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• Denominator choices for the fixed manufacturing overhead rate
• Production incentives• Break• Variances for variable overhead• Variances for fixed overhead
ACTG 321Agenda for Lecture 14
![Page 2: Denominator choices for the fixed manufacturing overhead rate Production incentives Break Variances for variable overhead Variances for fixed overhead](https://reader035.vdocuments.us/reader035/viewer/2022081513/56649d565503460f94a3385a/html5/thumbnails/2.jpg)
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.
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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.)
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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.
![Page 5: Denominator choices for the fixed manufacturing overhead rate Production incentives Break Variances for variable overhead Variances for fixed overhead](https://reader035.vdocuments.us/reader035/viewer/2022081513/56649d565503460f94a3385a/html5/thumbnails/5.jpg)
• Denominator choices for the fixed manufacturing overhead rate
• Production incentives• Break• Variances for variable overhead• Variances for fixed overhead
ACTG 321Agenda for Lecture 14
![Page 6: Denominator choices for the fixed manufacturing overhead rate Production incentives Break Variances for variable overhead Variances for fixed overhead](https://reader035.vdocuments.us/reader035/viewer/2022081513/56649d565503460f94a3385a/html5/thumbnails/6.jpg)
• Denominator choices for the fixed manufacturing overhead rate
• Production incentives• Break• Variances for variable overhead• Variances for fixed overhead
ACTG 321Agenda for Lecture 14
![Page 7: Denominator choices for the fixed manufacturing overhead rate Production incentives Break Variances for variable overhead Variances for fixed overhead](https://reader035.vdocuments.us/reader035/viewer/2022081513/56649d565503460f94a3385a/html5/thumbnails/7.jpg)
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
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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.
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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)
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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?
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• Denominator choices for the fixed manufacturing overhead rate
• Production incentives• Break• Variances for variable overhead• Variances for fixed overhead
ACTG 321Agenda for Lecture 14
![Page 12: Denominator choices for the fixed manufacturing overhead rate Production incentives Break Variances for variable overhead Variances for fixed overhead](https://reader035.vdocuments.us/reader035/viewer/2022081513/56649d565503460f94a3385a/html5/thumbnails/12.jpg)
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.
![Page 13: Denominator choices for the fixed manufacturing overhead rate Production incentives Break Variances for variable overhead Variances for fixed overhead](https://reader035.vdocuments.us/reader035/viewer/2022081513/56649d565503460f94a3385a/html5/thumbnails/13.jpg)
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.
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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
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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.
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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
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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
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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
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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.
![Page 20: Denominator choices for the fixed manufacturing overhead rate Production incentives Break Variances for variable overhead Variances for fixed overhead](https://reader035.vdocuments.us/reader035/viewer/2022081513/56649d565503460f94a3385a/html5/thumbnails/20.jpg)
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
![Page 21: Denominator choices for the fixed manufacturing overhead rate Production incentives Break Variances for variable overhead Variances for fixed overhead](https://reader035.vdocuments.us/reader035/viewer/2022081513/56649d565503460f94a3385a/html5/thumbnails/21.jpg)
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
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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
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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
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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
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First let’s allocate based on factory capacity in the
denominator
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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.
![Page 27: Denominator choices for the fixed manufacturing overhead rate Production incentives Break Variances for variable overhead Variances for fixed overhead](https://reader035.vdocuments.us/reader035/viewer/2022081513/56649d565503460f94a3385a/html5/thumbnails/27.jpg)
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
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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
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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
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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
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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
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Now let’s allocate based on budgeted production in
the denominator
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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
![Page 34: Denominator choices for the fixed manufacturing overhead rate Production incentives Break Variances for variable overhead Variances for fixed overhead](https://reader035.vdocuments.us/reader035/viewer/2022081513/56649d565503460f94a3385a/html5/thumbnails/34.jpg)
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
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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
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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
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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