Planning of Variable andFixed Overhead Costs

Effective planning of VOHinvolves reducing non-value added costs& consumption of cost allocation bases

FOH planning: appropriate level of capacity or investment that will benefit the company over an extended time period. Done much before the period begins.

Features of Standard Costing

Standard inputof allocation

base for actualoutput

Standard OH costrate

×

Cost ObjectDirect CostSQ X SP

Developing Budgeted VariableOverhead Absorption Rates

Step 1:Choose the time period used to compute the budget.

Webb uses a 12-month budget period.

Step 2:Select the cost-allocation base. Webb budgets

57,600 MHs for a budgeted output of144,000 jackets in year 2006.

Cont..

Step 3:Identify the variable overhead costs.

Webb’s budgeted variablemanufacturing costs for 2006 is Rs.17,28,000

Step 4:Compute the rate per unit ofeach cost-allocation base.

Rs.17,28,000÷ 57,600 hours = Rs.30/MH

Cont..

What is the budgeted variable overheadcost rate per output unit (Jacket)?

0.40 MH allowed per output unit × Rs.30budgeted variable overhead cost rate perinput unit = Rs.12 per jacket (output unit)

Variable OH variancesfor April, 2006

Actual Flexible budgetOutput units 10,000 10,000MHs/unit 0.45 0.40MHs 4,500 4,000Variable OH Rs.130500 Rs.120000Variable mfg. OH/MH Rs.29.00 Rs.30.00VMOH/jacket Rs.13.05 Rs.12.00

Variable OverheadCost Variances

Variable manufacturing overhead costs:Actual results: Rs.1,30,500Flexible-budget amount: Rs.1,20,000Variable mfg. OH variance = Rs.10,500(U)

Variable OH efficiency variance

= [Actual qty. of VOH allocation base used for actual output – Budgeted qty. of VOH allocation base for actual output] X Budgeted rate per unit of allocation base

= [4500 hours – 4000 hours] X Rs.30/hr.= Rs.15,000 U

Possible causes of adverse variance

Cause: Less skilled workers

Inefficient scheduling Bad machine

maintenance Rush order

acceptance

Too tight standard

Response:Hiring and trainingImprovePreventive maintenance

Coordination between sales and production staff

Revise/improve

Variable OH spending variance

Actual quantity of inputs at actual rate

4,500 × Rs.29=Rs.130,500

Actual quantityof inputs at

budgeted rate4,500 × Rs.30= Rs.1,35,000

Rs.4,500 FVariable overhead spending variance

Reasons % increase in MHs = 12.5 % increase in Variable OH cost =

8.75Why:1. Actual price of inputs included in VOH

may be less2. % increase in actual quantity usage

of individual items in VOH is less than % increase in MHs

Cont…

Reasons:Skillful negotiationBad quality indirect materialOversupply in the marketIs a favourable spending variance always desirable?

Not always! (low-quality indirect material, less talented supervisor, bad maintenance)

Variable Overhead Variances- Summary

Flexible-budget varianceRs.10,500 U

Efficiency varianceRs.15,000 U

Spending varianceRs.4,500 F

Developing Budgeted FixedOverhead Allocation Rates

Step 1:Choose the period used to compute the budget.The budget period is typically twelve months.

Why should you use annual rates?

Step 2:Select the cost-allocation base.

Webb budgets 57,600 MHs for a budgetedoutput of 1,44,000 jacket in year 2006.

Cont…

Step 3:Identify the fixed overhead costs. Webb’s fixedmanufacturing budget for 2006 is Rs.33,12,000.

Step 4:Compute the rate per unit of

cost-allocation base: Rs.33,12,000÷ 57,600 = Rs.57.50

Cont..

What is the budgeted fixed overhead cost rateper output unit (jacket)?

0.40 hours allowed per output unit

Rs.57.50 budgeted fixed OH cost rate per input unit

Rs.23 per jacket (output unit)

×

=

Fixed OH cost variances

Actual CostsIncurred

Rs.2,85,000

Flexible Budget:Budgeted

Fixed OverheadRs.2,76,000

Rs.9,000 UFixed OH spending variance

[also, Fixed OH flexible-budget variance]

––

Cont…

Reasons for unfavourable Fixed OH spending variance:

Higher plant leasing cost, higher depreciation, higher supervisory salary

Production-Volume Variance

Flexible Budget:Budgeted

Fixed OverheadRs.2,76,000

Fixed Overhead Allocated UsingBudgeted Input Allowed for

Actual Output Units Produced0.40 X 10,000 X Rs.57.50=230,000

Rs.46,000 UProduction-volume variance

2,000 (jackets not produced) × 0.40X Rs.57.50 = Rs.46,000

––

Fixed Overhead Variances

Fixed overhead varianceRs.55,000 U

Volume varianceRs.46,000 U

Spending varianceRs.9,000 U

Interpreting the Production-Volume Variance

Had Webb manufactured12,000 jackets instead of 10,000,

allocated fixed overheadwould have been = Rs.2,76,000

(12,000 × 0.40× Rs.57.50)

Had Webb manufactured12,000 jackets instead of 10,000,

allocated fixed overheadwould have been = Rs.2,76,000

(12,000 × 0.40× Rs.57.50)

No production-volume variancewould have occurred.

No production-volume variancewould have occurred.

Cont…

Lump-sum fixed costs represent cost of capacity acquired

Many a times capacity can be added in lump-sum fashion

Why the unused capacity? Weak demand/poor quality/product

and marketing strategy/strategic mistake

Integrated Analysis

A 4-variance analysis presents spending andefficiency variances for variable overheadcosts and spending and production-volume

variances for fixed overhead costs.

Managers can reconcile the actual overheadcosts with the overhead amounts allocated

during the period.

Integrated Analysis

Actual manufacturing overhead incurred:Variable manufacturing overhead Rs. 1,30,500Fixed manufacturing overhead 2,85,000Total Rs.

4,15,500Overhead allocated:Variable manufacturing overhead Rs. 1,20,000Fixed manufacturing overhead 2,30,000Total Rs.

3,50,000Amount underallocated Rs. 65,500

Integrated Analysis

4-Variance Analysis:Variable manufacturing overhead:Spending variance Rs. 4,500 FEfficiency variance Rs.15,000 UFixed manufacturing overhead:Spending variance 9,000 UVolume variance 46,000 UTotal Rs.65,500 U

Integrated analysis

3-Variance AnalysisVariable and fixed manufacturing overhead:Spending varianceRs.4,500 F + Rs.9,000 U = 4,500 UVariable manufacturing overhead:Efficiency variance 15,000 UFixed manufacturing overhead:Volume variance 46,000 UTotal Rs.65,500 U

Home task

2-Variance Analysis1-variance analysisProduction volume variance and Sales volume variance

Financial and Nonfinancial Performance

Overhead variances are examples of financial performance measures.

What are examples of nonfinancial measures?

Actual labor time, relative to budgeted time

Actual indirect materials usage per labor-hour, relative to budgeted indirect materials usage