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 01
STANDARD OVERHEAD
COSTS: PLANNING VS
CONTROL
 02
VARIANCE ANALYSIS
FOR MANUFACTURING
OVERHEAD COSTS
 03
RECORDING
STANDARD
OVERHEAD COSTS
 Journal Entries and Variances for
Overhead Costs
As noted above and in Chapter 14, a standard cost system incorporates
standard product costs in the formal accounting records (raw materials,
WIP inventory, finished goods inventory, and cost of goods sold). As in
the case of direct materials and direct labor, the standard overhead cost of
the output of the period is charged to production, while actual overhead
costs are recorded separately, in descriptive accounts such as Utilities
Payable, Accumulated Depreciation, and Salaries Payable.
 Assume that for October 2019, the Schmidt Machinery Company
incurred the following variable overhead costs: utilities, $30,000, and
indirect materials, $10,630. These actual overhead costs would be
recorded as incurred, in entries such as the following
 At the end of the month (process cost system) or at the completion of
one or more jobs (job order cost system), the WIP inventory account must
be charged for the standard variable overhead cost of the 780 units
produced. The standard variable overhead rate is $12 per labor hour and
the standard number of labor hours per unit is 5. Thus, for October 2019
the appropriate journal entry would be:
 At this point, you can see that the balance in the Factory Overhead
account ($46,800 cr. $40,630 dr. $6,170F) is the total variable overhead
variance for the period. Assume now, for simplicity, that the actual fixed
overhead cost for October 2010 consisted of only two items: $100,000
supervisory salaries plus $30,650 of depreciation expense. The journal
entry to record actual fixed overhead costs for the month would be:
 Recall that the standard fixed overhead rate is $24 per standard
labor hour allowed, or equivalently, $120 per unit produced (since
there are 5 standard labor hours per unit produced). The journal entry
to charge production with standard fixed overhead cost would be:
 Similar to entries we made in Chapter 14 for direct
materials and direct labor, we would then use the following
journal entry to transfer the standard overhead cost of
completed production from WIP Inventory to Finished Goods
Inventory:
 After these entries are posted to the ledger, the Manufacturing Overhead
account contains the net overhead balance for the period, $30,880 debit (i.e.,
net unfavorable variance). The component variances calculated using one of the
approaches described above could be calculated and used to close out the
$30,880 balance in the Manufacturing Overhead account. Assume that Schmidt
Machinery Company uses the four-variance approach for overhead analysis.
The appropriate journal entry to record the standard overhead cost variances for
October 2019 would be as follows:
 04
END OF PERIOD
DISPOSITION OF
VARIANCES
 Variance Disposition
For interim purposes (eg, preparation of monthly or quarterly financial
statements), the stan dard cost variances calculated in this chapter and in Chapter
14 are typically not disposed of. That is, the variance accounts are carried forward
on the balance sheet under the assumption that, over the course of the year,
favorable and unfavorable interim variances will offset one another. If interim
financial statements are prepared, the cost variances can be shown in a temporary
(ie., holding) account on the balance sheet awaiting ultimate disposition at the end
of the year.
 At the end of the year, the appropriate treatment for standard cost variances
depends on the size (materiality) of the net variance. Assume, for example,
that variance data for Schmidt Machinery from Chapters 14 and 15 relate to
the fiscal year, not just the month of October.

These cost variances are as follows:

Net Variance Considered Immaterial

Net Variance Considered Material in Amount

 If the net manufacturing cost variance is considered material in amount, the
net variance should be allocated to the inventory and Cost of Goods Sold
(CGS) accounts. This alloca- tion should be based on the relative amount of
this period's standard cost in the end-of- period balance of each affected
account. This means that the direct materials price variance from Chapter 14
will be apportioned to five accounts--Direct Materials Inventory. Materials
Usage Variance, WIP Inventory, Finished Goods Inventory, and CGS-based on
the amount of this period's standard direct materials cost in each account at the
end of the period. The direct materials usage variance would be allocated only
to WIP Inventory, Finished Goods Inventory, and CGS. This is because the
direct materials usage variance occurs after direct materials are issued to
production.
 The Effects of Denominator-Level Choice
on Absorption Costing Income
Earnings Management is the use of accounting techniques to produce
financial statements that present an overly positive view of a company's
business activities and financial position.
Under absorption (ie., full) costing, a portion of fixed manufacturing
overhead costs are either absorbed into or released from inventory,
depending on the relationship between pro- duction volume and sales
volume during the period.
 The amount of fixed overhead costs absorbed or released is affected by
the denominator level chosen for the predetermined overhead rate. Thus,
the effect of a change in inventory can be intensified or reduced based on
how the fixed overhead production volume variance is disposed of at the
end of the period. Specifically, this ability to affect reported income is
confined to the situation where the production volume variance is written
off entirely to cost of goods sold (CGS), as follows:
■If inventory is increasing, choosing a lower denominator
volume level will enhance the increase in absorption costing
income due to the deferral of fixed overhead in inventory.

■If inventory is decreasing, choosing a higher denominator

level will moderate the decrease in absorption-costing income
due to the release of fixed overhead into CGS.
The above points suggest that managers can increase short-run
operating income by

(1) choosing larger denominator levels if they expect inventory

to decrease or
(2) choosing smaller denominator levels if they expect
inventory to increase.
 05
STANDARD COSTS IN
SERVICE
ORGANIZATIONS
 Standard Costs in Service Organization
A standard cost system facilitates planning and short-term financial control
(through standard cost variance analysis) and aids managers in making
decisions such as product pricing and resource management. These benefits,
however, are not limited to manufacturing companies. All organizations can
potentially benefit from the use of a standard cost system.
Most costs in a service organization are short-term fixed costs. The bulk
of labor costs are for professional personnel who usually are paid a
monthly salary. Variations from one period to the next for salaried
personnel should be small or nonexis- tent. Other overhead costs for these
organizations often consist of expenses related to facili ties and equipment
and are, therefore, fixed in the short run.
Output Measures for Selected Service
Organizations
 06
OVERHEAD COST
VARIANCES IN
TRADITIONAL ABC
SYSTEM
 ABC-Based Flexible Budgets for Control
As described in Chapter 5, more modern cost systems, such as
activity-based costing (ABC) systems, apply manufacturing support
(i.e., factory overhead) costs to outputs on the basis of multiple
activities performed for each product produced. That is, ABC attempts
to assign manufacturing support costs to products on the basis of the
resource demands, or resource consumption, of each output.

To accomplish this, ABC systems use a broader set of activity

measures, both volume-related and non-volume-related, in the cost-
allocation process.
Cooper has developed a framework, in the form of a hierarchy, for classifying different
types of activity measures used in ABC systems. Cooper’s framework classifies
manufacturing support costs as unit-based, batch-level, product-level, or facility-level costs.

1. 1. Unit-based - measures are related to output volume and include machine hours,
direct labor hours, units of output, and units of raw materials.
2. 2. Batch-level - activity measures include the number of production setups, the
number of times materials and parts are moved during the manufacturing process,
and the number of receipts of materials.
3. 3. Product-level - activity measures typically relate to engineering support activities
and can include things such as number of products, number of processes, number of
engineering change orders (ECOs), and number of schedule changes.
At the top of the cost hierarchy are facility-level costs, which are related to the capacity or
ability to produce, rather than the variety of outputs, the number of batches produced, or
the volume of output.
 Flexible-Budget Analysis under
Traditional (i.e., Non-Time-Driven)
ABC When There Is a Standard Batch
Size for Production Activity
When production occurs in a standard (i.e., predetermined)
batch size, the accountant can modify the preceding
traditional ABC analysis to provide more detailed
information regarding the cause of any observed overhead
cost variances.
 Fixed Setup Costs in a Traditional
(i.e., Non-Time-Driven) ABC
System
The short-term fixed cost component of setup costs is controlled using the same procedures
discussed previously in this chapter. That is, the difference between actual fixed setup costs
and budgeted fixed setup costs is called a spending (or flexible-budget) variance. And the
difference between the fixed setup costs allocated to production and budgeted fixed setup
costs is called a production volume variance.

The only complicating factor in terms of calculating the latter is the possible
need to convert actual units produced to standard number of batches. This is
necessary only when setup-related support costs are allocated on
the basis of setup hours (not number of setups). We make this
conversion by dividing actual output by the standard
(i.e., budgeted or planned) batch size.
 Variable Setup Costs in a Traditional (i.e.,
Non-Time-Driven) ABC System
If output is produced in a standard batch size, we must first convert (as we did
above for fixed setup-related costs) the actual output of the period to number of
standard batches allowed. We then convert this to the standard allowed setup
hours. This latter figure, when multiplied by the standard variable setup cost per
setup hour gives us the flexible budget for variable setup overhead costs. As we
did earlier in the chapter, we then define the total flexible-budget variance for
variable setup overhead cost as the difference between actual variable setup
costs and the flexible budget for variable setup overhead costs. Finally, this total
flexible-budget variance is decomposed into a spending variance and an
efficiency variance using the procedures discussed earlier.
Interpretation of Setup-Related Standard Cost Variance
Management accountants can add value to their organization by accompanying cost-
variance data with plausible explanations for these variances. This holds true regardless
of whether the organization in question is using a traditional cost system or a traditional
ABC system.
1. Fixed spending variances for setup activities are likely to be relatively small but could arise if
new setup equipment is leased or if the leasing charge actually incurred on setup equipment is
different from the planned amount. They might also occur if salaries paid to supervisors or
engineers allocated to setup activity are different from those planned. The production volume
variance for fixed setup costs can be viewed roughly as a measure of capacity utilization. One
limitation of this interpretation, however, is the fact that it does not consider the income effect
of reduced output. That is, lower-than-anticipated output volume could have
been sold at a higher-than-budgeted selling price, thereby resulting in a net
increase to short-term operating profit.
. 2. The variable setup spending variance exists because the actual
variable cost per setup hour is different from the budgeted cost per setup
hour. The interpretation of this variance follows the interpretation
discussed earlier in this chapter. That is, this variance is partly due to the
fact that the actual quantity of individual resources (e.g., energy) per
setup hour is different than planned and/or the prices paid for these items
are different from planned amounts. The variable setup efficiency
variance is due to the actual number of setup hours, for the actual output
of the period, being different from the standard setup hours allowed.

This variance could be due to batch size being different from the
planned size and/or a different number of setup hours

per batch compared with standard.

Extension of ABC Analysis: GPK and RCA

 Enterprise resource planning (ERP) system

- system that tracks and maintains detailed information regarding resources and
activities associated with business processes.

 Grenzplankostenrechnung (GPK)
- GPK is a German cost management system that attempts to establish a strong
relationship between resources consumed and the appropriate cost driver.

 Resource consumption accounting (RCA)

- A comprehensive and fully integrated management accounting approach that
provides management with decision support information based on an operational
view of the organization.
 07
INVESTIGATION OF
VARIANCES
 INTRODUCTION
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