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Standard Costing: Factory Overhead Variance Analysis

Learn how to establish standard costs for variable overhead, calculate and explain variances, and analyze factory overhead variances using two or three-variance procedures.

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Standard Costing: Factory Overhead Variance Analysis

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  1. Chapter 14 Standard Costing: Factory Overhead

  2. Learning Objectives • Establish standard costs for variable overhead • Calculate and explain variable overhead variances • Compute and interpret fixed factory overhead variances • Use two-variance or three-variance procedures to analyze and interpret factory overhead variances • Dispose of variances in financial accounting systems

  3. Learning Objectives • Apply standard costs to service organizations • Analyze and explain the variances in an activity-based standard cost system • Describe the effects of advances in new manufacturing technologies and changes in operating environments on standard cost systems • Determine whether to investigate variances

  4. Learning Objective One Establish standard costs for variable overhead

  5. Energy costs • Indirect materials • Indirect labor • Equipment repair and maintenance • Factory managers’ salaries • Plant and equipment depreciation • Plant security guards • Insurance and property taxes for factory building and equipment Standard Costs for Factory Overhead VariableOverhead FixedOverhead

  6. Standard Costs for Factory Overhead We will use a general model similar to labor and material to calculate overhead variances.

  7. Learning Objective Two Calculate and explain variable overhead variances

  8. A General Model for Variable Overhead Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual OH Rate Standard OH Rate Standard OH Rate SpendingVariance EfficiencyVariance The total variance is the flexible budget variance.

  9. A General Model for Variable Overhead Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual OH Rate Standard OH Rate Standard OH Rate SpendingVariance EfficiencyVariance Standard Overhead rate is the amount that should have been paid for the resources acquired.

  10. A General Model for Variable Overhead Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual OH Rate Standard OH Rate Standard OH Rate SpendingVariance EfficiencyVariance Standard quantity is the quantityallowed for the actual good output.

  11. A General Model for Variable Overhead Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual OH Rate Standard OH Rate Standard OH Rate SpendingVariance EfficiencyVariance AQ(AR - SR) SR(AQ - SQ) AQ = Actual Quantity SR= Standard RateAR = Actual Rate SQ = Standard Quantity Materials price variance Materials quantity varianceLabor rate variance Labor efficiency varianceVariable overhead Variable overhead spending variance efficiency variance

  12. Establishing the Standard Costfor Variable Factory Overhead • Determine the behavioral patterns of variable factory overhead costs. • Select one or more appropriate activity driver for applying variable factory overhead to cost objects such as products, services, or divisions. • Ascertain the intended level of operation and estimate the total variable factory overhead and the corresponding total amount of the selected activity driver. • Compute the standard variable factory overhead rate.

  13. Determining a Standard VariableFactory Overhead Rate • Decide the level of operation. • Determine total variable factory overhead for the operation. • Select an activity driver for variable factory overhead and determine the amount for the operation. • Divide the amount in 2 by the amount in 3 to arrive at the standard variable overhead rate.

  14. Variable Factory OverheadVariances Example Do you remember theHanson Inc. examplefrom Chapter 13 thatwe used for materialand labor? Let’s revisit Hansonfor factory overheadanalysis.

  15. Jerf Variable Factory OverheadVariances Example Hanson Inc. applies variable factory overhead on the basis of direct labor hours. Hanson has the following variable factory overhead standard to manufacture one Jerf: 1.5 standard hours of labor per Jerf at a variable overhead rate of $3.00 per direct labor hour. Last month 1,550 hours were worked to make 1,000 Jerfs, and $5,115 was spent for variable factory overhead.

  16. Jerf Variable Factory OverheadVariances Question 1 What was Hanson’s actual rate (AR)for variable factory overhead rate for the month? a. $3.00 per hour. b. $3.19 per hour. c. $3.30 per hour. d. $4.50 per hour.

  17. Jerf Variable Factory OverheadVariances Question 1 What was Hanson’s actual rate (AR)for variable factory overhead rate for the month? a. $3.00 per hour. b. $3.19 per hour. c. $3.30 per hour. d. $4.50 per hour. AR = $5,115 ÷ 1,550 hours AR = $3.30 per hour

  18. Jerf Variable Factory OverheadVariances Question 2 Hanson’s spending variance (SV)for variable factory overhead forthe month was: a. $465 unfavorable. b. $400 favorable. c. $335 unfavorable. d. $300 favorable.

  19. Jerf Variable Factory OverheadVariances Question 2 Hanson’s spending variance (SV)for variable factory overhead forthe month was: a. $465 unfavorable. b. $400 favorable. c. $335 unfavorable. d. $300 favorable. SV = AH(AR - SR) SV = 1,550 hrs($3.30 - $3.00) SV = $465 unfavorable

  20. Jerf Variable Factory OverheadVariances Question 3 Hanson’s efficiency variance (EV)for variable factory overhead forthe month was: a. $435 unfavorable. b. $435 favorable. c. $150 unfavorable. d. $150 favorable.

  21. Jerf Variable Factory OverheadVariances Question 3 Hanson’s efficiency variance (EV)for variable factory overhead forthe month was: a. $435 unfavorable. b. $435 favorable. c. $150 unfavorable. d. $150 favorable. EV = SR(AH - SH) EV = $3.00(1,550 hrs - 1,500 hrs) EV = $150 unfavorable

  22. Jerf Variable Factory OverheadVariances Question 3 Hanson’s efficiency variance (EV)for variable factory overhead forthe month was: a. $435 unfavorable. b. $435 favorable. c. $150 unfavorable. d. $150 favorable. EV = SR(AH - SH) EV = $3.00(1,550 hrs - 1,500 hrs) EV = $150 unfavorable 1,000 units × 1.5 hrs per unit

  23. Jerf Variable Factory OverheadVariances – Summary Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,550 hours 1,550 hours 1,500 hours × × × $3.30 per hour $3.00 per hour $3.00 per hour $5,115 $4,650 $4,500 Spending variance$465 unfavorable Efficiency variance$150 unfavorable

  24. Efficiency Variance Interpretation and Implications of Variable Factory Overhead Variances Spending Variance Results from paying moreor less than expected foroverhead items such assupplies and utilities. A function of the selected activitymeasure. It does not reflectoverhead control.

  25. Learning Objective Three Compute and interpret fixed factory overhead variances

  26. Fixed Overhead Variances Now let’s turn our attention to fixed overhead.

  27. Determining a Standard FixedFactory Overhead Rate • Determine the total budgeted fixed factory overhead for level of operation. • Select an activity driver or drivers for applying fixed factory overhead. • Calculate the denominator quantity for the selected activity driver at the planned level of operations. • Divide the amount in Step 1 by the amount in Step 3 to determine the standard fixed factory overhead rate.

  28. Learning Objective Four Use two-variance or three-variance procedures to analyze and interpret factory overhead variances

  29. Fixed Overhead Variances Fixed factory overhead costs are assigned to products and services using a standard fixed overhead rate (FR): Assigned Overhead = FR × Standard Quantity Budgeted total fixed overhead costsDenominator quantity for activity driver FR =

  30. Fixed Overhead Variances Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied SH × FR Spending Variance VolumeVariance FR = Standard Fixed Overhead RateSH = Standard Hours Allowed

  31. Jerf $9,000 budgeted fixed overhead 3,000 budgeted units FR = = $3.00 per unit Fixed Overhead Variances – Example Hanson Inc.’s budgeted fixed overhead is $9,000 for the month. The budgeted activity measure for the month is 3,000 units. Actual production is 3,200 units and actual fixed overhead is $8,450 for the month. Compute the fixed overhead spending and volume variances. First, calculate the fixed overhead rate.

  32. Jerf Fixed Overhead Variances – Example Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied $8,450 $9,000 Spending variance$550 favorable

  33. Jerf Fixed Overhead Variances – Example Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied 3,200 units × $3.00 per unit $8,450 $9,000 $9,600 Spending variance$550 favorable Volume variance$600 favorable

  34. Volume Variance Interpretation of Fixed FactoryOverhead Variances • Spending Variance Results from paying moreor less than expected foroverhead items. Results from the inabilityto operate at the activitybudgeted for the period.

  35. Fixed Factory Overhead Variances Let’s look at a graph showing fixed overhead variances. We will use Hanson’snumbers from the previous example.

  36. Jerf 3,200 units × $3.00 fixed overhead rate $600FavorableVolume Variance $9,600 applied fixed OH { { $550FavorableSpending Variance $8,450 actual fixed OH 3,200 Units Fixed Factory Overhead Variances – Example Cost $9,000 budgeted fixed OH Fixed overhead applied to products Volume 3,000 UnitsBudgeted Activity

  37. Unfavorable when standardquantity < budgeted quantity Favorable when standardquantity > budgeted quantity Interpretation of Fixed Factory Overhead Volume Variance A measure offacility use VolumeVariance Results when standard quantitydiffer from budgeted quantity

  38. Has no significance for cost control Explainable by and controllable only throughactivity Interpretation of Fixed Factory Overhead Volume Variance A measure offacility use VolumeVariance Results when standard quantitydiffer from budgeted quantity Unfavorable when standardquantity < budgeted quantity Favorable when standardquantity > budgeted quantity

  39. Factors Contributing to a Fixed Overhead Spending Variance • Ineffective budget procedures • Inadequate control of costs • Misclassification of cost items

  40. Factors Contributing to a Fixed Overhead Volume Variance • Management decisions • Unexpected changes in market demand • Unforeseen problems in manufacturing operations

  41. Total OHSpendingVariance Variable OHEfficiencyVariance Fixed OHVolumeVariance Three-Way Analysis of Factory Overhead Variances Variable OHSpendingVariance Fixed OHSpendingVariance Variable OHEfficiencyVariance Fixed OHVolumeVariance

  42. Fixed Factory Overhead Variances Let’s return to Hanson Inc to observe three-way analysis of factory overhead variances.

  43. Three-Way Analysis of FactoryOverhead Variances Variable OHSpendingVariance$465 U Fixed OHSpendingVariance$550 F Variable OHEfficiencyVariance$150 U Fixed OHVolumeVariance$600 F Total OHSpendingVariance$85 F Variable OHEfficiencyVariance$150 U Fixed OHVolumeVariance$600 F

  44. Total OHControllableVariance Fixed OHVolumeVariance Two-Way Analysis of Factory Overhead Variances Variable OHSpendingVariance Fixed OHSpendingVariance Variable OHEfficiencyVariance Fixed OHVolumeVariance

  45. Fixed Factory Overhead Variances Now, let’s use the same numbers from Hanson Inc to illustrate two-way analysis of factory overhead variances.

  46. Two-Way Analysis of Factory Overhead Variances Variable OHSpendingVariance$465 U Fixed OHSpendingVariance$550 F Variable OHEfficiencyVariance$150 U Fixed OHVolumeVariance$600 F Total OHControllingVariance$65 U Fixed OHVolumeVariance$600 F

  47. Learning Objective Five Dispose of variances in financial accounting systems

  48. Disposition of Variances 1. Dispose of the variance in the period it occurs in the income statement. 2. Prorate variances to: – work in process – finished goods – cost of goods sold First, we will look at this method using Hanson Inc’s resultsfor the month of June with this additional data:Sales at the standard price $100,000Cost of goods sold at standard cost $ 60,000Selling price variance $ 7,000 favorableSelling and administrative expenses $ 41,000

  49. Disposition of Variances Recall Hanson’s manufacturing costvariances from our previous work:

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