps managers control capacity-related resource
spending.
14-34Factory Overhead Variance: Four Variance Analysis (40
Minutes)
1.Total Factory Overhead Application Rate:
Fixed factory overhead application rate:
Total machine hours at practical capacity:
Number of units of output at practical capacity =
40,000
Machine hours per unit
x 2
Standard machine hours @ practical capacity
80,000
Fixed factory overhead rate per machine hour = budgeted
Fixed Overhead/machine hours @ practical capacity =
$360,000/80,000 machine hours =
$4.50
Variable factory overhead rate per machine hour (given)
+ 3.00
Total overhead application rate per machine hour
$7.502. Total Flexible Budget (FB) for Overhead Based on Units
Produced:
Total standard machine hours allowed for the units produced
42,000 units produced x 2 machine hours per unit = 84,000
hours
Manufacturing overhead in the flexible budget for 42,000
units:
Variable factory overhead = $3.00/hr. x 84,000 hrs. =
$252,000
Fixed factory overhead (lump-sum amount)
360,000
Total FB for Overhead based on Units Produced
$612,0003. Production Volume Variance for 2007:
Fixed Overhead:
Actual Cost Budget Applied
$360,000 $378,000
= 84,000 hrs. x $4.50/hr.
Production volume variance
= $360,000 $378,000
= $18,000F
or, Production Volume Variance = SP x (Denominator Volume
SQ)
= $4.50/machine hr. x (80,000 84,000) machine hours
= $18,000F
14-34 (Continued-1)4. & 5. FB Based on FB Based on
Actual Inputs Output Applied
VOH
$3 x 85,000 hrs. $3 x 84,000 hrs. $3 x 84,000 hrs.
= $255,000= $252,000= $252,000
FOH
$4.50 x 84,000 hrs.
360,000 360,000= 378,000
$625,000$615,000612,000$630,000
Spending Variance Efficiency Variance Prod. Volume Variance
= $625,000 $615,000= $615,000 $612,000
= $10,000U = $3,000U
Total factory overhead incurred$625,000
FB for Overhead Based on Inputs (i.e., actual machine
hours):
Variable factory overhead:85,000 x $3 =$255,000
Fixed factory overhead:
360,000 615,000
Factory overhead spending variance$ 10,000U5.FB for Overhead
Based on Inputs (i.e., actual machine hours)$615,000
FB for Overhead Based on Output (from 2. above) 612,000
(Variable) Factory Overhead Efficiency Variance$ 3,000U
or, Efficiency Variance = SP x (AQ SQ)
= $3.00/machine hr. x (85,000 84,000) hours
= $3,000U14-34 (Continued-2) FB Based FB Based
on Inputs on Output
6. Actual(AQ x SP) (SQ x SP) Applied
VOH$250,000$255,000$252,000
Spending VarianceEfficiency Variance
= $250,000 $255,000 = $255,000 $252,000
= $5,000F = $3,000U
FOH $375,000 $360,000
$378,000
Spending (Budget) VarianceProduction Volume Variance
= $375,000 $360,000
= $360,000 $378,000
= $15,000F
= $18,000F
An Excel spreadsheet solution file for this assignment is
embedded below. You can open this object by doing the
following:
1. Right click anywhere in the worksheet area below.
2. Select worksheet object and then select Open.
3. To return to the Word document, select File and then Close
and return to... while you are in the spreadsheet mode. The screen
should then return you to the Word document.
14-35 Factory Overhead Flexible Budget and Variance Analysis (40
minutes)1.Total factory overhead in the master budget (given)
$180,000
Less: Budgeted fixed factory overhead (given)
60,000
Budgeted total variable factory overhead
$120,000
Total machine hours (MH) in the master budget
( 37,500
Standard variable factory overhead rate per machine hour
$3.20
Standard machine hours per unit:37,500 MH/150,000 units = 0.25
MH
Flexible Budget (FB) for the 10,800 units produced during the
period
Budgeted variable factory overhead:
Number of units manufactured in March10,800
Standard machine hours per unitx 0.25
Total standard MH for the units manufactured2,700
Variable factory overhead rate per MHx $ 3.20
Total budgeted variable factory overhead
$8,640
Budgeted fixed factory overhead per month $60,000 ( 12 =
5,000
FB for overhead based on 10,800 units produced in March =
$13,6402.Total factory overhead incurred (given)
$13,000
FB for factory overhead based on output
13,640
Factory overhead flexible-budget (controllable) variance
$ 640F
3. Total factory overhead spending variance
a.Variable factory overhead spending variance:
Variable factory overhead incurred ($13,000 $4,500)
$8,500
FB for variable overhead based on Inputs:
Actual machine hours (MH) worked 2,850
Standard VOH rate per MHx $ 3.20 9,120
Variable factory overhead spending variance
$ 620F
Fixed factory overhead spending variance:
Fixed factory overhead incurred
$4,500
Budgeted fixed factory overhead for the month
5,000
Fixed factory overhead spending variance
$ 500F
14-35(Continued)
b.Variable factory overhead efficiency variance:
Machine hours worked at standard VOH rate (from 3a)
$9,120
Total standard variable factory overhead for the output
8,640
Variable factory overhead efficiency variance
$ 480U
c. Fixed factory overhead production volume variance:
Budgeted fixed factory overhead for the month = $60,000 ( 12
=$5,000
Fixed factory overhead applied to the units manufactured:
Total standard MH for the units manufactured = 2,700
Standard fixed factory overhead per MH =
Budgeted total fixed overhead ( Total Budgeted
machine hours (MH) = $60,000 ( 37,500 = $1.60 4,320
Factory overhead production volume variance
$ 680U
Alternatively, the production volume variance can be computed
using the difference between the budgeted units (in general, the
denominator activity level) and the units actually manufactured
during the month:
Units actually manufactured in March
10,800
Budgeted units to manufacture per month = 150,000 ( 12
=12,500
Difference in units
1,700U
Standard fixed overhead cost/unit = $1.60 x 0.25 MH =
$ 0.40
Factory overhead production volume variance=
$ 680U
Alternatively, the production volume variance = standard fixed
overhead rate per MH x (denominator hours SQ)
= $1.60/MH x ([37,500/12] 2,700) MH = $1.60 x (3,125 2,700)
= $1.60/MH x 425MH = $680U
4.Variable factory overhead spending variance (answer 3a)
$620F
Fixed factory overhead spending variance (answer 3a)
500F
Variable factory overhead efficiency variance (answer 3b)
480U
Factory overhead FB (controllable) variance (answer 2)
$640F
14-35 (Continued)5. Management of the Lopez Co. should consider
using practical capacity as the denominator volume (denominator
activity volume) when establishing its standard fixed overhead
allocation rate. This procedure, contrary to the use of budgeted
activity for the upcoming period, does not spread the cost of
unused facilities over the units produced during the period.
Rather, the cost of unused capacity is reflected in the production
volume variance for the period. This variance can be monitored over
time to provide managers with feedback regarding capacity
utilization. Note, too, that when the fixed overhead rate is
calculated using practical capacity as the denominator, the
numerator (budgeted spending for capacity-related costs) is
consistent with the denominator (capacity supplied).
14-36 Three-Variance and Two-Variance Analyses (10-15 minutes)1.
a. Total factory overhead spending variance:
Variable overhead spending variance (see 3a, 14-35)
$ 620F
Fixed overhead spending variance (see 3a, 14-35)
500F
Factory overhead spending variance
$1,120F
b.Factory overhead efficiency variance (see 3b, 14-35)$480U
or, VOH efficiency variance = SP x (AQ SQ)
= $3.20/MH x (2,850 [10,800 units x 0.25MH/unit])
= $3.20/MH x (2,850 2,700) MH
= $3.20/MH x 150 MH = $480U
c.Production volume variance (see 3c, 14-35)$680U
2. a.Factory overhead controllable (flexible-budget)
variance:
Factory overhead spending variance (1a, above)
$1,120F
Factory overhead efficiency variance (1b, above) 480U
Factory overhead controllable variance (see 2, 14-35)$640F
b.Production volume variance (see 3c, 14-35)$680U3. In all cases
(four-way, three-way, and two-way variance decompositions) the
total overhead variance for the month of March is the same, $40U,
as follows:
Total factory overhead variance = total actual factory overhead
factory overhead applied to production
= $13,000 (10,800 units x 0.25 MH/unit x
[$180,000/37,500MH])
= $13,000 (10,800 units x 0.25 MH/unit x $4.80/MH)
= $13,000 (2,700 MH x $4.80/MH)
= $13,000 $12,960 = $40U14-37
Flexible Budget and Variances for Depreciation (1520
minutes)
1.Budgeted depreciation, factory equipment for September:
$258,000 ( 12 = $21,500
2.Spending VarianceEquipment Depreciation Expense:
Actual depreciation for the month
$20,500
Budgeted depreciation for the month
21,500
Spending varianceEquipment Depreciation
$ 1,000F
3.Production Volume VariancePortion Pertaining to
Depreciation:
Budgeted depreciation for the month
$21,500
Total standard depreciation expense applied:
Total chargeable hours for the month =8,170
Standard depreciation per chargeable hour:
Total budgeted depreciation ( Total budgeted
hours = $258,000 ( 103,200 hours = $2.50 20,425
Production Volume Variance Pertaining to Depreciation
$ 1,075U
Interpretation: Because chargeable hours (i.e., activity or
volume) were less than anticipated, a portion of the budgeted
depreciation expense for equipment did not get charged to the
output of the period.
4.Reasons for the favorable spending variance regarding
equipment depreciation expense include:
The company disposed of some of its equipment during the
period
The company changed the method used to calculate
depreciation
An accounting error was found regarding the amount of
capitalized cost of the equipment (i.e., the actual cost is less
than what was originally recorded)
The estimated residual value of the equipment was increased,
or
The length of the period for calculating depreciation was
increased.
14-38 Four-Variance Analysis of Total Overhead Variance (30
minutes)
Fixed factory overhead application rate: $18,000 ( 4,500 =
$4.00/DLH
Actual fixed factory overhead: $40,000 $24,150 = $15,850;
Actual variable OH rate/DLH = $24,150/4,200DLHs = $5.75/DLH
Standard Cost
Flexible Budget Flexible Budget Applied to
Actual Based on Inputs Based on Outputs Production
(AQ x AP) (AQ x SP) (SQ x SP) (SQ x SP)
Variable (4,200 x $5.75) (4,200 x $5.00) (4,000 x $5.00) (4,000
x $5.00)
Overhead = $24,150 = $21,000 = $20,000 = $20,000
Spending
Efficiency N/A
Variance = $3,150U Variance = $1,000U
Lump-sum Lump-Sum Applied
Actual
Amount
Amount (SQ x SP)Fixed (4,000 x $4.00)
Overhead $15,850 $18,000 $18,000 = $16,000 Spending N/A
Production Volume
Variance = $2,150F Variance = $2,000U
(4,000 x $9.00) $40,000 $36,000
Total
Overhead
Total Overhead Variance = $4,000U (from a product-costing
standpoint this is referred to as total underapplied overhead of
$4,000)
Four-Variance Decomposition of Total Overhead Variance for
December:
(1) Variable Overhead Spending Variance =
$3,150U
(2) Variable Overhead Efficiency Variance = $1,000U
(3) Fixed Overhead Spending Variance =$2,150F
(4) Production Volume Variance =$2,000U
Total Overhead Variance =$4,000U
14-39 Graphical Analysis: Variable Overhead Variances (2025
minutes)
Solution:
(A) = Variable Overhead Costs per Machine Hour (label)
(B) = Machine Hours (i.e., the activity measure used to apply
variable overhead costs) (label)
(C) = Actual variable overhead cost per machine hour = AP
(D) = Standard variable overhead cost per machine hour = SP
(E) = Standard machine hours allowed (in total) for output
achieved = SQ
(F) = Actual machine hours worked (in total) for output achieved
= AQ
(G) = Variable overhead spending variance = AQ x (AP SP)
(H) = Standard variable overhead cost applied to production =
Flexible budget for variable overhead based on units produced
(i.e., based on standard allowed machine hours) = SQ x SP
(I) = Variable Overhead Efficiency Variance = SP x (AQ SQ)
Sum of areas (G), (H), and (I) = actual variable overhead cost
for the period = AP x AQ
14-40 Graphical AnalysisFixed Overhead Variances (3040
minutes)
Solution:
(A) = Fixed Overhead Cost (label)
(B) = Machine Hours = Activity Measure for Applying Fixed
Overhead Cost (label)
(C) = Applied Fixed Overhead Cost
(D) = Standard Fixed Overhead Application Rate (per Machine
Hour)
(E) = Budgeted Fixed Overhead (Lump-Sum Amount)
(F) = Denominator Activity Level (for setting the fixed overhead
allocation rate)
(G) = Standard Allowed Machine Hours for Units Produced this
Period
(H) = Standard Fixed Overhead Applied to Units Produced = (G) x
(D)
(I) = Actual Fixed Overhead Costs Incurred During the Period
(J) = Fixed Overhead Production Volume Variance (= D x (G
F))
(K) = Total Fixed Overhead Variance = (J) + (L)
(L) = Fixed Overhead Spending (Budget) Variance = (I) - (E)14-41
Fixed Overhead Rate, Denominator Level, and 2-Variance Analysis of
Fixed Overhead Variance (15 minutes)
1. Standard fixed factory overhead rate = budgeted total
overhead cost per machine hour budgeted variable overhead cost per
machine hour = $4.50 $3.00 = $1.50/MH2. Denominator activity level
(used to set the standard fixed overhead allocation rate) =
Budgeted Fixed Overhead/Fixed Overhead Allocation Rate per MH =
$7,200 ( $1.50/MH = 4,800MH3. Two-Way Analysis (Breakdown) of Total
Overhead Variance
Standard OH
Standard Cost Flexible Budget Applied to
Actual Based on Outputs Production
VOH 3,500 x $3 = $10,500 3,500 x $3 = $10,500
FOH $ 7,200 3,500 x $1.50 = $ 5,250Total OH $28,800 $ 17,700
$15,750
Flexible-budget
(Controllable) Production Volume
Variance = $11,100U Variance = $1,950U
Total Factory Overhead Variance = $13,050U = Underapplied
Overhead
Note: from a product-costing standpoint, we use the term
over/under-applied overhead; for control purposes, the term total
factory overhead variance is typically preferred.
14-42Performance Reporting: the Use of Standard Cost Variance
Information (2025 minutes)
Among recommended improvements to the cost-variance report
currently used by ABC Manufacturing Company to evaluate subunit
performance are the following:
(1) The reports should emphasize that the terms favorable and
unfavorable should not automatically be interpreted, without
further consideration, as good performance and bad performance.
These labels simply reflect the impact of the calculated amount on
the operating profit of the current period. Thus, a favorable cost
variance is not necessarily good and an unfavorable variance is not
necessarily bad.
(2) The current use of cost-variance information by managers at
the ABC Manufacturing Company seems to be punitive, that is, an
attempt to fix blame for not achieving budgeted costs. This
negative use of variance information will most likely lead to
dysfunctional behavioral consequences (e.g., employees gaming the
performance indicators, providing excessive slack in determining
standard costs for manufacturing operations).
(3) Short-term financial performance (measured, for example, by
the type of cost-variance report used by the ABC Manufacturing
Company), while important, is not inclusive enough to achieve
operational control. As such, the performance report might be made
more balanced by including one or more non-financial performance
indicators, such as quality indicators, on-time delivery, or
manufacturing cycle-time, depending on the critical success factors
associated with the strategy the company is pursuing.
(4)The current variance report does not report for manufacturing
overhead controllable vs. non-controllable variances. For example,
some decisions, which have cost implications, are made by the
next-higher level of management in the plant. The cost variance
reports to individual line managers should include only items over
which these managers exercise control.
(5) Related to (4) above, the current profit-variance report
does not admit to shared responsibility. For example, excessive
consumption of direct materials could be traceable to poor quality
materials purchased by the Purchasing Manager. As such, at least a
portion of some of the other manufacturing cost variances would be
attributable to the purchasing, not the manufacturing,
function.
(6) Of significant concern is the need to incorporate flexible
budgets into the cost-variance report. Currently, there is no way
to evaluate efficiency (consumption of resources relative to
output); the use of the master budget amounts to calculate cost
variances compounds efficiency and effectiveness dimensions of
performance. The use of a flexible budget (based on output
achieved) results in a better assessment of efficiency of
operations since the actual costs incurred during the period are
compared to the budgeted costs that should have been incurred given
the actual output achieved during the period.
14-42 (Continued)
(7) Level of detail. Variable-cost variances can be decomposed
into price and efficiency effects. It would seem as if the
performance report would be improved by at least allowing for the
possibility of including these component variances, particularly
since they are likely the responsibility of different individuals
in the organization.
(8) It is not clear from the sample report, but it may be the
case that ABC Company uses a single activity measure (e.g., machine
hours) as the basis for applying overhead costs to products
(product-costing purpose) and for developing the flexible-budget
for control purposes. To the extent that the chosen measure (or
measures) does (do) not accurately predict changes in manufacturing
support (factory overhead) costs, noise is introduced into the
variance-decomposition process. That is, a portion of any
calculated variance for overhead is attributable to the method used
to generate estimates of standard costs, against which actual costs
are compared.
14-43Overhead at Two Activity Levels and 4-Way versus 2-Way
Analysis of the Total Overhead Variance (4550 minutes)
1. Budgeted fixed factory overhead:
Total standard factory overhead at 80% level of theoretical
capacity
= 20,000 machine hours (MH) x $12.60/MH = $252,000
Budgeted variable factory overhead at 80% level of operation =
72,000 Budgeted fixed factory overhead (at both 80% and 100%)
$180,0002.Standard overhead application rates, 2007:
Variable factory overhead rate per machine hour (MH), 2007 =
budgeted variable overhead, 2006 ( standard direct machine hours
allowed for output achieved, 2006 =
$72,000 ( 20,000 MH = $3.60/MH
Fixed factory overhead rate per machine hour, 2007 = Budgeted
fixed factory overhead, 2007 ( denominator activity hours, 2007 =
$180,000 ( (25,000 MH x 90%) =
$180,000 ( 22,500 MH = $8.00/MH3.Factory overhead flexible
budget for 2007:
Flexible budget for variable factory overhead, based on output
in 2007
= (11,300 units x 2 MH/unit) x $3.60/MH =
= 22,600 MH x $3.60/MH = $ 81,360
Total fixed factory overhead (same as 2006) 180,000
Total flexible budget for factory overhead, 2007 $261,360
4.Variable Factory Overhead Variances, 2007:
Actual variable factory overhead incurred = Total standard
variable factory overhead for the units manufactured +/ Total
variable overhead variance:
Total standard variable factory overhead (see 3 above) =
$81,360
Total variable overhead variance:
Total factory overhead flexible-budget variance$12,000U
Fixed factory overhead flexible-budget variance 5,000U
7,000U
Actual variable factory overhead incurred
$88,36014-43 (Continued-1)
FB based on Inputs FB based on OutputActual Cost (i.e., standard
VOH cost (i.e., standard VOH cost
Incurred for the MH Worked) for standard MH allowed)
23,000MH x $3.60/MH 22,600MH x $3.60/MH
$88,360 = $82,800 = $81,360
a. Spending Varianceb. Efficiency Variance
= $88,360 $82,800= $82,800 $81,360
= $5,560U= $1,440U
Alternative calculations:
a. Variable overhead spending variance = AQ x (AP SP)
= 23,000 MH x ($3.8417391 $3.60)/MH
= 23,000 MH x $0.2417391/MH = $5,560U
b. Variable overhead efficiency variance = SP x (AQ SQ)
= $3.60/MH x (23,000 22,600) MH
= $3.60 x 400 MH = $1,440UFixed Factory Overhead Variances,
2007:
Actual fixed factory overhead incurred = budgeted fixed overhead
+/ fixed overhead spending (budget) variance
Budgeted fixed overhead =
$180,000Fixed factory overhead budget variance (given)
5,000U
Actual fixed factory overhead incurred
$185,000
Fixed Overhead Variances:
Actual Budget Applied
$185,000 $180,000 $180,800
Spending Variance Production Volume Variance
= $5,000U = $800F14-43 (Continued-2)
Alternative calculation:
Fixed overhead production volume variance, 2007 =
= SP x (denominator volume SQ)
= $8.00/MH x (22,500 MH 22,600 MH)
= $8.00/MH x 100 MH = $8005. Two-Way Breakdown of Total Overhead
Variance:
a.Factory overhead flexible-budget variance = Variable overhead
spending variance + variable overhead efficiency variance + fixed
overhead spending variance = $5,560U + $1,440U + $5,000U =
$12,000U
b.Factory overhead production volume variance =
$800F Total Overhead Variance
= $11,200U
Alternatively, we can calculate the total controllable
(flexible-budget) variance and the production volume variance
directly, as follows:
a. Total overhead variance = actual overhead standard overhead
applied to production (based on allowed machine hours for the
11,300 units produced)
= ($88,360 + $185,000)1 (22,600 MH x $11.60/MH)2
= $273,360 $262,160 = $11,200U (i.e., underapplied overhead)
b. Total flexible (control) budget variance = actual overhead
flexible budget (FB) for total overhead based on output (i.e.,
based on allowed MH for the 11,300 units produced)
=$273,360 ($180,000 + [22,600 MH x $3.60/MH])
=$273,360 ($180,000 + $81,360)
=$273,360 $261,360 = $12,000U
c. Production volume variance = FB based on output Applied
Overhead
=$261,360 $262,160 = $800F
Notes:
1See part 4 above
2See part 2 above ($3.60/MH variable overhead rate + $8.00/MH
fixed overhead rate)14-44 Flexible Overhead Budgets for Control
(4045 minutes)
Note: An Excel spreadsheet solution file for this assignment is
embedded below. You can open this object by doing the
following:
1. Right click anywhere in the worksheet area below.
2. Select worksheet object and then select Open.
3. To return to the Word document, select File and then Close
and return to... while you are in the spreadsheet mode. The screen
should then return you to the Word document.
14-45 Journal Entries: Factory Overhead Costs and Standard Cost
Variances (5060 minutes)
Note: An Excel spreadsheet solution file for this assignment is
embedded below. You can open this object by doing the
following:
1. Right click anywhere in the worksheet area below.
2. Select worksheet object and then select Open.
3. To return to the Word document, select File and then Close
and return to... while you are in the spreadsheet mode. The screen
should then return you to the Word document.
14-46 2-Variance Analysis and Direct Labor Variance (3040
minutes)1. Break-down of total direct labor variance for April:
Actual FB Based on Inputs FB Based on Output
(AP x AQ) (SP x AQ) (SP x SQ) $6.20 x 14,000
= $86,800
? x 14,000 hours ? x 15,000 hours
Rate Variance Efficiency Variance
$2,800 U ?
Standard direct labor hourly wage rate, SP:
FB Based on Inputs (hours worked) = $86,800 $2,800 = $84,000
Actual direct labor hours worked, AQ
( 14,000 Standard direct labor rate per hour, SP =
$6.00Direct labor efficiency variance:FB Based on Inputs (i.e.,
based on actual hours worked) =
$84,000
FB Based on Output (i.e., SP x SQ) = $6.00 x 15,000 =
90,000Direct labor efficiency variance
$ 6,000FAlternatively, we can calculate the Direct Labor
Efficiency Variance as:
SP x (AQ SQ) = $6.00 x (14,000 15,000) hours = $6,000F14-46
(Continued)
2. and 3.
4. When variable overhead costs are related to the number of
direct labor hours worked, then to the extent there is a
direct-labor efficiency variance there will a variable overhead
efficiency variance in the same direction. The former variance
reflects the impact on manufacturing costs of using a nonstandard
amount of direct labor hours based on the production for a given
period. The latter variance represents the impact on variable
overhead cost of using a nonstandard amount of direct labor hours
for the period. Note, however, the key assumption that there is a
strong relationship between number of labor hours worked (activity)
and variable overhead cost. This reinforces the need for selecting
the appropriate activity measure for applying variable overhead
costs.
14-47 Three-Variance Breakdown of Total Overhead Variance (3040
minutes)
1., 2., and 3.
4. Reconciliation of two-variance and three-variance analysis of
the total overhead variance:
(1) Total Overhead Variance = Actual Applied =$1,750F
(2) Two-Way Breakdown of Total Overhead Variance (Ex.
14-46):
Total Flexible-budget (Controllable) Variance=$500U
Production Volume Variance
= $2,250F
Total Overhead Variance
= $1,750F
(3) Three-Way Breakdown of Total Overhead Variance (Ex.
14-47):
Total Overhead Spending Variance
= $2,000U
Variable Overhead Efficiency Variance
=$1,500F
Production Overhead Variance
=$2,250F
Total Overhead Variance
=$1,750F
14-48Four-Variance Analysis of Total Overhead Variance (40-45
minutes)
14-49 Working Backwards: Total Factory Overhead (3040
minutes)
1.
Flexible Budget Applied Overhead
Actual Based on Output (i.e., (based on standard
Costs standard allowed MH) allowed machine hours)
VOH:
?$600,000$600,000
FOH:
?$300,000$360,000
Flexible-budget Variance Production Volume Variance
$120,000F
Total factory overhead applied to production, 2007:
Variable factory overhead (given)$600,000
Fixed factory overhead (given) 360,000$960,000
Favorable total factory overhead variance
120,000
( Actual factory overhead cost incurred, 2007
$840,0002.
Flexible Budget Applied Overhead
Actual Based on Output (based on standard
Costs (i.e., actual machine hours) allowed machine hours)
V:
$600,000$600,000
F:
$300,000$360,000
$120,000F
Flexible Budget for overhead based on output:
Variable factory overhead$600,000
Fixed factory overhead 300,000$900,000
Total favorable flexible-budget variance
120,000
Total factory overhead incurred, 2007
$780,00014-49 (Continued)
3. Budgeted fixed overhead
$300,000
Total fixed overhead applied to the units manufactured
360,000
Production volume variance (for both)
$ 60,000F
4. a. Standard allowed machine hours for this periods production
= flexible-budget for variable overhead based on output ( standard
variable overhead rate per machine hour
= $600,000 ( $10.00/MH = 60,000MH
b. variable overhead efficiency variance = SP x (AQ SQ)
= $10.00/MH x (50,000 60,000) MH
= $10.00/MH x 10,000MH = $100,000F
c. variable overhead spending variance = AQ x (AP SP)
= 50,000MH x ([$504,000/50,000MH] $10.00/MH)
= 50,000MH x ($10.08/MH $10.00/MH)
= 50,000MH x $0.08/MH
= $4,000U
d. fixed overhead spending variance = total flexible-budget
(controllable) variance variable overhead efficiency variance
variable overhead spending variance
= $120,000F $100,000F $4,000U
= $24,000F
Check: total flexible-budget (controllable) variance = variable
overhead efficiency variance + variable overhead spending variance
+ fixed overhead spending variance
= $100,000F + $4,000U + $24,000F
= $120,000F
14-50 Factory Overhead Variances (3040 minutes)
Standard MH per unit: 10,000 MH ( 5,000 units = 2 MH per
unit
1 & 2: Variable factory overhead variances
Flexible Budget Flexible Budget Based
on Inputs (i.e., actual on Output (i.e., standard
Actual machine hours) allowed machine hours)
$32,500
9,500 x $3 = $28,500 (4,500 x 2) x $3 = $27,000
Spending Variance Efficiency Variance
= $32,500 $28,500 = $28,500 $27,000
= $4,000U (1)
= $1,500U (2)
3 & 4: Fixed factory overhead variances:
Budgeted fixed overhead (given)
$20,000
Denominator volume (machine hours)
( 10,000
Standard fixed overhead rate per machine hour $2.00Actual
Budget Standard Applied
$21,400
$20,000 (4,500 x 2) x $2 = $18,000
Spending VarianceProduction Volume Variance
= $21,400 $20,000 = $20,000 $18,000
= $1,400U (3)
= $2,000U (4)
5. Variable factory overhead spending variance (1, above) =
$4,000U
Fixed factory overhead spending variance (3, above) =
1,400U
Total factory overhead spending variance
$5,400U14-50 (Continued)
6.Total factory overhead spending variance (5, above) =
$5,400U
Variable factory overhead efficiency variance (2, above) =
1,500U
Factory overhead controllable variance $6,900UNote: An Excel
spreadsheet solution file for this assignment is embedded below.
You can open this object by doing the following:
1. Right click anywhere in the worksheet area below.
2. Select worksheet object and then select Open.
3. To return to the Word document, select File and then Close
and return to... while you are in the spreadsheet mode. The screen
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14-51 ABC Costing (3040 minutes) Standard MH per unit = 32,000
MH ( 6,400 units = 5 MH per unit
No. of units manufactured during the period = standard allowed
MH ( standard MH/unit = 30,000MH ( 5MH/unit = 6,000 units
Budgeted no. of units/setup = 6,400 units ( 32 set-ups = 200
units/set-up
Standard no. of setups for the units manufactured = 6,000 ( 200
= 30
FB based on Inputs
FB based on Output (i.e., based on actual (i.e., based on
standard
1.
Actualactivity units) allowed activity units)VOH:
Setup28 x $600 =$ 16,80030 x $600 =$ 18,000
MH35,000 x $5 =175,00030,000 x $5 =150,000
FOH:
264,000
264,000
Total OH$480,000
$455,800
$432,000
Spending VarianceEfficiency Variance
= $24,200U= $23,800U
Flexible-budget (Controllable) Variance
= $48,000U
FB based on Inputs FB Based on Output (i.e., on actual (i.e.,
based on standard
2. Actual activity units) allowed activity units)VOH:
Setup28 x $2,600 =$ 72,80030 x $2,600 =$ 78,000
MH35,000 x $5 =175,00030,000 x $5 =150,000
FOH:
200,000
200,000
Total OH$480,000
$447,800
$428,000
Spending VarianceEfficiency Variance
= $32,200U= $19,800U
Flexible-Budget Variance
= $52,000U
14-51 (Continued)3.Standard variable overhead application rate =
budgeted variable manufacturing overhead in the master budget (
practical capacity (MH)
Setup cost$64,000 + ($600 x 32) =$ 83,200
Applied based on machine hours32,000 x $5.00 = 160,000
Total variable factory overhead @ practical capacity =
$243,200
Practical capacity (machine hours)
( 32,000
Standard variable factory overhead rate/MH
$7.60
FB based on Inputs FB Based on Output (i.e., on actual (i.e., on
standard
Actual activity units) allowed activity units)VOH: 35,000 x
$7.60 =266,00030,000 x $7.60 =228,000
FOH:
200,000
200,000
Total OH$480,000
$466,000
$428,000
Spending VarianceEfficiency Variance
= $14,000U= $38,000U
Flexible-Budget Variance
= $52,000U
Notice that assumptions made regarding the number and type of
activity measures used to apply standard overhead costs to
production can affect both the total flexible-budget (controllable)
variance and the components of this variance. For this reason, the
activities used to construct flexible-budgets for control purposes
should be carefully selected.
14-52 ABC and Practical Capacity (4045 minutes)Note: An Excel
spreadsheet solution file for this assignment is embedded below.
You can open this object by doing the following:
1. Right click anywhere in the worksheet area below.
2. Select worksheet object and then select Open.
3. To return to the Word document, select File and then Close
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14-53 Fixed Overhead Variances (15 minutes)
1.Budgeted monthly salary = $324,000/year ( 12 mos./year =
$27,000
Actual salary in September
28,000
Budget (spending) variance
$1,000U
2.$0. There is no efficiency variance for fixed overhead. The
efficiency variance for overhead refers to the effect on overhead
costs of efficiency or inefficiency in the use of the activity
measure(s) used to construct the flexible-budget for variable
overhead cost.
3.Units manufactured during the month =
15,750
Standard fixed ovh. rate/unit = ($324,000/year ( 180,000 units)
= $1.80
Total fixed overhead applied to production =
$28,350
Budgeted monthly fixed overhead cost = 27,000
Fixed overhead production volume variance =
$ 1,350F
4. For product-costing purposes, companies must unitize fixed
overhead costs. This is done by dividing budgeted fixed overhead
(i.e., capacity-related manufacturing costs) by some level of
activity, called the denominator volume. Thus, strictly speaking,
the resulting fixed overhead cost per unit is valid only at the
denominator activity level. For this reason, when actual activity
is different from the denominator activity level a production
volume variance will occur. This variance represents the difference
between total budgeted fixed overhead cost and the amount of fixed
overhead cost assigned to production. As such, the variance is
referred to as over/under-applied fixed overhead.
14-54 Flexible Budgets with ABC (30 minutes)
(1) Budgeted manufacturing support costs:
Output Level
4,000 5,000 6,000
Unit-level support costs:
Electricity$4,000$5,000$6,000
Maintenance labor $6,000$7,500$9,000
Total unit-level support$10,000$12,500$15,000
Batch-level support costs:
Production set-ups$6,000$7,200$8,400
Incoming inspections$1,000$1,500$2,000
Total batch-level support$7,000$8,700$10,400
Product-level support costs:
Engineering support$24,000$30,000$36,000
Facilities-level support costs:
Factory depreciation$15,000$15,000$15,000
Property taxes/insurance $5,000$5,000$5,000
Total facilities-level support$20,000$20,000$20,000
Total Manufacturing Support$61,000$71,200$81,400 Note: An Excel
spreadsheet solution file for part (1) of this assignment is
embedded below. You can open this object by doing the
following:
1. Right click anywhere in the worksheet area.
2. Select worksheet object and then select Open.
3. To return to the Word document, select File and then Close
and return to... while you are in the spreadsheet mode. The screen
should then return you to this document.
14-54 (Continued)
2. When a single activity measure is used to construct the
flexible (control) budget for factory overhead costs, then all
component overhead costs must be categorized as variable or fixed
with respect to changes in this single activity measure. For
example, some overhead costs that are characterized as fixed under
the conventional approach (e.g., with respect to changes in machine
hours) are not fixed in terms of changes in other activities (e.g.,
number of production runs).
Under ABC, as seen in this example, factory overhead costs are
modeled as a function of several activity measures (cost drivers).
As such, the resulting overhead flexible (control) budget can
provide a more accurate benchmark of manufacturing support costs.
For example, some support costs can be modeled as variable with
respect to number of production runs or number of purchase
orders.
Note that when a conventional system uses a volume-based cost
driver (e.g., machine hours), then unit-level manufacturing support
costs and facilities-level support costs under ABC will be treated
as variable and fixed costs under a conventional cost system. As
such, differences in cost estimates between ABC and conventional
systems are likely attributable to the different ways that each
system treats batch-level and product-sustaining support costs. In
this example, the traditional system would treat production set-up
costs, incoming inspection costs, and engineering support costs as
fixed with respect to volume of output.
From a cost-control standpoint, these differences are important
because they affect the nature (favorable or unfavorable) and
dollar amount of the flexible-budget variances calculated under
each system. For further information, the interested reader can
consult any of the following:
Kaplan, R. S. (1994). Flexible-budgeting in an activity-based
costing framework. Accounting Horizons (June), pp. 104109.
Mak, Y. T. and Roush, M. L. (1994). Flexible-budgeting and
variance analysis in an activity-based costing environment.
Accounting Horizons (June), pp. 93103.
Ruhl, J. M. (1994). Activity-based variance analysis. Journal of
Cost Management (July/August), pp. 3847.
14-55 Payoff Tables for Variance Investigation (2030
minutes)
(1) Expected value of the decision to investigate the
variance:
E(Investigate) = [(I x (1 p)] + [(I + C) x p]
= [($750 x (1 0.15)] + [($750 + $3,000) x 0.15]
= $637.50 + $562.50 = $1,200
(2) Payoff table:
Management States of Nature (prob.) Expected
Action Random (85%) Systematic (15%) Value Investigate $750
$3,750 $1,200
Dont Investigate - 0 - $25,000 $3,750
(3) Let p = the indifference probability, that is, the
probability of for a nonrandom variance such that management is
indifferent between the two courses of action, investigate or do
not investigate.
p = I /(L C)
= $750/($25,000 $3,000)
= $750/$22,000 = 3.41%
where I = the expected cost to conduct an investigation, L =
expected loss associated with leaving an out-of-control process out
of control (i.e., the present value of losses the organization will
experience until the next decision point), and C = the expected
cost to correct the process if the variance is found to have a
nonrandom cause.
That is, if the probability for a nonrandom cause (or causes) is
3.41%, management would be indifferent, in expected value terms,
between investigating and not investigating the variance. The
expected cost of each course of action to the organization would be
the same. If, as in the present case, p > 3.41%, the indicated
course of action is not to investigate.
14-55 (Continued)Note: An Excel spreadsheet solution for this
exercise is embedded below. You can open this object by doing the
following:
1. Right click anywhere in the worksheet area below.
2. Select worksheet object and then select Open.
3. To return to the Word document, select File and then Close
and return to... while you are in the spreadsheet mode. The screen
should then return you to this document
PROBLEMS
14-56 Four-Variance Analysis of Total Overhead Variance (60
minutes)
Variable factory overhead
Flexible-budget (FB) based FB Based on Output on Inputs (i.e.,
hrs. worked) (i.e., allowed hours)
Actual
(AQ x SP) (SQ x SP)$352,000 440,000 x SP
SQ x SP
Spending Variance Efficiency Variance
Fixed factory overhead Budget Applied
Actual
(Lump-Sum) (SQ x SP)
200,000 units x $3/unit
$575,000
= $600,000396,000 x SP
Spending Variance Production Volume Variance
1.
a. Total units manufactured
198,000
Standard hours allowed per unit manufactured
x 2Total standard hours for the units manufactured
396,000
b. Standard variable factory overhead rate per hour
Total budgeted factory overhead
$900,000
Denominator activity (capacity level)200,000
Fixed factory overhead rate per unitx $ 3.00Total budgeted fixed
factory overhead
$600,000Total budgeted variable factory overhead
$300,000
Total direct labor hours @ capacity (200,000 x 2)
( 400,000
Standard variable factory overhead rate per hour
$0.75
( Variable factory overhead efficiency variance
= (440,000 396,000) DLHs x $0.75/DLH = $33,000U14-56
(Continued-1)c. Variable factory overhead incurred (given)
=$352,000
FB based on Inputs = 440,000 DLHs x $0.75/DLH = 330,000
Variable overhead spending variance
$ 22,000Ud. Fixed factory overhead incurred (given)=$575,000
Budgeted fixed factory overhead
= 600,000Fixed factory overhead spending variance
$ 25,000F
e.Total standard hours allowed for units
manufactured=396,000
Standard fixed overhead rate/DLH = $3.00 ( 2 = $1.50
Total fixed factory overhead applied to production
$594,000
Alternative computation:
Units manufactured (given)
198,000
Standard fixed factory overhead rate/unit (given) x $3.00
Total fixed overhead applied
$594,000f.Total budgeted fixed factory overhead
$600,000
Total applied fixed factory overhead
$594,000
Fixed factory overhead production volume variance
$ 6,000U
(2) Journal entries:
Dr. Variable Overhead
$352,000
Cr. Accounts payable, etc.
$352,000
To record actual variable overhead costs for the period.
Dr. WIP Inventory ($0.75 x 396,000)$297,000
Cr. Variable Overhead
$297,000
To apply standard variable overhead costs to production for the
period.
Dr. Variable Overhead Spending Variance$22,000
Dr. Variable Overhead Efficiency Variance$33,000
Cr. Variable Overhead
$55,000
To record variable overhead variances for the period.
14-56 (Continued-2)
Dr. Fixed Factory Overhead
$575,000
Cr. Accumulated depreciation, etc.
$575,000
To record actual fixed overhead costs for the period.
Dr. WIP Inventory (396,000 x $1.50)$594,000
Cr. Fixed Factory Overhead
$594,000
To apply standard fixed overhead costs to production for the
period.
Dr. Production Volume Variance$6,000
Dr. Fixed Factory Overhead
$19,000
Cr. Fixed Overhead Spending Variance
$25,000
To record fixed overhead variances for the period.
(3) One view of the production volume variance is an artifact of
the product-costing purpose of standard costing. To unitize
budgeted fixed overhead for product-costing purposes, a denominator
activity level must be chosen over which the budgeted fixed
overhead costs can be spread. If the actual level of activity
differs from the level chosen to establish the fixed overhead
application rate, a production volume variance will occur. From a
cost-control standpoint, the production volume variance,
particularly when the denominator activity level is defined as
practical capacity, can be thought of as representing the cost of
unused capacity. As such, this variance information can be
monitored over time to help better manage the supply of
capacity-level resources.
The fixed overhead spending variance represents the difference
between planned (budgeted) fixed overhead costs and actual fixed
overhead costs for the period. If management desires, this total
variance can be broken down on a line-item basis.
The variable overhead spending variance is partly attributable
to the fact that the measure(s) chosen to budget variable overhead
costs are imperfect. In the present case, a single activity
measure, DLHs, is used to construct the flexible (control) budget
for variable overhead cost. We know that such a simplification
introduces error into the variance-determination process. This
variance is also attributable to spending on overhead items being
different from expectations. These variances (e.g., spending on
electricity) can theoretically be decomposed into price and
quantity components, much the same as we did in chapter 13 for
direct manufacturing costs.
The variable overhead efficiency variance refers to the impact
of manufacturing overhead of efficiency or inefficiency in the use
of the activity measure(s) used to construct the flexible-budget
for variable overhead. It is a misnomer, therefore, to interpret
this variance as measuring the effect of
efficiencies/inefficiencies associated with the consumption of
individual variable overhead components. Note, too, that this
variance is affected by the strength of the relationship between
variable overhead cost and the activity measure(s) used to budget
these costs for control purposes. That is, a clean interpretation
of this variance exists only if the relationship between cost and
activity is perfect. 14-57 All Manufacturing Variances (4550
minutes) 1. At the time of purchase. Recording the price variance
for materials at time of purchase recognizes the variance at the
point it occurs. Further, if the organization in question uses a
standard cost system, then this practice results in the materials
inventory being carried at standard cost, which is consistent with
the way WIP Inventory and Finished Goods Inventory are carried.
Finally, recognizing the price variance at point of purchase
provides management with timely information that, presumably, can
be used to correct any problems that arise.
2. Total actual direct labor cost =(2,000 x $7) + (1,400 x
$7.20) =$24,080
Total actual hours at the standard hourly rate =3,400 x $7 =
23,800
Direct labor rate (price) variance
$ 280U3.Total actual direct labor hours at standard wage rates
=
2.
AQ x SP = 3,400 x $7.00 =$23,800
Total standard direct labor cost for units manufactured
= 800 units x 4 hours/unit x $7.00/hour = 22,400Direct labor
efficiency variance = SP x (AQ SQ) = $ 1,400U
4.
Price Price
AQ APSPAP-SP VarianceIron
5,000$2 $2- 0 - - 0 -
Copper2,200$3.10$3 $0.10 $220Direct Materials purchase price
variance
$220U5.
Usage
AQ SQ (AQ SQ) SP VarianceIron
3,900800 x 5 = 4,000100F$2.00$200F
Copper2,600 800 x 3 = 2,400200U$3.00 600U
Direct Materials usage (quantity) variance
$400U
6.Actual variable overhead (given)
=$12,000
FB for Variable Overhead based on Inputs (actual hours
worked) = 3,400 hours x $3.00/hours = 10,200Variable overhead
spending variance=$1,800U
Alternative formula for variable overhead spending variance:
Variance = AQ x (AP SP)
= 3,400 hours x ([$12,000/3,400 hours] $3.00)/hour
= 3,400 hours x ($3.5294117 $3.00)/hour
= 3,400 hours x $0.5294117