1. ACTG 321 Agenda for Lecture 14
Denominator choices for the fixed manufacturing overhead rate
Production incentives
Break
Variances for variable overhead
Variances for fixed overhead

2. Two Ways To Treat Fixed Manufacturing Overhead
Variable Costing
a.k.a. direct costing
Fixed Mfg O/H is a Period Cost
Focus is on Contri- bution Margin
This isn’t G.A.A.P.
Absorption Costing
a.k.a. full costing
Fixed Mfg O/H is an Inventoriable Cost
Focus is on Gross Margin
This is G.A.A.P.

3. What Costs Are Included In Inventory?
Non-manufacturing costs (e.g. selling, general & admin.)
Variable manufac- turing costs (& any direct, fixed costs)
Variable Costing
Absorption Costing
Fixed Manufacturing Overhead

4. Allocating Fixed Manufacturing Overhead
There are important issues related to how the denominator in the overhead rate is calculated for the purpose of allocating fixed overhead. Two choices are:
1. Practical Capacity: The level of the allocation base that would be incurred if fixed assets run full-time, but allowing for routine maintenance and unavoidable interruptions.
2. Budgeted Utilization: The level of the allocation base that would be incurred for budgeted production.

5. ACTG 321 Agenda for Lecture 14
Denominator choices for the fixed manufacturing overhead rate
Production incentives
Break
Variances for variable overhead
Variances for fixed overhead

6. ACTG 321 Agenda for Lecture 14
Denominator choices for the fixed manufacturing overhead rate
Production incentives
Break
Variances for variable overhead
Variances for fixed overhead

7. The variable cost flexible budget variance decomposes into a “price” variance and an “efficiency” variance
Abbreviations:
Price or Wage Rate or Spending Variance = PV
Quantity or Usage or Efficiency Variance = QV
Actual quantity of inputs = AQ
Standard quantity of inputs = SQ
Actual price per input unit = AP
Standard price per input unit = SP

8. The variable cost flexible budget variance decomposes into a “price” variance and an “efficiency” variance
These variances apply to direct materials, direct labor, and variable overhead.
Formulas:
PV = AQ x (AP - SP)
QV = SP x (AQ - SQ)
For Variable Overhead, the Q’s are the quantity of the allocation base. AQ is the actual quantity of the allocation base used. SQ is the standard quantity of the allocation base. The P’s are the Overhead Rate. AP is the Actual Overhead Rate. SP is the Budgeted Overhead Rate.

9. The variable overhead variances
Spending Variance =
Actual quantity of allocation base incurred x (Actual O/H rate – Budgeted O/H rate)
Efficiency Variance =
Budgeted O/H rate x (Actual quantity of allocation base incurred – Standard quantity of allocation base based on actual output)

10. The variable overhead variances
Spending Variance =
Actual quantity of allocation base incurred x (Actual O/H rate – Budgeted O/H rate)
Efficiency Variance =
Budgeted O/H rate x (Actual quantity of allocation base incurred – Standard quantity of allocation base based on actual output)
Question: Given the above definitions, what is the economic interpretation of each of these variances?

11. ACTG 321 Agenda for Lecture 14
Denominator choices for the fixed manufacturing overhead rate
Production incentives
Break
Variances for variable overhead
Variances for fixed overhead

12. Cost Variances for Fixed Overhead
There are important issues related to how the denominator in the overhead rate is calculated for the purpose of allocating fixed overhead. Two choices are:
1. Practical Capacity: The level of the allocation base that would be incurred if fixed assets run full-time, but allowing for routine maintenance and unavoidable interruptions.
2. Budgeted Utilization: The level of the allocation base that would be incurred for budgeted production.

13. Cost Variances for Fixed Overhead
Budget variance (a.k.a. spending variance)
= actual total FMOH  budgeted total FMOH
Volume variance = budgeted total FMOH  FMOH allocated to output using a standard costing system (budgeted FMOH per unit x actual units produced)
Budgeted FMOH per unit = FMOH ÷ the denominator concept, as discussed on the previous slide.
The volume variance is favorable if actual production exceeds the denominator in the FMOH rate.

14. Coachman Company
The Coachman Company manufactures pencils. The pencils are sold by the box.
Budget Actual Capacity
# of boxes , , ,000
D.L.H ,000
Machine hr.s ,000
Fixed O/H $40, $42,000

15. Coachman Company # of boxes 10,000 12,000 20,000 D.L.H. 200 250 5,000
Budget Actual Capacity
# of boxes , , ,000
D.L.H ,000
Machine hr.s ,000
Fixed O/H $40, $42,000
The outputs here are boxes of pencils. The inputs are direct labor hours and machine hours.

16. Coachman Company # of boxes 10,000 12,000 20,000 D.L.H. 200 250 5,000
Budget Actual Capacity
# of boxes , , ,000
D.L.H ,000
Machine hr.s ,000
Fixed O/H $40, $42,000
Let’s calculate a fixed overhead rate using actual information:
$42,000  12,000 boxes = $3.50 per box

17. Coachman Company # of boxes 10,000 12,000 20,000 D.L.H. 200 250 5,000
Budget Actual Capacity
# of boxes , , ,000
D.L.H ,000
Machine hr.s ,000
Fixed O/H $40, $42,000
Let’s calculate a fixed overhead rate using budgeted costs, budgeted production, and outputs as the allocation base:
$40,000  10,000 boxes = $4.00 per box

18. Coachman Company # of boxes 10,000 12,000 20,000 D.L.H. 200 250 5,000
Budget Actual Capacity
# of boxes , , ,000
D.L.H ,000
Machine hr.s ,000
Fixed O/H $40, $42,000
Let’s calculate a fixed overhead rate using budgeted costs in the numerator, production capacity in the denominator, and outputs as the allocation base:
$40,000  20,000 boxes = $2.00 per box

19. Coachman Company # of boxes 10,000 12,000 20,000
Budget Actual Capacity
# of boxes , , ,000
Fixed O/H $40, $42,000
$40,000  20,000 boxes = $2.00 per box
The advantage of using capacity in the denominator is that this shows how low the fixed cost per unit can go. Fixed cost per unit goes down as production goes up. But production levels cannot generally exceed capacity.

20. Coachman Company # of boxes 10,000 12,000 20,000 D.L.H. 200 250 5,000
Budget Actual Capacity
# of boxes , , ,000
D.L.H ,000
Machine hr.s ,000
Fixed O/H $40, $42,000

21. Overhead Variances For Fixed Overhead
Actual Fixed
Overhead
Budgeted Fixed
Overhead
Applied Fixed
Overhead
This is what we actually spent
From either the static or flexible budget
O/H rate x the application base
Budget Variance
Volume Variance
Under- or Over- applied Fixed Overhead
These variances are computed for the company as a whole, not for individual jobs.

22. Overhead Variances For Fixed Overhead
Actual Fixed
Overhead
Budgeted Fixed
Overhead
Applied Fixed
Overhead
$42,000
From either the static or flexible budget
O/H rate x the application base
Budget Variance
Volume Variance
Under- or Over- applied Fixed Overhead
These variances are computed for the company as a whole, not for individual jobs.

23. Overhead Variances For Fixed Overhead
Actual Fixed
Overhead
Budgeted Fixed
Overhead
Applied Fixed
Overhead
$42,000
$40,000
O/H rate x the application base
Budget Variance
Volume Variance
Under- or Over- applied Fixed Overhead
These variances are computed for the company as a whole, not for individual jobs.

24. Overhead Variances For Fixed Overhead
Actual Fixed
Overhead
Budgeted Fixed
Overhead
Applied Fixed
Overhead
$42,000
$40,000
O/H rate x the application base
$2,000 Unfavorable
Volume Variance
Under- or Over- applied Fixed Overhead
These variances are computed for the company as a whole, not for individual jobs.

25. First let’s allocate based on factory capacity in the denominator

26. Coachman Company # of boxes 10,000 12,000 20,000
Budget Actual Capacity
# of boxes , , ,000
Fixed O/H $40, $42,000
$40,000  20,000 boxes = $2.00 per box
The advantage of using capacity in the denominator is that this shows how low the fixed cost per unit can go. Fixed cost per unit goes down as production goes up. But production levels cannot generally exceed capacity.

27. Overhead Variances For Fixed Overhead
Actual Fixed
Overhead
Budgeted Fixed
Overhead
Applied Fixed
Overhead
$42,000
$40,000
$2.00 per unit x 12,000 units
$2,000 Unfavorable
Volume Variance
Under- or Over- applied Fixed Overhead
These variances are computed for the company as a whole, not for individual jobs.

28. Overhead Variances For Fixed Overhead
Actual Fixed
Overhead
Budgeted Fixed
Overhead
Applied Fixed
Overhead
$42,000
$40,000
$24,000
$2,000 Unfavorable
Volume Variance
Under- or Over- applied Fixed Overhead
These variances are computed for the company as a whole, not for individual jobs.

29. Overhead Variances For Fixed Overhead
Actual Fixed
Overhead
Budgeted Fixed
Overhead
Applied Fixed
Overhead
$42,000
$40,000
$24,000
$2,000 Unfavorable
$16,000 Unfavorable
Under- or Over- applied Fixed Overhead
These variances are computed for the company as a whole, not for individual jobs.

30. Overhead Variances For Fixed Overhead
Actual Fixed
Overhead
Budgeted Fixed
Overhead
Applied Fixed
Overhead
$42,000
$40,000
$24,000
$2,000 Unfavorable
$16,000 Unfavorable
$18,000 Fixed Overhead Underapplied.
These variances are computed for the company as a whole, not for individual jobs.

31. Overhead Variances For Fixed Overhead
Actual Fixed
Overhead
Budgeted Fixed
Overhead
Applied Fixed
Overhead
$42,000
$40,000
$24,000
$2,000 Unfavorable
$16,000 Unfavorable
$18,000 Fixed Overhead Underapplied.
The $16,000 Unfavorable Volume Variance can also be calculated as follows: $2 per unit x 8,000 units (capacity less actual production). Hence, this is the cost of producing below capacity.

32. Now let’s allocate based on budgeted production in the denominator

33. Coachman Company # of boxes 10,000 12,000 20,000 D.L.H. 200 250 5,000
Budget Actual Capacity
# of boxes , , ,000
D.L.H ,000
Machine hr.s ,000
Fixed O/H $40, $42,000
Let’s calculate a fixed overhead rate using budgeted costs and production, and outputs as the allocation base:
$40,000  10,000 boxes = $4.00 per box

34. Overhead Variances For Fixed Overhead
Actual Fixed
Overhead
Budgeted Fixed
Overhead
Applied Fixed
Overhead
$42,000
$40,000
$4.00 per unit x 12,000 units
$2,000 Unfavorable
Volume Variance
Under- or Over- applied Fixed Overhead
These variances are computed for the company as a whole, not for individual jobs.

35. Overhead Variances For Fixed Overhead
Actual Fixed
Overhead
Budgeted Fixed
Overhead
Applied Fixed
Overhead
$42,000
$40,000
$48,000
$2,000 Unfavorable
$8,000 Favorable
Under- or Over- applied Fixed Overhead
These variances are computed for the company as a whole, not for individual jobs.

36. Overhead Variances For Fixed Overhead
Actual Fixed
Overhead
Budgeted Fixed
Overhead
Applied Fixed
Overhead
$42,000
$40,000
$48,000
$2,000 Unfavorable
$8,000 Favorable
$6,000 Fixed Overhead Overapplied.
These variances are computed for the company as a whole, not for individual jobs.

37. Overhead Variances For Fixed Overhead
Actual Fixed
Overhead
Budgeted Fixed
Overhead
Applied Fixed
Overhead
$42,000
$40,000
$48,000
$2,000 Unfavorable
$8,000 Favorable
$6,000 Fixed Overhead Over-applied.
The $8,000 Favorable Volume Variance can also be calculated as follows: $4 per unit x 2,000 units (actual production less budgeted production). Hence, this is the cost/benefit of producing below/above budget.