Flexible Budgets, Variances, and Management Control: II Chapter 8

Explain in what ways the planning of variable overhead Learning Objective 1 Explain in what ways the planning of variable overhead costs and fixed overhead costs are similar and in what ways they differ.

Planning of Variable and Fixed Overhead Costs Effective planning of variable overhead costs involves undertaking only those variable overhead activities that add value for customers using the product or service. The key challenge with planning fixed overhead is choosing the appropriate level of capacity or investment that will benefit the company over an extended time period.

Identify the features of a standard-costing system. Learning Objective 2 Identify the features of a standard-costing system.

× Standard Costing Direct Cost Cost Object Standard cost per input unit Standard input allowed for one output unit ×

Developing Budgeted Variable Overhead Allocation Rates Step 1: Choose the time period used to compute the budget. Pasadena Co. uses a twelve-month budget period. Step 2: Select the cost-allocation base. Pasadena budgets 26,000 labor-hours for a budgeted output of 13,000 suits in year 2004.

Developing Budgeted Variable Overhead Allocation Rates Step 3: Identify the variable overhead costs. Pasadena’s budgeted variable manufacturing costs for 2004 are $312,000. Step 4: Compute the rate per unit of each cost-allocation base. $312,000 ÷ 26,000 hours = $12/hour

Developing Budgeted Variable Overhead Allocation Rates What is the budgeted variable overhead cost rate per output unit (dress suit)? 2.00 hours allowed per output unit × $12 budgeted variable overhead cost rate per input unit = $24 per suit (output unit)

Compute the variable overhead efficiency variance and Learning Objective 3 Compute the variable overhead efficiency variance and the variable overhead spending variance.

Variable Overhead Cost Variances The following data are for 2004 when Pasadena produced and sold 10,000 suits: Output units: 10,000 Labor-hours: Actual results: 21,500 Flexible-budget amount: 20,000

Variable Overhead Cost Variances Labor-hours per output unit: Actual results: 21,500 ÷ 10,000 = 2.15 Flexible-budget amount: 20,000 ÷ 10,000 = 2.00 Variable manufacturing overhead costs: Actual results: $244,775 Flexible-budget amount: $240,000

Variable Overhead Cost Variances Variable manufacturing overhead cost per labor-hour: Actual results: $244,775 ÷ 21,500 = $11.3849 Flexible-budget amount: $240,000 ÷ 20,000 = $12.00

Variable Overhead Cost Variances Variable manufacturing overhead cost per output unit: Actual results: $244,775 ÷ 10,000 = $24.4775 Flexible-budget amount: $240,000 ÷ 10,000 = $24.00

Flexible-Budget Analysis The variable overhead flexible-budget variance measures the difference between the actual variable overhead costs and the flexible-budget variable overhead costs. Actual results: $244,775 – Flexible-budget amount $240,000 = $4,775 U

Flexible-Budget Analysis Actual Costs Incurred 21,500 × $11.3849 = $244,775 Budgeted Inputs Allowed for Actual Outputs at Budgeted Rate 20,000 × $12.00 = $240,000 $4,775 U Flexible-budget variance

Flexible-Budget Analysis Actual Quantity of Inputs at Budgeted Rate 21,500 × $12.00 = $258,000 Budgeted Inputs Allowed for Actual Outputs at Budgeted Rate 20,000 × $12.00 = $240,000 $18,000 U Variable overhead efficiency variance

Flexible-Budget Analysis Actual Costs Incurred 21,500 × $11.3849 = $244,775 Actual Quantity of Inputs at Budgeted Rate 21,500 × $12.00 = $258,000 $13,225 F Variable overhead spending variance

Variable Overhead Variances Flexible-budget variance $4,775 U Efficiency variance $18,000 U Spending variance $13,225 F

Explain how the efficiency variance for a variable indirect-cost item Learning Objective 4 Explain how the efficiency variance for a variable indirect-cost item differs from the efficiency variance for a direct-cost item.

Efficiency Variance In the Pasadena Co.’s example, the 21,500 actual direct manufacturing labor-hours are 7.5% greater than the flexible-budget amount of 20,000 direct manufacturing labor-hours. (21,500 – 20,000) ÷ 20,000 = 7.5% Actual variable overhead costs of $244,775 are only 2% greater than the flexible-budget amount of $240,000.

Efficiency Variance Because actual variable overhead costs increase less than labor-hours, the actual variable overhead cost per labor-hour ($11.3849) is lower than the budgeted amount ($12.00). The key cause for Pasadena’s unfavorable efficiency variance is the higher-than-budgeted labor-hours used.

fixed overhead cost rate. Learning Objective 5 Compute a budgeted fixed overhead cost rate.

Developing Budgeted Fixed Overhead Allocation Rates Step 1: Choose the time period used to compute the budget. The budget period is typically twelve months. Step 2: Select the cost-allocation base. Pasadena budgets 26,000 labor-hours for a budgeted output of 13,000 suits in year 2004.

Developing Budgeted Fixed Overhead Allocation Rates Step 3: Identify the fixed overhead costs. Pasadena’s fixed manufacturing budget for 2004 is $286,000. Step 4: Compute the rate per unit of each cost-allocation base. $286,000 ÷ 26,000 = $11

Developing Budgeted Fixed Overhead Allocation Rates What is the budgeted fixed overhead cost rate per output unit (dress suit)? 2.00 hours allowed per output unit × $11 budgeted fixed overhead cost rate per input unit = $22 per suit (output unit)

Flexible-Budget Variance Actual Costs Incurred $300,000 Flexible Budget: Budgeted Fixed Overhead $286,000 – $14,000 U Fixed overhead spending variance Fixed overhead flexible-budget variance

Production-Volume Variance Flexible Budget: Budgeted Fixed Overhead $286,000 Fixed Overhead Allocated Using Budgeted Input Allowed for Actual Output Units Produced $220,000 – $66,000 U Production-volume variance 10,000 × 2.00 × $11 = $220,000

Fixed Overhead Variances $80,000 U Volume variance $66,000 U Spending variance $14,000 U

production-volume variance as a measure of the economic Learning Objective 6 Explain two concerns when interpreting the production-volume variance as a measure of the economic cost of unused capacity.

Interpreting the Production-Volume Variance Management may have maintained some extra capacity. Production volume variance focuses only on costs. This variance results from “unitizing” fixed costs.

Interpreting the Production-Volume Variance Had Pasadena manufactured 13,000 suits instead of 10,000, allocated fixed overhead would have been = $286,000 (13,000 × 2.00 × $11). No production-volume variance would have occurred.

analysis approach reconciles the actual overhead incurred Learning Objective 7 Show how the 4-variance analysis approach reconciles the actual overhead incurred with the overhead amounts allocated during the period.

Integrated Analysis A 4-variance analysis presents spending and efficiency variances for variable overhead costs and spending and production-volume variances for fixed overhead costs. Managers can reconcile the actual overhead costs with the overhead amounts allocated during the period.

– Integrated Analysis Actual variable overhead costs incurred $244,775 Flexible budget: budgeted inputs allowed × budgeted rate $240,000 – Flexible-budget variance $4,775 U Underallocated variable overhead

– Integrated Analysis Actual variable Actual inputs overhead costs × incurred $244,775 Actual inputs × budgeted rate $258,000 – Variable overhead spending variance $13,225 F

allowed × budgeted rate Integrated Analysis Actual inputs × budgeted rate $258,000 Flexible budget: budgeted inputs allowed × budgeted rate $240,000 – Variable overhead efficiency variance $18,000 U

– Integrated Analysis Actual fixed Budgeted fixed overhead costs incurred $300,000 Budgeted fixed overhead costs $286,000 – Fixed overhead spending variance $14,000 U

Budgeted inputs allowed Integrated Analysis Budgeted fixed overhead costs $286,000 Budgeted inputs allowed × budgeted rate $220,000 – Volume variance $66,000 U

Integrated Analysis Actual manufacturing overhead incurred: Variable manufacturing overhead $244,775 Fixed manufacturing overhead 300,000 Total $544,775 Overhead allocated: Variable manufacturing overhead $240,000 Fixed manufacturing overhead 220,000 Total $460,000 Amount underallocated $ 84,775

Integrated Analysis 4-Variance Analysis: Variable manufacturing overhead: Spending variance $13,225 F Efficiency variance 18,000 U Fixed manufacturing overhead: Spending variance 14,000 U Volume variance 66,000 U Total $84,775 U

Integrated Analysis 3-Variance Analysis Variable and fixed manufacturing overhead: Spending variance $13,225 F + $14,000 U = $ 775 U Variable manufacturing overhead: Efficiency variance 18,000 U Fixed manufacturing overhead: Volume variance 66,000 U Total $84,775 U

Integrated Analysis 2-Variance Analysis Variable and fixed manufacturing overhead: Spending variance $ 775 U Variable manufacturing overhead: Efficiency variance 18,000 U Flexible-budget variance: $18,775 U Fixed manufacturing overhead Volume variance: 66,000 U Total $84,775 U

Different Purposes of Overhead Cost Analysis The greater the number of output units manufactured, the higher the budgeted total variable manufacturing overhead costs and the higher the total variable manufacturing overhead costs allocated to output units.

Different Purposes of Overhead Cost Analysis Every output unit that Pasadena manufactures will increase the fixed overhead allocated to products by $22. Managers should not use this unitization of fixed manufacturing overhead costs for planning and control.

Journal Entries for Overhead Costs and Variances What is the journal entry to record variable manufacturing overhead? Variable Manufacturing Overhead Control 244,775 Accounts Payable 244,775 To record actual variable manufacturing overhead costs incurred

Journal Entries for Overhead Costs and Variances What is the journal entry to allocate variable manufacturing overhead? Work in Process Control 240,000 Variable Manufacturing Overhead Allocated 240,000 To record variable manufacturing overhead cost allocated: (2.00 × 10,000 × $12) What is the journal entry to isolate variances?

Journal Entries for Overhead Costs and Variances Variable Manufacturing Overhead Allocated 240,000 Variable Overhead Efficiency Variance 18,000 Overhead Control 244,775 Spending Variance 13,225 To isolate variances for the accounting period

Journal Entries for Overhead Costs and Variances What is the journal entry to record fixed manufacturing overhead? Fixed Manufacturing Overhead Control 300,000 Accumulated Depreciation, etc. 300,000 To record actual fixed manufacturing overhead costs incurred

Journal Entries for Overhead Costs and Variances What is the journal entry to allocate fixed manufacturing overhead? Work in Process Control 220,000 Fixed Manufacturing Overhead Allocated 220,000 To record fixed manufacturing overhead cost allocated: (2.00 × 10,000 × $11) What is the journal entry to isolate variances?

Journal Entries for Overhead Costs and Variances Fixed Manufacturing Overhead Allocated 220,000 Fixed Overhead Spending Variance 14,000 Volume Variance 66,000 Overhead Control 300,000 To isolate variances for the accounting period

Financial and Nonfinancial Performance Overhead variances are examples of financial performance measures. What are examples of nonfinancial measures? Actual labor time, relative to budgeted time Actual indirect materials usage per labor-hour, relative to budgeted indirect materials usage

Illustrate how the flexible- budget variance approach can Learning Objective 8 Illustrate how the flexible- budget variance approach can be used in activity-based costing.

Activity-Based Costing and Variance Analysis ABC systems classify costs of various activities into a cost hierarchy (output-unit level, batch level, product sustaining, and facility sustaining). The basic principles and concepts for variable and fixed manufacturing overhead costs can be extended to ABC systems.

End of Chapter 8