This action might not be possible to undo. Are you sure you want to continue?

Page 1 of 6

**MANAGEMENT ACCOUNTING: CONCEPTS AND TECHNIQUES
**

By Dennis Caplan PART 4: DETERMINING THE COST OF INVENTORY

CHAPTER 17: COST VARIANCES FOR VARIABLE AND FIXED OVERHEAD Chapter Contents:

Cost Variances for Variable Overhead Cost Variances for Fixed Overhead The Fixed Overhead Spending Variance The Fixed Overhead Volume Variance Additional Issues Related to the Volume Variance Comprehensive Example of Fixed Overhead Variances

**Cost Variances for Variable Overhead:
**

The formulas for splitting the flexible budget variance for variable overhead into a “price” variance and an “efficiency” variance are the same as the formulas for direct materials and direct labor explained in Chapter 6. The “price” variance for variable overhead is called the variable overhead spending variance: Spending variance = PV = AQ x (AP – SP) Efficiency variance = EV = SP x (AQ – SQ) Where AP is the actual overhead rate used to allocate variable overhead, and SP is the budgeted overhead rate. The “Q’s” refer to the quantity of the allocation base used to allocate variable overhead, so that AQ is the actual quantity of the allocation base used during the period, and SQ is the standard quantity of the allocation base. The standard quantity of the allocation base is the amount of the allocation base that should have been used (i.e., would have been budgeted) for the actual output units produced. Given the use of the allocation base in these formulas for the cost variances for variable overhead, the meaning of these variances differs fundamentally from the interpretation of the variances for direct materials and direct labor. Consider a company that allocates electricity using direct labor as the allocation base. A negative variable overhead efficiency variance does not necessarily mean that the factory used more electricity than the flexible budget quantity of kilowatt hours for the actual outputs produced. Rather, the negative variance literally means that the factory used more direct labor than the flexible budget quantity for direct labor. If there is a cause-and-effect relationship between the allocation base and the variable overhead cost category (i.e., if more direct labor hours implies more electricity used), then the negative efficiency variance suggests that more electricity was used than the flexible budget quantity, but the efficiency variance does not measure kilowatts directly. Similarly, a negative spending variance for variable overhead does not necessarily mean that the cost per kilowatt-hour

http://classes.bus.oregonstate.edu/spring-07/ba422/Management%20Accounting%20Chapt... 5/10/2011

Hence. The volume variance attaches a dollar amount to the difference between two production levels. or more kilowatt hours used per unit of the allocation base. Rather. In this case: volume variance budgeted fixed overhead budgeted production =( X units produced )− budgeted fixed overhead The term in parenthesis equals the amount of fixed overhead that would be allocated to production under a standard costing system. direct labor. whereas cost variances for direct materials. the production volume variance is the difference between budgeted fixed overhead (a lump sum). and do not use these formulas at all. 5/10/2011 . what one might think should be included in the efficiency variance (kilowatt hours required per direct-labor-hour being higher or lower than budgeted) actually gets included as part of the spending variance. there are two common choices for this denominator: (1) budgeted production (2) factory capacity The interpretation of the volume variance depends on which of these two denominators are used. and variable overhead all use the same two formulas. and the amount of fixed overhead that would be allocated to production under a standard costing system using this fixed overhead rate. a negative spending variance for variable overhead literally states that the actual overhead rate was higher than the budgeted overhead rate.CHAPTER 17: COST VARIANCES FOR VARIABLE AND FIXED OVERHEAD Page 2 of 6 was higher than budgeted. As discussed in the previous chapter. The volume variance with budgeted production in the denominator of the O/H rate: First we use budgeted production to calculate the volume variance. The Fixed Overhead Volume Variance: The fixed overhead volume variance is also called the production volume variance. expressed in units. because this variance is a function of production volume. which could be due either to a higher cost per kilowatthour. Since budgeted fixed overhead ÷ budgeted production = budgeted overhead rate http://classes.. Also.. The second production level is the denominator-level concept in the budgeted fixed overhead rate. when budgeted production is the denominator-level concept. (More precisely.edu/spring-07/ba422/Management%20Accounting%20Chapt. The first production level is the actual output for the period.) There are two fixed overhead cost variances: the spending variance and the volume variance. cost variances for fixed overhead can only be calculated for the factory or facility as a whole.oregonstate. The Fixed Overhead Spending Variance: The fixed overhead spending variance is the difference between two lump sums: Actual fixed overhead costs incurred − Budgeted fixed overhead costs The fixed overhead spending variance is also called the fixed overhead price variance or the fixed overhead budget variance. and variable overhead can be calculated for individual products in a multi-product factory. Cost Variances for Fixed Overhead: Whereas the cost variances for direct materials. direct labor. fixed overhead cost variances can only be calculated for the combined operations to which the resources represented by the fixed costs apply. the cost variances for fixed overhead are different.bus. but in either case.

CHAPTER 17: COST VARIANCES FOR VARIABLE AND FIXED OVERHEAD Page 3 of 6 the above expression for the volume variance is algebraically equivalent to the following formula: volume variance = (units produced − budgeted production) x budgeted overhead rate This formula for the volume variance illustrates the statement above. then assuming those additional units can be sold. When actual production is greater than budgeted production. etc. it really is less profitable than was budgeted. this greater profitability is reflected in a lower per-unit production cost. In this case. The volume variance represents the fixed overhead costs that are not allocated to product because actual production is below capacity. the volume variance represents the fixed overhead costs that are not allocated to product because actual production is below budget. In this case. In the unlikely event that the factory produces above capacity (which can occur if the concept of practical capacity is used. 5/10/2011 . and actual down-time for routine maintenance. The interpretation of the volume variance. On the other hand. In this case: volume variance =( budgeted fixed overhead factory capacity x units produced )− budgeted fixed overhead Since budgeted fixed overhead ÷ factory capacity = budgeted overhead rate the above expression for the volume variance is algebraically equivalent to the following formula: volume variance = (units produced − factory capacity) x budgeted overhead rate The interpretation of the volume variance. the volume variance is unfavorable. and under what circumstances would a company use factory capacity as the denominatorlevel concept? The use of budgeted production in the calculation of the volume variance attaches a lump sum benefit or cost to actual http://classes. then the volume variance represents the additional fixed overhead costs that are allocated to product because actual production exceeds budget. is the following. and this variance is typically unfavorable. and expenses fixed overhead as a lump-sum period cost. The volume variance with factory capacity in the denominator of the O/H rate: Next we use factory capacity to calculate the volume variance. the company is more profitable. the volume variance is favorable. In this case. and the company is less profitable. When fixed overhead is allocated to production. if fewer units are produced than planned. When actual production is less than budgeted production.bus. Hence the volume variance represents the cost of idle capacity. then the volume variance represents the additional fixed overhead costs that are allocated to product because actual production exceeds capacity. it really is more profitable than was budgeted.edu/spring-07/ba422/Management%20Accounting%20Chapt.oregonstate.e. In this case. that the volume variance attaches a dollar amount to the difference between two production levels. because the same amount of total fixed overhead is spread over more units.. when factory capacity is used in the denominator of the overhead rate. and when the company makes and sells more units than planned using the same fixed overhead resources. Additional Issues Related to the Volume Variance: Under what circumstances would a company calculate the volume variance using budgeted production as the denominator-level concept.. the volume variance is favorable. when the company makes and sells fewer units than planned using the same fixed overhead resources. If the company can produce more units of output using the same fixed assets (i. this volume variance is sometimes called the idle capacity variance.. when budgeted production is used in the denominator of the overhead rate. the two production levels are actual production and budgeted production. is the following. For this reason. is less than expected). The intuition for when the volume variance is favorable and when it is unfavorable is the following. then the same fixed overhead is spread over fewer units. the per-unit production cost is higher. This higher or lower profitability that arises from changes in production levels is not an artifact of the accounting system. Even if the company uses Variable Costing.. Actual production is almost always below capacity. the resources that comprise fixed overhead).

and to either show the cost of idle capacity as separate line-items on the cost reports and profit statements of the factory manager and product managers. Allocating fixed overhead using actual production can provide managers short-run incentives to overproduce. such as direct labor hours or direct materials dollars. no matter whether the $10-per-unit rate is used..edu/spring-07/ba422/Management%20Accounting%20Chapt.bus. For example. Another reason to use factory capacity in the denominator of the fixed overhead rate. Comprehensive Example of Fixed Overhead Variances: The Coachman Company makes pencils. the decision to build a factory that is larger than current demand warrants is a strategic decision made at high levels within the organization. The pencils are sold by the box.. calculating the volume variance using budgeted production in the denominator of the overhead rate can provide managers short-run incentives to overproduce. the amount of fixed overhead that will be allocated to product does not depend on the choice of allocation base. but these sales prices might be too high to generate sufficient initial consumer interest in the product for a successful product launch.CHAPTER 17: COST VARIANCES FOR VARIABLE AND FIXED OVERHEAD Page 4 of 6 production levels that exceed or fall short of budgeted production levels. If the fixed overhead associated with this factory is allocated based on budgeted or actual production. and the cost reports of factory managers and the product profitability statements of product managers are negatively affected by this unused capacity. It is important to recognize that even though most manufacturing companies use a standard costing system. the budgeted fixed overhead rate is $10 per unit. and even though the calculation of the fixed overhead volume variance relies on the concept of standard costing. the calculation is identical to the discussion above. Then using direct labor hours as the allocation base. but rather. but the company will not be able to obtain the required information from the cost accounting system itself. For example. 5/10/2011 . because it isolates the volume variance such that the performance reports of these managers need not be affected by it. refer back to Chapter 10 on standard costing. because as production increases. or the $5-per-direct-labor-hour rate is used. companies can calculate the volume variance even if they do not use a standard costing system. the budgeted fixed overhead rate is $5 per direct labor hour. In this case. the per-unit cost decreases. then product managers might feel pressured to set sales prices that will cover full product costs at initially-low production levels. and assume that if fixed overhead is allocated based on output units. we saw in the chapter on activity-based costing that units of production is often a poor choice of allocation base in a multiproduct factory. if demand equals or exceeds factory capacity. the per-unit cost of every unit manufactured includes a small portion of the cost of this strategic decision. affect the calculation of the volume variance? The answer is: Not at all. for the purpose of calculating the volume variance. For this reason. many companies consider this calculation of the volume variance to be an important performance measure for the factory manager and marketing managers responsible for making and marketing the product. Often. If fixed overhead is allocated based on budgeted production. However. some companies choose not to allocate fixed overhead at all. Because of the way in which standard costing systems work. Following is information about the http://classes. or remove this cost entirely from these performance reports. and in the calculation of the volume variance. The question might arise.oregonstate. calculating the per-unit cost in this manner will encourage product managers to take this long-run perspective. and many companies that use standard costing systems use allocation bases that are more sophisticated. If senior management would like product managers to make pricing and operating decisions based on a long-term expectation that demand for the product will equal or exceed factory capacity. that fixed overhead is allocated based on units of output. (If this fact is not obvious to you. $10 of fixed overhead will be allocated to every unit produced.) Therefore. which is units-ofoutput. even though current or short-term demand is below capacity. the use of factory capacity in the denominator of the fixed overhead rate accomplishes the same objective. we might as well use the easiest allocation base. consider the launch of a new product line in a new factory. We have assumed. For this reason. and report it only at the corporate level. no matter how many direct labor hours are actually used per unit. the volume variance becomes increasingly favorable. will need to make a separate calculation. such as direct labor hours. is that doing so isolates the cost of idle capacity. throughout this section. Similarly. Because of the mechanics of standard costing systems. The use of factory capacity in the calculation of the volume variance provides an indication of how low the per-unit cost can go. because as production exceeds budget. how does the use of a different allocation base. However. assume that a one-product company budgets two direct labor hours to make each unit. Some companies prefer to isolate the cost associated with this strategic decision.

and budgeted output units as the denominator-level concept: $40.000 boxes = $4.000 actual − $40..000 − $24.000 − ($2.50 per box. and factory capacity as the denominator-level concept (expressed in terms of output units). $40.000 unfavorable.000 = $16.000 unfavorable volume variance.000 ÷ 20.000 200 500 $40. 5/10/2011 .000 ÷ 10.000 boxes = $3. and fixed overhead allocated to product. every box of pencils is costed at the variable cost of production plus $3.50 in allocated fixed overhead. how low the total cost per unit can go. The advantage of using capacity in the denominator is that this denominator-level concept shows how low the fixed cost per unit can go.00 per box. the amount of overallocated or underallocated fixed overhead is the difference between actual fixed overhead incurred.000 boxes) = $16.00 per box x 12.CHAPTER 17: COST VARIANCES FOR VARIABLE AND FIXED OVERHEAD Page 5 of 6 company’s only factory: Number of boxes Direct labor hours Machine hours Fixed overhead Budget 10.000 = $8. First we calculate a fixed overhead rate using actual amounts..000 boxes = $2. and output units as the allocation base: $42.000 = $18.00 per box x 12.000 boxes) − $40.000 250 650 $42.000 boxes) = $42.00 per box.000 unfavorable or equivalently: volume variance = $2.00 per box x (12.000 favorable http://classes. Next.000 budgeted = $2. Next. The inputs are direct labor hours and machine hours. we calculate the volume variance using capacity as the denominator-level concept: volume variance = ($2.000 Capacity 20. Next we calculate a fixed overhead rate using budgeted costs.00 per box x 12.000 boxes − 20.000 of underallocated fixed overhead is equal to the sum of the $2.edu/spring-07/ba422/Management%20Accounting%20Chapt. Next we calculate a fixed overhead rate using budgeted costs.000 unfavorable If the company uses a standard costing system.000 ÷ 12.000 Actual 12. as production increases. Using this overhead rate.000 underallocated This $18. The fixed overhead spending variance is calculated as follows: $42.000 unfavorable fixed overhead spending variance and the $16.000 The outputs here are boxes of pencils.oregonstate.bus. we calculate the volume variance using budgeted production as the denominator-level concept: volume variance = ($4.000 boxes) − $40. and hence. calculated as follows: actual fixed overhead − fixed overhead allocated $42.

as before..000 ÷ 500 machine hours = $80 per machine hour.oregonstate.000 favorable If the company uses a standard costing system.000 favorable.000 favorable volume variance.CHAPTER 17: COST VARIANCES FOR VARIABLE AND FIXED OVERHEAD Page 6 of 6 or equivalently: volume variance = $4.000 boxes) = $42.000 boxes ÷ 20 boxes per machine hour) = $80 per machine hour x 600 machine hours = $48. TABLE OF CONTENTS PREVIOUS CHAPTER NEXT CHAPTER GLOSSARY http://classes.000 boxes − 10. calculated as follows: actual fixed overhead − fixed overhead allocated $42. and fixed overhead allocated to product.000 − ($4.000 of overallocated fixed overhead is equal to the sum of the $2..000 = $6.000 And the volume variance is fixed overhead allocated to product − budgeted fixed overhead = $48. the amount of overallocated or underallocated fixed overhead is the difference between actual fixed overhead incurred.edu/spring-07/ba422/Management%20Accounting%20Chapt.000 overallocated This $6.bus.000 − $40. To illustrate that the choice of allocation base does not affect the calculation of the volume variance. the standard costing system will allocate fixed overhead as follows: Budgeted overhead rate x (standard inputs allowed for actual outputs achieved) = $80 per machine hour x (12. Since the standard for machine time is one hour for every twenty boxes (derived from the budget column in the box at the beginning of the example).00 per box x 12.000 boxes) = $8. we recalculate the volume variance assuming the company allocates overhead using machine hours as the allocation base and budgeted production as the denominator-level concept.000 unfavorable fixed overhead spending variance (which did not change when we changed the denominator-level concept from capacity to budgeted production) and the $8. 5/10/2011 .000 = $8. The budgeted overhead rate is now $40.000 − $48.00 per box x (12.

- Workmen Compensation ACt
- MM Prog
- MBAIR
- Employee State Insurance Act 1948
- Urdu Press Release
- Resolution Urdu
- Resolution English
- bba&mba
- 4. Wages
- Introduction to Retail
- What is Franchising
- paper schdeule.xlsx
- 27758691 Consumer Decision Making
- Introduction to Retail
- Schedule
- bba&mba
- 19854293-Retail-Management.ppt
- 4. Modern Modes of Business
- 2. Business Support Services
- 44286160 Compensation Management
- CM
- Food
- Food
- CAMPSCHDEC_oddsem_29dec10

Sign up to vote on this title

UsefulNot usefulAccounting

Accounting

- Chapter 17_ Cost Variances for Variable and Fixed Overhead
- Chap 015
- UNIT 5
- Module 10 Standard Costs
- 05 x05 Standard Costing & Variance Analysis
- Standard Costing
- Chapter 15 ed.5
- Chapter 23
- Chapter 1
- Hansen AISE IM Ch09 Biaya Standar (Klp 2).ppt
- variance analysis
- Accounting Standard costing
- Production Order Variance - Part 1
- Akuntansi Manajemen 4
- A MIT Lecture on Standard Costs
- Performance Evaluation Using Variances From Standard Costs
- Hansen and Mowen Management Accounting CH 9
- final sc and vc
- ch11
- Standard Costs and Variance Analysis
- 11.pdf
- lec34
- Ch18SM
- Sol14_4e
- 3rd Module
- Bab 8 Variance Analysis
- Ma Wa5 Final
- Chapter 22
- cost accounting
- 305 Final Exam Cram Question Package
- MAccounting Variances and overhead.pdf