Overhead and Marketing Variances Chapter Thirteen Overhead and Marketing Variances McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

Connection to Other Chapters Chapter 13 extends the price and quantity variances to overhead and marketing. Chapter 12 began the price and quantity variance analysis with direct labor and direct materials. Chapter 9 described how absorption costing applies overhead to jobs. Chapter 4 built the foundation on how internal accounting is used for decision control.

Overhead Volume Measures BV: Budgeted volume (also known as denominator volume) Estimated at the beginning of the year and used for calculating the overhead rate SV: Standard volume (also known as earned or allowed volume) (Output units completed)  (Standard input hours per output unit) Volume used to apply overhead to work-in-process inventory AV: Actual volume Actual hours or other input resource used during period

Budget Volume Estimates Estimated budget volume influences overhead rate. Increasing budgeted volume (denominator) while holding total budgeted dollars constant (numerator) decreases the overhead rate. Expected volume to set budget Adjust expectation based on number of units forecast for next year. Rises and falls with business cycle Normal volume to set budget Forecast of long-run average annual production Does not change over business cycle

Flexible Overhead Budget Flexible overhead budget is the formula for budget forecast. Flexible overhead budget = FOH + (VOH  V) = $1,350,000 + ($14  V) Estimate budgeted overhead (BOH) dollars using a specific budgeted volume number (BV) and the flexible overhead budget formula. BOH = FOH + (VOH  BV) = $ 1,350,000 + ($14  67,500 hours) = $ 2,295,000

Overhead Rate Overhead rate is the total budgeted overhead dollars for the year divided by the budgeted volume for the year. OHR = (BOH  BV) = (FOH  BV) + VOH The overhead rate consists of the estimated: fixed overhead $ per input hour (FOH  BV), and variable overhead $ per input hour (VOH)

Overhead Absorbed Overhead is absorbed (also known as applied) by the product when work is done in the factory. The accounting system transfers costs from the overhead account to the work-in-process account (Figure 9-1). For most firms, overhead is absorbed using the standard volume. Overhead absorbed = Overhead rate  Standard volume = OHR  SV Standard Volume = Units of output  Standard input per output See Table 13-3: SV = 67,400 machine hours for 96,000 blocks Overhead absorbed = $34  67,400 machine hours

Total Overhead Variance Overhead variances occur when the actual overhead incurred does not equal the overhead absorbed (see Figure 9-1 and the T-accounts). Actual overhead Overhead absorbed cost incurred (applied to product) AOH (OHR  SV) |_________________________________________| AOH - (OHR  SV) Total overhead variance Underabsorbed, if actual > absorbed Overabsorbed, if actual < absorbed

3-way Overhead Variances Actual overhead Flex. budget at Flex. budget at Overhead absorbed at actual volume actual volume standard volume (applied to product) AOH [FOH + (VOH AV)] [FOH + (VOH SV)] (OHR  SV) |________________| |_____________________| |________________| Overhead Overhead Overhead Spending Efficiency Volume Variance Variance Variance |______________________________________________________ __________| Total overhead variance Over/underabsorbed overhead See Table 13-5 example and Self-Study Problem.

Overhead Efficiency Variance Flexible budget at Flexible budget at actual volume standard volume [FOH + (VOH AV)] [FOH + (VOH SV)] |__________________________________| Overhead Efficiency Variance [FOH + (VOH AV)] - [(FOH + (VOH SV)] = VOH AV - SV) Unfavorable (U) when AV > SV Favorable (F) when AV < SV When overhead is allocated with the same base as direct labor, the overhead efficiency and labor efficiency variances will be in the same direction.

Overhead Volume Variance Flexible budget at Overhead absorbed actual volume (applied to product) [FOH + (VOH SV)] (OHR SV) |_______________________________________| Overhead Volume Variance [FOH + (VOH SV)] - (OHR SV) = [FOH BV – SV)]  BV Unfavorable (U) when BV > SV Favorable (F) when BV < SV When output exceeds planned capacity, SV>BV, the volume variance is favorable. Rewarding favorable volume variances encourages inventory building.

Overhead Spending Variance Actual overhead at Flexible budget at actual volume actual volume AOH [FOH + (VOH AV)] |______________________________________| Overhead Spending Variance AOH - [FOH + (VOH AV)] Unfavorable (U) when AOH > [FOH + (VOH AV)] Favorable (F) when AOH < [FOH + (VOH AV)] Cause: unexpected changes in prices of variable and fixed overhead items, and changes in production technology

Inaccurate Flexible Budget Usefulness of overhead variances in performance measurement depends on accuracy of flexible budget in predicting cost-volume relation. Flexible budget assumes a linear formula over relevant range. But as production volume increases to levels near or above plant capacity, congestion occurs and: actual costs increase above flexible budget. unfavorable spending variance is reported. A more accurate flexible budget formula would forecast congestion costs, and allow variable costs to increase as volume increases.

Sales Price and Quantity Variances Symbols: Q = Quantity; P = Price; a = actual; s = standard Total Flexible budget Total actual based on budgeted sales actual quantity sold sales (Qa  Pa) (Qa  Ps) (Qs  Ps) |____________________| |____________________| [Qa  (Pa - Ps)] [(Qa - Qs)  Ps] Price variance Quantity variance |_____________________________________________| [( Qa  Pa)  (Qs  Ps)] Total sales variance in sales dollars Price variances measure sales manager’s pricing policy. Quantity variances depend on salespersons’ efforts and customer orders.

Marketing Contribution Margin Variances Q = Quantity; CM = Contribution margin per unit; a = actual; s = standard [Note: Cma is (actual price – budgeted variable costs).] Total Flexible budget Total actual based on budgeted sales actual quantity sold sales (Qa  Cma) (Qa  CMs) (Qs  CMs) |___________________| |____________________| [Qa  (CMa - CMs)] [(Qa - Qs)  CMs] CM price variance CM quantity variance |_____________________________________________| [(Qa  CMa)  (Qs  CMs)] Total sales variance in profit dollars Price variances measure sales manager’s pricing and purchasing policy. Quantity variances depend on salespersons’ efforts and customer orders.

Marketing Sales and Mix Variances Actual Flex. budget at Flex. budget at Standard revenue actual mix % standard mix % revenue $23,241 10,600  57.55%  $3.80 10,600  60%  $3.80 6,000 $3.80 24,210 10,600  42.45%  $5.40 10,600  40%  $5.40 4,000 $5.40 $47,451 $47,480 $47,064 $44,400 |________________| |_______________| |__________________| Price variance Mix variance Sales variance $ 29 U $ 416 F $ 2,664 F |______________________________________| Quantity variance $ 3,080 F |_________________________________________________________| Total sales variance $ 3,051 F