The Flexible Budget: Factory Overhead

1. The Flexible Budget:Factory Overhead Chapter Fourteen

2. Learning Objectives • Distinguish between the product-costing and control purposes of standard costs for factory overhead • Calculate and properly interpret standard cost variances for factory overhead using traditional approaches • Record factory overhead costs and associated standard cost variances • Apply standard costs to service organizations

3. Learning Objectives (continued) • Analyze overhead variances in an activity-based cost (ABC) system • Understand decision rules that can be used to guide the variance-investigation decision

4. 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 Factory Overhead Costs: Examples Variable Overhead FixedOverhead

5. Standard Variable Overhead Costs: Product Costing vs. Control Variable OverheadCost Product Costing & Control (SQ x SP) Activity Variable (e.g., DL Hrs.) SQ = Standard allowed DLHs for units produced SP = Standard variable overhead rate/DLH

6. Variable Overhead Variance Analysis Variable OverheadCost Product Costing & Control (SQ x SP) SQ x SP Efficiency Variance Total Variance AQ x SP Spending Variance AQ x AP Activity Variable (e.g., DL Hrs.) SQ AQ SQ = Standard allowed DLHs for units produced; AQ = Actual DLHs worked; overhead rate/DLH; SP = Standard variable overhead rate/DLH; AP = Actual variable overhead rate/DLH

7. Variable Overhead Variance Analysis: Equation Approach

8. Variable Overhead Variance Analysis: Equation Approach (continued)

9. Variable Overhead Variance Analysis: Example Calculations Hanson, Inc. applies variable factory overhead on the basis of DLHs. Hanson has the following variable factory overhead standard to manufacture one unit of product: 1.5 standard DLHs per unit @ a variable overhead rate of $3.00 per DLH Last month, 1,550 hours were worked to make 1,000 units, and $5,115 was spent for variable factory overhead

10. Variable Overhead Variance Analysis: Example Calculations (continued)

11. Variable Overhead Variance Analysis: Alternative Solution Format Total Variable Overhead Variance = Actual Variable Overhead – Flexible Budget for Variable Overhead = $5,115 - $4,500 = $615 U Variable Overhead Spending Variance = AQ x (AP – SP) = 1,550 DLHs x ($3.30 - $3.00)/DLH = $465 U Variable Overhead Efficiency Variance = SP x (AQ – SQ) = $3.00/DLH x (1,550 – 1,500) DLHs = $150 U

12. Interpretation of Variable Overhead Variances Results from spending more or less than expected for overhead items such assupplies and utilities. Spending Variance Efficiency Variance Reflects efficiency or inefficiency in the use of the selected activity measure; does not reflect overhead control.

13. Standard Fixed Overhead Cost: Planning vs. Control Fixed OverheadCost Product Costing: Standard Fixed OH Applied = SQ x SP Control Budget (Lump Sum) Activity Variable (e.g., DL Hrs.) SQ = Standard allowed DLHs for units produced SP = Standard fixed overhead rate/DLH

14. Product Costing: Determining the Standard Fixed Factory Overhead Rate • Determine the total budgeted fixed factory overhead for level of operation. • Select an activity driver (or drivers) for applying fixed factory overhead. • Choose a denominator volume for the selected activity driver (e.g., “practical capacity”). • Divide the amount in Step 1 by the amount in Step 3 to determine the standard fixed factory overhead application rate for product costing purposes.

15. Fixed Overhead Variance Analysis Fixed OverheadCost Product Costing: Standard Fixed OH Applied = SQ x SP Actual FOH Spending Variance (U) Total Variance (U) Budgeted FOH Volume Variance (U) Applied FOH Activity Variable (e.g., DL Hrs.) SQ Den. Vol. SQ = Standard allowed DLHs for units produced SP = Standard fixed overhead rate/DLH

16. Calculating Fixed Overhead Variances

17. $9,000 budgeted fixed overhead 3,000 budgeted units FR = = $3.00 per unit Example: Calculating Fixed Overhead Variances 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.

18. Example: Calculating Fixed Overhead Variances (continued)

19. Fixed Overhead Variance Analysis: Alternative Solution Format Total Fixed Overhead Variance = Actual Fixed Overhead – Fixed Overhead Applied to Production = $8,450 - $9,600 = $1,150 F (also called Overapplied fixed overhead) Fixed Overhead Spending (Budget) Variance = Actual Fixed Overhead – Budgeted Fixed Overhead = $8,450 - $9,000 = $550 F Fixed Overhead Production Volume Variance = Budgeted Fixed Overhead – Applied Fixed Overhead = $9,000 - $9,600 = $600 F

20. Fixed Overhead Production Volume Variance: Alternative Calculation Fixed Overhead Production Volume Variance = Standard Fixed Overhead Application Rate x (Actual Units Produced – Denominator Volume) = $3.00/unit x (3,200 – 3,000) units = $600 F (i.e., overapplied fixed overhead)

21. Interpretation of Fixed Overhead Variances Results from spending more or less than expected for individual fixed overhead items. That is, spending on individual fixed overhead items was different than planned. Spending (Budget) Variance Production Volume Variance Results from operating at a level other than the denominator volume level. Arises because of the product-costing purpose of fixed overhead. Not of direct interest for control purposes

22. Causes of Fixed Overhead Variances • Spending (Budget) Variance: • Ineffective budget procedures • Inadequate control of costs • Misclassification of cost items • Production Volume Variance: • Management decisions • Unexpected changes in market demand • Unforeseen problems in manufacturing operations

23. Three-Way Breakdown of Total Overhead Variance

24. Hanson, Inc.: Three-Way vs. Analysis of Total Factory Overhead Variance

25. Two-Way Analysis of Total Factory Overhead Variance

26. Hanson, Inc.: Two-Way Analysis of Total Factory Overhead Variance

27. Class problem Bluecap Co. used a flexible budget system. The following information pertains to 2007 which was prepared at the 80% level of operation: Number of units 8,000 Total standard direct labor hours 24,000 Flexible budget variable factory overhead $103,200 Total factory overhead rate per direct labor hour $15.10

28. Class problem In preparing a budget for 2008 Bluecap decided to raise the level of operation to 90% to manufacture 9,000 units for 27,000 direct labor hours. During 2006, Bluecap spent 28,000 direct labor hours and manufactured 9,600 units. The actual factory overhead was $14,000 greater than the flexible budget amount for the units produced, of which $6,000 was due to fixed factory overhead. The total budget for fixed factory overhead in 2008 is: A) $230,400. B) $259,200. C) $265,200. D) $276,480. E) $288,000.

29. Class problem The standard fixed overhead application rate in 2008 is: A) $4.30 per direct labor hour. B) $4.50 per direct labor hour. C) $6.90 per direct labor hour. D) $9.30 per direct labor hour. E) $9.60 per direct labor hour.

30. Class problem The standard fixed overhead application rate in 2008 is: A) $4.30 per direct labor hour. B) $4.50 per direct labor hour. C) $6.90 per direct labor hour. D) $9.30 per direct labor hour. E) $9.60 per direct labor hour.

31. Class problem The standard variable overhead application rate in 2008 is: A) $4.30 per direct labor hour. B) $4.50 per direct labor hour. C) $6.90 per direct labor hour. D) $9.30 per direct labor hour. E) $9.60 per direct labor hour.

32. Class problem The total flexible budget overhead variance in 2008 is: A) $11,440 unfavorable. B) $14,000 unfavorable. C) $15,040 favorable. D) $17,280 favorable. E) $17,440 unfavorable.

33. Class problem The variable overhead spending variance in 2008 is: A) $ 6,000 unfavorable. B) $ 8,000 unfavorable. C) $ 9,200 favorable. D) $11,440 unfavorable. E) $17,440 unfavorable.

34. Class problem The factory overhead spending variance in 2008 using a three-variance analysis is: A) $ 3,200 favorable. B) $11,440 unfavorable. C) $15,040 favorable. D) $17,280 favorable. E) $17,440 unfavorable.

35. Class problem The variable overhead efficiency variance in 2008 is: A) $ 3,440 favorable. B) $ 8,000 unfavorable. C) $ 9,200 favorable. D) $11,440 unfavorable. E) $17,200 unfavorable.

36. Class problem The fixed overhead spending variance in 2008 is: A) $ 6,000 unfavorable. B) $ 8,000 unfavorable. C) $ 9,200 favorable. D) $11,440 unfavorable. E) $17,440 unfavorable.

37. Class problem The fixed overhead production volume variance in 2008 is: A) $11,280 favorable. B) $17,280 favorable. C) $28,800 unfavorable. D) $34,800 unfavorable. E) $57,840 favorable.

38. Assignment • For next class do 14-30 Part 1, 14-31Parts 1 & 2 and 14-32 Part 1