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