Sol14_4e

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


$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


$ 5,000


$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 $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 $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


$280,000

(b) To Record Overhead Variances Using a Two-Variance Approach


$50,000

Cr. Total Flexible-Budget Variance

$ 7,000


$ 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


$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


$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


$ 2,000

Cr. Factory Overhead (or, Fixed Factory Overhead)

$2,000

14-31 (Continued)

To Record Unfavorable 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


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:




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:




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


= $2,250F


= $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


=$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:




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


= $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


= $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


= $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:



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.

14-53 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.


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:



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

Sol14_4e

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