In this section, we will evaluate the manufacturing overhead variances. The total overhead variance is the difference between:
Learning Objective 4 Compute the standard cost variances for manufacturing overhead
Exhibit 2310 shows that Cheerful Colors incurred $30,160 in variable overhead costs and $23,920 in fixed overhead costs. Therefore, total overhead costs incurred are
$54,080 ($30,160 + $23,920). The next step is to see how Cheerful Colors allocates over
head in a standard cost system.
Allocating Overhead in a Standard Cost System
In a standard cost system, the manufacturing overhead allocated to production is as follows:
Budgeted allocation base = 50,000 batches * 0.25 direct labor hours per batch = 12,500 DLHr Overhead allocated
to production = Standard overhead
allocation rate * Standard quantity of the allocation base allowed for actual output
In a standard cost system, the standard overhead allocation rate replaces the predeter- mined overhead allocation rate illustrated in previous chapters, but the concept is the same.
It is a rate calculated during the budgeting process when other standards are determined.
Let’s begin by computing Cheerful Colors’s standard variable and fixed overhead allocation rates. Cheerful Colors allocates overhead based on direct labor hours. The static budget that was presented in Exhibit 232 indicated expected production would be 50,000 batches of crayons. At that level of production and using the direct labor efficiency stan
dard of 0.25 direct labor hours per batch, Cheerful Colors expected to incur 12,500 direct labor hours, which is calculated as follows:
The static budget also shows budgeted variable overhead at $37,500 and budgeted fixed overhead at $25,000. We are using static budget amounts here because standards are set before the budgeting period, so the accountants at Cheerful Colors did not yet know the actual production levels for the year when the standards were set.
The standard overhead allocation rate is calculated as follows:
Cheerful Colors used a $3.00 per direct labor hour rate to allocate variable overhead to batches and $2.00 per direct labor hour rate to allocate fixed overhead to batches in 2019.
Now, let’s analyze the variances for variable and fixed overhead.
Variable Overhead Variances
Standard overhead
allocation rate = Budgeted overhead cost Budgeted allocation base
= Budgeted VOH*
Budgeted allocation base + Budgeted FOH*
Budgeted allocation base Standard overhead
allocation rate = +37,500
12,500 DLHr + +25,000 12,500 DLHr
= +3.00 per DLHr + +2.00 per DLHr
= +5.00 per DLHr
*VOH = Variable overhead; FOH = Fixed overhead
and 13,000 direct labor hours were budgeted for 52,000 batches of crayons in the flexible budget (0.25 DLHr per batch * 52,000 batches). However, actual variable overhead cost was $30,160, and it took 10,400 direct labor hours to make 52,000 batches. To summarize the data for variable overhead:
Variable overhead cost standard $3.00 per DLHr
Variable overhead efficiency standard 0.25 DLHr per batch of crayons Actual amount of direct labor hours 10,400 DLHr
Actual cost of variable overhead $30,160 Variable Overhead Cost Variance
Using the above information, we can calculate the variable overhead cost variance which mea
sures the difference between the actual variable overhead (actual cost) and the standard variable overhead for the actual allocation base incurred (standard cost). This variance measures how well the business keeps unit costs of variable overhead inputs within standards. Notice that Cheerful Colors paid less than expected for variable overhead. The actual cost of variable overhead per hour of direct labor is $2.90 ($30,160 / 10,400 DLHr = $2.90 per DLHr) and the standard cost is $3.00 per DLHr. Using the formula, the variable overhead cost vari
ance is $1,040 favorable. The calculation follows:
Variable Overhead Cost Variance The difference between the actual variable overhead (actual cost) and the standard variable overhead for the actual allocation base incurred (standard cost). (AC- SC)*AQ.
Variable Overhead Cost Variance = (AC − SC) : AQ
= (+2.90 per DLHr - +3.00 per DLHr) * 10,400 DLHr
= +1,040 F
Variable Overhead Efficiency Variance= (AQ − SQ) : SC
= (10,400 DLHr - 13,000 DLHr) * +3.00 per DLHr
= +7,800 F
The $1,040 variable overhead cost variance is favorable because Cheerful Colors spent $0.10 less per hour than budgeted ($2.90 actual cost - $3.00 standard cost).
Variable Overhead Efficiency Variance
Now let’s see how efficiently Cheerful Colors used its variable overhead. The variable overhead efficiency variance measures the difference in the actual allocation base (actual quantity) and the amount of the allocation base that should have been used (standard quan
tity). This variance measures how well the business uses its variable overhead inputs. Because variable overhead is allocated based on direct labor hours used, this variance will also be favorable, as the direct labor efficiency variance was favorable. The standard quantity of direct labor hours that workers should have used to make 52,000 batches of crayons is 13,000 total direct labor hours (52,000 batches * 0.25 DLHr per batch). The variable overhead efficiency variance is as follows:
Variable Overhead Efficiency Variance The difference between the actual allocation base (actual quantity) and the amount of the allocation base that should have been used (standard quantity).
(AQ - SQ) *SC.
The $7,800 variable overhead efficiency variance is favorable because laborers actually worked 2,600 fewer hours than the flexible budget called for to produce 52,000 batches of crayons, and variable overhead is allocated based on direct labor hours.
Summary of Variable Overhead Variances
Exhibit 2313 summarizes how Cheerful Colors divides the $8,840 favorable variable overhead flexible budget variance into its cost and efficiency components.
The $8,840 favorable variable overhead variance indicates that variable overhead costs were less than expected. To manage Cheerful Colors’s variable overhead costs, we need to get more insight:
• Cheerful Colors incurred $1,040 less than anticipated actual variable overhead costs—for a favorable cost variance.
• Workers made 52,000 batches of crayons in 10,400 hours instead of the budgeted 13,000 hours—for a favorable efficiency variance.
Management may decide that the variable overhead cost variance is sufficiently small and does not warrant investigation. However, the company may want to investigate the variance further to determine if the reduction in costs was controllable or if the cost standard needs to be updated.
Fixed Overhead Variances
The three production costs analyzed so far were variable costs, so the analysis was similar for direct materials, direct labor, and variable overhead. However, Cheerful Colors uses a slightly different approach to analyze the fixed overhead variances. Remember that fixed costs are not expected to change in total within the relevant range, but they do change per unit when there is a change in volume. To analyze fixed overhead costs, we will need three amounts:
• Actual fixed overhead costs incurred
• Budgeted fixed overhead costs
• Allocated fixed overhead costs
Keep in mind that the budgeted amount for fixed overhead is the same in both the static budget and the flexible budget because fixed costs are not expected to change in total
Exhibit23-13 | Variable Overhead Variances
AC × AQ
$30,160
SC × SQ
$3.00 per DLHr
× 13,000 DLHr
$39,000 SC × AQ
$3.00 per DLHr
× 10,400 DLHr
$2.90 per DLHr
× 10,400 DLHr
$31,200
Total Variable Overhead Variance
$8,840 F
Efficiency Variance VarianceCost
$1,040 F $7,800 F
Both of these amounts, the actual fixed overhead and the budgeted fixed overhead, are given in Exhibit 232, Static Budget Performance Report, and Exhibit 235, Flexible Budget Performance Report.
Fixed Overhead Cost Variance = Actual fixed overhead − Budgeted fixed overhead
= +23,920 - +25,000
= +1,080 F
Fixed Overhead Volume Variance = Budgeted fixed overhead − Allocated fixed overhead
= +25,000 - +26,000
= +1,000 F Overhead allocated
to production = Standard overhead
allocation rate : Standard quantity of the allocation base allowed for actual output
= +2.00 per DLHr * (0.25 DLHr per batch * 52,000 batches)
= +2.00 per DLHr * 13,000 DLHr
= +26,000
The $1,080 fixed overhead cost variance is favorable because Cheerful Colors actually spent less than budgeted for fixed overhead. Notice that the fixed overhead cost variance calculated above is the same as the fixed overhead flexible budget variance calculated in Exhibit 235. Changes in volume do not affect fixed costs; therefore, there is only a cost effect and not an efficiency effect in the fixed overhead flexible budget variance.
Fixed Overhead Volume Variance
The fixed overhead volume variance measures the difference between the budgeted fixed overhead and the amount of fixed overhead allocated to actual output. This variance measures how fixed overhead is allocated when actual volume is not equal to budgeted volume. Using the standard overhead allocation rate for fixed overhead previously calcu
lated, fixed overhead is allocated at $2.00 per direct labor hour and each batch of crayons has an efficiency standard of 0.25 direct labor hours per batch. Therefore, the amount of fixed overhead allocated is $26,000, as shown below:
Fixed Overhead Volume Variance Determines the cost associated with
the difference between budgeted fixed overhead and the amount of fixed overhead allocated to actual output. Budgeted fixed overhead -Allocated fixed overhead.
The fixed overhead volume variance is as follows:
The $1,000 fixed overhead volume variance is favorable because Cheerful Colors produced more batches than budgeted and, therefore, allocated more overhead to crayon batches than the $25,000 budgeted fixed overhead amount. In other words, based on the standard for fixed overhead, Cheerful Colors has overallocated fixed overhead by $1,000. When overhead is adjusted at the end of the accounting period, the adjustment for the overal
location of overhead will decrease Cost of Goods Sold. Because the adjustment is a decrease to an expense, the fixed overhead volume variance is favorable.
The fixed overhead volume variance is not a cost variance—it is a volume variance—
and explains why fixed overhead is overallocated or underallocated. Exhibit 2314 graphs the fixed overhead volume variance for Cheerful Colors. The small blue triangle bordered by the lines representing budgeted fixed overhead, standard fixed overhead allocated, and standard direct labor hours lines represents the favorable fixed overhead volume variance for this example.
Summary of Fixed Overhead Variances
Exhibit 2315 summarizes the fixed overhead variances.
To manage Cheerful Colors’s fixed overhead costs, we need to get more insight:
• Cheerful Colors incurred $1,080 less than anticipated in fixed overhead costs for a favorable cost variance.
• Workers made 52,000 batches of crayons, which was 2,000 batches more than budgeted and resulted in a $1,000 favorable volume variance.
Management may decide that the fixed overhead cost variance is sufficiently small and does not warrant investigation. However, they may want to investigate the variance further to deter
mine if the reduction in costs was controllable or if the cost standard needs to be updated.
Exhibit23-14 | Fixed Overhead Volume Variance
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000 Unfavorable Volume Variance
Favorable Volume Variance
The blue triangle represents the Volume
Variance for Cheerful Colors Standard FOH
at actual production
Budgeted DLHr (12,500 DLHr)
Standard DLHr for actual production
(13,000 DLHr)
Direct Labor Hours
Fixed Overhead Cost
Budgeted FOH
Standard FOH at budgeted
production
Exhibit23-15 | Fixed Overhead Variances
$23,920 Actual Fixed
Overhead
Volume Variance Cost
Variance
$1,080 F $1,000 F
$25,000 Budgeted Fixed
Overhead
$26,000 Allocated Fixed
Overhead