• Denominator choices for the fixed manufacturing overhead rate

• Production incentives• Break• Variances for variable overhead• Variances for fixed overhead

ACTG 321Agenda for Lecture 14

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.

What Costs Are Included In Inventory? V

ari

ab

le C

osti

ng

Ab

sorp

tion

Costi

ng

Variable manufac- turing costs (& any direct, fixed costs)

Fixed Manufacturing Overhead

Non-manufacturing costs (e.g. selling, general & admin.)

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.

• Denominator choices for the fixed manufacturing overhead rate

• Production incentives• Break• Variances for variable overhead• Variances for fixed overhead

ACTG 321Agenda for Lecture 14

• Denominator choices for the fixed manufacturing overhead rate

• Production incentives• Break• Variances for variable overhead• Variances for fixed overhead

ACTG 321Agenda for Lecture 14

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

The variable cost flexible budget variance decomposes into a “price”

variance and an “efficiency” variance

The variable cost flexible budget variance decomposes into a “price”

variance and an “efficiency” variance

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.

These variances apply to direct materials, direct labor, and variable overhead.

The variable overhead variancesSpending 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)

The variable overhead variancesSpending 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?

• Denominator choices for the fixed manufacturing overhead rate

• Production incentives• Break• Variances for variable overhead• Variances for fixed overhead

ACTG 321Agenda for Lecture 14

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.

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.

Coachman Company

The Coachman Company manufactures pencils. The pencils are sold by the box.

Budget Actual Capacity

# of boxes 10,000 12,000 20,000

D.L.H. 200 250 5,000

Machine hr.s 500 600 10,000

Fixed O/H $40,000 $42,000

Coachman Company

Budget Actual Capacity

# of boxes 10,000 12,000 20,000

D.L.H. 200 250 5,000

Machine hr.s 500 600 10,000

Fixed O/H $40,000 $42,000

The outputs here are boxes of pencils. The inputs are direct labor hours and machine hours.

Coachman Company Budget Actual Capacity

# of boxes 10,000 12,000 20,000

D.L.H. 200 250 5,000

Machine hr.s 500 600 10,000

Fixed O/H $40,000 $42,000

Let’s calculate a fixed overhead rate using actual information:

$42,000 12,000 boxes = $3.50 per box

Coachman Company Budget Actual Capacity

# of boxes 10,000 12,000 20,000

D.L.H. 200 250 5,000

Machine hr.s 500 600 10,000

Fixed O/H $40,000 $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

Coachman Company Budget Actual Capacity

# of boxes 10,000 12,000 20,000

D.L.H. 200 250 5,000

Machine hr.s 500 600 10,000

Fixed O/H $40,000 $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

Coachman Company Budget Actual Capacity

# of boxes 10,000 12,000 20,000

Fixed O/H $40,000 $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.

Coachman Company

Budget Actual Capacity

# of boxes 10,000 12,000 20,000

D.L.H. 200 250 5,000

Machine hr.s 500 600 10,000

Fixed O/H $40,000 $42,000

Overhead VariancesFor Fixed Overhead

Actual Fixed

Overhead

Budgeted Fixed

Overhead

Applied Fixed

OverheadO/H rate x the application

base

Under- or Over- applied Fixed Overhead

Budget Variance Volume Variance

These variances are computed for the company as a whole, not for individual jobs.

This is what we actually spent

From either the static or flexible budget

Overhead VariancesFor Fixed Overhead

Actual Fixed

Overhead

Budgeted Fixed

Overhead

Applied Fixed

OverheadO/H rate x the application

base

Under- or Over- applied Fixed Overhead

Budget Variance Volume Variance

These variances are computed for the company as a whole, not for individual jobs.

$42,000 From either the static or flexible budget

Overhead VariancesFor Fixed Overhead

Actual Fixed

Overhead

Budgeted Fixed

Overhead

Applied Fixed

OverheadO/H rate x the application

base

Under- or Over- applied Fixed Overhead

Budget Variance Volume Variance

These variances are computed for the company as a whole, not for individual jobs.

$42,000 $40,000

Overhead VariancesFor Fixed Overhead

Actual Fixed

Overhead

Budgeted Fixed

Overhead

Applied Fixed

OverheadO/H rate x the application

base

Under- or Over- applied Fixed Overhead

$2,000 Unfavorable Volume Variance

These variances are computed for the company as a whole, not for individual jobs.

$42,000 $40,000

First let’s allocate based on factory capacity in the

denominator

Coachman Company Budget Actual Capacity

# of boxes 10,000 12,000 20,000

Fixed O/H $40,000 $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.

Overhead VariancesFor Fixed Overhead

Actual Fixed

Overhead

Budgeted Fixed

Overhead

Applied Fixed

Overhead$2.00 per unit x 12,000 units

Under- or Over- applied Fixed Overhead

$2,000 Unfavorable Volume Variance

These variances are computed for the company as a whole, not for individual jobs.

$42,000 $40,000

Overhead VariancesFor Fixed Overhead

Actual Fixed

Overhead

Budgeted Fixed

Overhead

Applied Fixed

Overhead$24,000

Under- or Over- applied Fixed Overhead

$2,000 Unfavorable Volume Variance

These variances are computed for the company as a whole, not for individual jobs.

$42,000 $40,000

Overhead VariancesFor Fixed Overhead

Actual Fixed

Overhead

Budgeted Fixed

Overhead

Applied Fixed

Overhead$24,000

Under- or Over- applied Fixed Overhead

$2,000 Unfavorable $16,000 Unfavorable

These variances are computed for the company as a whole, not for individual jobs.

$42,000 $40,000

Overhead VariancesFor Fixed Overhead

Actual Fixed

Overhead

Budgeted Fixed

Overhead

Applied Fixed

Overhead$24,000

$18,000 Fixed Overhead Underapplied.

$2,000 Unfavorable $16,000 Unfavorable

These variances are computed for the company as a whole, not for individual jobs.

$42,000 $40,000

Overhead VariancesFor Fixed Overhead

Actual Fixed

Overhead

Budgeted Fixed

Overhead

Applied Fixed

Overhead$24,000

$18,000 Fixed Overhead Underapplied.

$2,000 Unfavorable $16,000 Unfavorable

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.

$42,000 $40,000

Now let’s allocate based on budgeted production in

the denominator

Coachman Company Budget Actual Capacity

# of boxes 10,000 12,000 20,000

D.L.H. 200 250 5,000

Machine hr.s 500 600 10,000

Fixed O/H $40,000 $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

Overhead VariancesFor Fixed Overhead

Actual Fixed

Overhead

Budgeted Fixed

Overhead

Applied Fixed

Overhead$4.00 per unit x 12,000 units

Under- or Over- applied Fixed Overhead

$2,000 Unfavorable Volume Variance

These variances are computed for the company as a whole, not for individual jobs.

$42,000 $40,000

Overhead VariancesFor Fixed Overhead

Actual Fixed

Overhead

Budgeted Fixed

Overhead

Applied Fixed

Overhead$48,000

Under- or Over- applied Fixed Overhead

$2,000 Unfavorable $8,000 Favorable

These variances are computed for the company as a whole, not for individual jobs.

$42,000 $40,000

Overhead VariancesFor Fixed Overhead

Actual Fixed

Overhead

Budgeted Fixed

Overhead

Applied Fixed

Overhead$48,000

$6,000 Fixed Overhead Overapplied.

$2,000 Unfavorable $8,000 Favorable

These variances are computed for the company as a whole, not for individual jobs.

$42,000 $40,000

Overhead VariancesFor Fixed Overhead

Actual Fixed

Overhead

Budgeted Fixed

Overhead

Applied Fixed

Overhead$48,000

$6,000 Fixed Overhead Over-applied.

$2,000 Unfavorable $8,000 Favorable

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.

$42,000 $40,000