Factory Overhead (Chapter 14)

8/4/2019 Factory Overhead (Chapter 14)

1/49

Blocher,Stout,Cokins,Chen, Cost Management 4e The McGraw-Hill Companies 2008

The Flexible Budget:Factory Overhead

Chapter Fourteen


2/49


2

Distinguish between the product-costing andcontrol purposes of standard costs for factoryoverhead

Calculate and properly interpret standard costvariances for factory overhead using traditionalapproaches

Record factory overhead costs and associatedstandard cost variances

Apply standard costs to service organizations

Learning Objectives


3/49


3

Analyze overhead variances in an activity-basedcost (ABC) system

Understand decision rules that can be used toguide the variance-investigation decision

Learning Objectives(continued)


4/49


5/49


5

Standard Variable Overhead Costs:Product Costing vs. Control

VariableOverhead

Cost

Activity Variable(e.g., DL Hrs.)

Product Costing &Control (SQ x SP)

SQ = Standard allowed DLHs for units producedSP = Standard variableoverhead rate/DLH


6/49


6

Variable Overhead VarianceAnalysis

VariableOverhead

Cost


Product Costing &Control (SQ x SP)

SQ = Standard allowed DLHs for units produced; AQ = Actual DLHs worked;overhead rate/DLH; SP = Standard variable overhead rate/DLH; AP = Actual variableoverhead rate/DLH

SQ x SP

AQ x SP

AQ x AP

SQAQ

SpendingVariance

EfficiencyVariance Total

Variance


7/49


7

Variable Overhead Variance Analysis:Equation Approach


8/49


8

Variable Overhead Variance Analysis:Equation Approach (continued)


9/49


9

Variable Overhead Variance Analysis:Example Calculations

Hanson, Inc. applies variable factory overhead onthe basis of DLHs. Hanson has the following

variable factory overhead standard to

manufacture one unit of product:1.5 standard DLHs per unit @ a variable overhead

rate of $3.00 per DLH

Last month, 1,550 hours were worked to make1,000 units, and $5,115 was spent for variable

factory overhead


10/49


10

Variable Overhead Variance Analysis:Example Calculations (continued)


11/49


11

Variable Overhead Variance Analysis:Alternative Solution Format

Total Variable Overhead Variance = Actual VariableOverhead Flexible Budget for Variable Overhead

= $5,115 - $4,500 = $615 U

Variable Overhead Spending Variance = AQ x (AP SP)

= 1,550 DLHs x ($3.30 - $3.00)/DLH

= $465 U

Variable Overhead Efficiency Variance = SP x (AQ SQ)

= $3.00/DLH x (1,550 1,500) DLHs

= $150 U


12/49


13/49


13

Standard Fixed Overhead Cost:Planning vs. Control

FixedOverhead

Cost


Product Costing:Standard Fixed OHApplied = SQ x SP

SQ = Standard allowed DLHs for units producedSP = Standard fixedoverhead rate/DLH

Control Budget(Lump Sum)

14


14/49


14

Determine the total budgeted fixed factoryoverhead for level of operation.

Select an activity driver (or drivers) for applying

fixed factory overhead.

Choose a denominator volume for the selectedactivity driver (e.g., practical capacity).

Divide the amount in Step 1 by the amount inStep 3 to determine the standard fixed factoryoverhead application rate for product costingpurposes.

Product Costing: Determining the StandardFixed Factory Overhead Rate

15


15/49


15

Fixed Overhead Variance Analysis

FixedOverhead

Cost


Product Costing: StandardFixed OH Applied = SQ x SP

SQ = Standard allowed DLHs for units producedSP = Standard fixedoverhead rate/DLH

Actual FOH

Budgeted FOH

Applied FOH

Spending

Variance (U)VolumeVariance (U)

SQ Den. Vol.

TotalVariance

(U)

16


16/49


16

Calculating Fixed Overhead Variances

17


17/49


17

Example: Calculating Fixed OverheadVariances

Hanson Inc.s budgeted fixed overhead is $9,000 forthe month. The budgeted activity measure for the

month is 3,000 units.

Actual production is 3,200 units and actual fixedoverhead is $8,450 for the month.

Compute the fixed overhead spending andvolume variances.

$9,000 budgeted fixed overhead

3,000 budgeted unitsFR = = $3.00 per unit

18


18/49


18

Example: Calculating Fixed OverheadVariances (continued)

19


19/49


19

Fixed Overhead Variance Analysis:Alternative Solution Format

Total Fixed Overhead Variance = Actual Fixed OverheadFixed Overhead Applied to Production

= $8,450 - $9,600 = $1,150 F (also called

Overapplied fixed overhead)Fixed Overhead Spending (Budget) Variance

= Actual Fixed Overhead Budgeted Fixed Overhead= $8,450 - $9,000 = $550 F

Fixed Overhead Production Volume Variance

= Budgeted Fixed Overhead Applied Fixed Overhead= $9,000 - $9,600 = $600 F

20


20/49


20

Fixed Overhead Production VolumeVariance: Alternative Calculation

Fixed Overhead Production Volume Variance

= Standard Fixed Overhead Application Rate x(Actual Units Produced DenominatorVolume)

= $3.00/unit x (3,200 3,000) units

= $600 F (i.e., overapplied fixed overhead)

21


21/49


21

Interpretation of Fixed OverheadVariances

Results from spending

more or less thanexpected for individualfixed overhead items.That is, spending on

individual fixed

overhead items wasdifferent than planned.

Spending (Budget)Variance

Production VolumeVariance

Results from operating

at a level other than thedenominator volumelevel. Arises because of

the product-costingpurpose of fixed

overhead. Not of directinterest for control

purposes

22


22/49


22

Causes of Fixed Overhead Variances

Spending (Budget) Variance:

Ineffective budget procedures

Inadequate control of costs

Misclassification of cost items

Production Volume Variance:

Management decisions Unexpected changes in market demand

Unforeseen problems in manufacturing operations

23


23/49


23

Three-Way Breakdown of Total OverheadVariance

24


24/49


24

Hanson, Inc.: Three-Way vs. Four-Way Analysisof Total Factory Overhead Variance

25


25/49


25

Two-Way Analysis of Total FactoryOverhead Variance

26


26/49


26

Hanson, Inc.: Two-Way Analysis of TotalFactory Overhead Variance

27


27/49


27

Disposition of Standard Manufacturing CostVariances

From Chapter 13

Material price variance $ 170 F

Material usage variance 800 U

Labor rate variance 310 U

Labor efficiency variance 600 U

From Chapter 14

Variable factory overhead spending variance 465 UVariable factory overhead efficiency variance 150 U

Fixed factory overhead spending variance 550 F

Fixed factory overhead volume variance 600 F

Total manufacturing cost variance $ 1,005 U

Hanson IncManufacturing Cost Variances

For the Month Ending June 30, 2008

28


28/49


8

Alternative 1: Close Net Manufacturing CostVariance to CGS

Dr. CGS (net variance) $1,005

Dr. DM Price Variance 170

Dr. FOH Spending Variance 550

Dr. FOH Volume Variance 600

Cr. DM Usage Variance $ 800

Cr. DL Rate Variance 310

Cr. DL Efficiency Variance 600

Cr. VOH Spending Variance 465

Cr. VOH Efficiency Variance 150

29


29/49


Income Statement after Disposition of NetManufacturing Cost Variance

Sales 100,000$

Add: Favorable selling price variance 7,000

Net sales 107,000$

Cost of goods sold (at standard) 60,000$

Add: Unfavorable manufacturing cost variances 1,005

Total cost of goods sold 61,005

Gross margin 45,995$Selling and administrative expenses 41,000

Operating income 4,995$

Hanson Inc

Income statement

For the Month Ended June 30, 2008

30


30/49


Alternative 2: Prorate (Allocate) NetManufacturing Cost Variance

Cost at Percent Adjusted

Accounts Standard of Total Total cost

Ending WIP 20,000$ 20% 20% of $1,005 201$ 20,201$

Ending Fin. Goods 20,000 20% 20% of $1,005 201 20,201

CGS 60,000 60% 60% of $1,005 603 60,603

Total 100,000$ 100% 1,005$ 101,005$

Proration of

Variance

Proration of Manufacturing Cost Variances

End-of-period account balances are used to allocatethe net manufacturing cost variance, as follows:

31


31/49


Alternative 2: Prorate Net ManufacturingCost Variance

Dr. CGS (net variance) $ 603

Dr. WIP Inventory 201

Dr. Finished Good Inventory 201

Dr. DM Price Variance 170

Dr. FOH Spending Variance 550

Dr. FOH Volume Variance 600

Cr. DM Usage Variance $ 800

Cr. DL Rate Variance 310

Cr. DL Efficiency Variance 600

Cr. VOH Spending Variance 465

Cr. VOH Efficiency Variance 150

32


32/49


Traditional vs. ABC Approach to OverheadCost Analysis

Cost Item Variable Per Fixed

Direct materials $20 UnitDirect labor 30 DLH

Indirect materials 2 DLH

Repair and Maintenance 5 DLH

Receiving $5,000Engineering Support 30,000

Setup 75,000

Traditional Approach to Product Costing:

33


33/49


Traditional Performance Report

Actual Flexible

Cost Item Cost Budget Variance

Direct materials $50,000 $40,000 $10,000 U

Direct labor 36,000 30,000 6,000 U

Indirect materials 3,000 2,000 1,000 URepair and Maintenance 6,500 5,000 1,500 U

Receiving 3,000 5,000 2,000 F

Engineering Support 30,000 30,000 30,000

Setup 50,000 75,000 25,000 FTotal $178,500 $187,000 $8,500 F

34


34/49


Flexible Budget Using ABC

Flexible

Cost Item Budget

Direct materials $40,000 (2,000 x $20)

Direct labor 30,000 (2,000 x 0.5 x $30)Indirect materials 2,000 (1,000 x $2)

Repair and Maintenance 6,000 (300,000 X $0.01 +$3,000)

Receiving 3,500 (2 x $1,500 + $500)

Engineering Support 30,000 ($30,000 per period)Setup 50,000 (2 x $25,000)Total $161,500

35


35/49


Performance Report Using ABC

Actual Flexible

Cost Item Cost Budget Variance

Direct materials $50,000 $40,000 $10,000 U

Direct labor 36,000 30,000 6,000 UIndirect materials 3,000 2,000 1,000 U

Repair and Maintenance 6,500 6,000 500 U

Receiving 3,000 3,500 500 F

Engineering Support 30,000 30,000Setup 50,000 50,000

Total $178,500 $161,500 $17,000 U

36


36/49


Standard Costing Applied toService Contexts

Examples

Jobs with repetitive tasks lend themselvesto efficiency measures

Computing non-manufacturing efficiencyvariances requires some assumedrelationship between input and outputactivity

37


37/49


Service Applications (continued)

Department Input Output

Mailing Labor hours Number of pieces mailed

Personnel Labor hours Number of personnel changes processed

Food service Labor hours Number of meals served

Consulting Billable hours Customer revenues

Nursing Labor hours Number of patients and/or procedures

Check Processing Computer hours Number of checks processed

38


38/49


The Variance Investigation Decision

How do I know whichvariances toinvestigate?

Larger variances, in

dollar amount or asa percentage of the

standard, areinvestigated first.

39


39/49


The Variance Investigation Decision(continued)

Uncontrollable:

Random Error

Controllable (Systematic):

Prediction error

Modeling error

Measurement error

Implementation error

40


40/49


Control Charts

ControlCharts

Display variations in aprocess and help to

analyze the variations

over time

Distinguish betweenrandom variationsand variations that

should be investigated

Provide a warning signal when variationsare beyond a specified level

41


41/49


Control Charts (continued)


42/49

43


43/49


Appendix: Variance InvestigationDecisionsUsing Payoff Tables

States of Nature

Action Random Nonrandom

Investigate I I+ C

Do not investigate none L

Where: I= cost of an investigation

C= the cost to correct a variance

L = present value of losses by notcorrecting the variance

44


44/49


Appendix: Variance InvestigationDecisionsIndifference Probability

E(Investigate) = [(I + (1 - p)] + [(I + C) x p]

E(Do not investigate) = L x p

Set the above two equations equal, solve for

p, the indifference probability:p= I/(LC)

45


45/49


We distinguished between the product-costingandcontrolpurposes of standard costs for factoryoverhead

For variable overhead costs, we saw that these twopurposes are the same (see Exhibit 14.1)

For fixed overhead costs, these purposes are different

(see Exhibit 14.3)

Chapter Summary

46


46/49


For product-costing purposes, we defined the totaloverhead variance for the period as the differencebetween the actual overhead costs incurred and the

overhead costs applied to production using theoverhead application rate

We saw that this total variance is also referred to asthe total over- or under-applied overhead for theperiod

Chapter Summary(continued)

47


47/49


The total overhead variance for the period can bedecomposed using a four-way, three-way, or two-way analysis:

Four-way analysis= variable overhead spending variance

+ variable overhead efficiency variance + fixed overheadspending (budget) variance + fixed overhead productionvolume variance

Three-way analysis= total overhead spending variance +

variable overhead efficiency variance + fixed overheadproduction volume variance

Two-way analysis= flexible (controllable) budget variance+ fixed overhead production volume variance

Chapter Summary (continued)

48


48/49


Chapter Summary (continued)

We discussed how to record standard overhead costsin the accounting records and how any standard costvariances for product-costing purposes are disposed ofat the end of the accounting period

We learned how traditional and ABC approaches tooverhead cost analysis differ in terms of insightsprovided to management

We learned how to apply standard costs to serviceorganizations

49


49/49

We discussed indicated managerial actionsassociated with particular types of errors

We covered the use of control charts, includingstatistical control charts, for monitoring activities andensuring financial control

Finally, we presented in the Appendix a formal

decision approach to the variance-investigationdecision under uncertainty; this decision modelinvolved the use of pay-off tables

Chapter Summary(continued)

Documents

Factory Overhead (Chapter 14)