chapter 9 flexible budget & overhead analysis
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Management AccountingChapter 9 Flexible Budget & Overhead AnalysisTRANSCRIPT
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Flexible Budgets and Overhead Analysis
by:
April Alfonso
Copyright © 2006. The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Static Budgets and Performance Reports
Static budgetsare prepared fora single, plannedlevel of activity.
Performance evaluation is difficult when actual activity
differs from the planned level of
activity.
Hmm! Comparingstatic budgets withactual costs is likecomparing apples
and oranges.
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Flexible Budgets
Improve performance evaluation.
May be prepared for any activity level in the relevant range.
Show costs that should have beenincurred at the actual level ofactivity, enabling “apples to apples”cost comparisons.
Reveal variances related tocost control.
Let’s look at CheeseCo.
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CheeseCo
Static Budgets and Performance Reports
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CheeseCo
Static Budgets and Performance Reports
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U = Unfavorable variance CheeseCo was unable to achieve
the budgeted level of activity.
CheeseCo
Static Budgets and Performance Reports
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CheeseCo
F = Favorable variance that occurs when actual costs are less than budgeted costs.
Static Budgets and Performance Reports
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Since cost variances are favorable, havewe done a good job controlling costs?
CheeseCo
Static Budgets and Performance Reports
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I don’t think Ican answer thequestion usinga static budget.
Actual activity is belowbudgeted activity.
So, shouldn’t variable costsbe lower if actual activity
is lower?
Static Budgets and Performance Reports
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The relevant question is . . .
“How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?”
To answer the question,we mustthe budget to theactual level of activity.
The relevant question is . . .
“How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?”
To answer the question,we mustthe budget to theactual level of activity.
Static Budgets and Performance Reports
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Preparing a Flexible Budget
To a budget we need to know that: Total variable costs change
in direct proportion to changes in activity.
Total fixed costs remainunchanged within therelevant range. Fixed
Variable
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Preparing a Flexible Budget
Let’s prepare budgets for CheeseCo.
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Cost Total Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00$ Indirect material 3.00 Power 0.50 Total variable cost 7.50$
Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs
Flexible Budgets
Preparing a Flexible Budget
Fixed costs areexpressed as atotal amount.
Variable costs are expressed as a constant amount per hour.
$40,000 ÷ 10,000 hours is$4.00 per hour.
CheeseCo
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Cost Total Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00$ 32,000$ Indirect material 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$
Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs
Flexible Budgets
Preparing a Flexible Budget
$4.00 per hour × 8,000 hours = $32,000
CheeseCo
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Preparing a Flexible Budget
CheeseCoCost Total
Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00$ 32,000$ Indirect material 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$
Fixed costs Depreciation 12,000$ 12,000$ Insurance 2,000 2,000 Total fixed cost 14,000$ Total overhead costs 74,000$
Flexible Budgets
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Cost Total Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00$ 32,000$ 40,000$ Indirect material 3.00 24,000 30,000 Power 0.50 4,000 5,000 Total variable cost 7.50$ 60,000$ 75,000$
Fixed costs Depreciation 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ ?
Flexible Budgets
Preparing a Flexible Budget
Total fixed costsdo not change in
the relevant range.
CheeseCo
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Preparing a Flexible Budget
Cost Total Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Indirect labor 4.00$ 32,000$ 40,000$ 48,000$ Indirect material 3.00 24,000 30,000 36,000 Power 0.50 4,000 5,000 6,000 Total variable cost 7.50$ 60,000$ 75,000$ 90,000$
Fixed costs Depreciation 12,000$ 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ 104,000$
Flexible Budgets
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Let’s prepare a budget performance report for CheeseCo.
Flexible Budget Performance Report
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Cost Total Formula Fixed Flexible Actualper Hour Cost Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs Indirect labor 4.00$ 34,000$ Indirect material 3.00 25,500 Power 0.50 3,800 Total variable cost 7.50$ 63,300$
Fixed costs Depreciation 12,000$ 12,000$ Insurance 2,000 2,050 Total fixed cost 14,050$ Total overhead costs 77,350$
CheeseCoFlexible budget is prepared for the
same activity level (8,000 hours) as
actually achieved.
Flexible Budget Performance Report
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Cost Total Formula Fixed Flexible Actualper Hour Cost Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 25,500 Power 0.50 3,800 Total variable cost 7.50$ 63,300$
Fixed costs Depreciation 12,000$ 12,000$ Insurance 2,000 2,050 Total fixed cost 14,050$ Total overhead costs 77,350$
CheeseCo
Flexible Budget Performance Report
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Cost Total Formula Fixed Flexible Actualper Hour Cost Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 24,000 25,500 1,500 U Power 0.50 4,000 3,800 200 FTotal variable cost 7.50$ 60,000$ 63,300$ $ 3,300 U
Fixed costs Depreciation 12,000$ 12,000$ 12,000$ $ 0 Insurance 2,000 2,000 2,050 50 UTotal fixed cost 14,000$ 14,050$ 50 UTotal overhead costs 74,000$ 77,350$ $ 3,350 U
CheeseCo
Flexible Budget Performance Report
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Remember the question: “How much of the total variance is due to lower activity and how much isdue to cost control?”
Flexible Budget Performance Report
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Static Budgets and Performance
How much of the $11,650 favorable variance is due to lower activity and how much is due to cost control?
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Difference between original static budgetand actual overhead = $11,650 F.
Overhead Variance Analysis
Static ActualOverhead OverheadBudget at at
10,000 Hours 8,000 Hours
89,000$ 77,350$
Let’s place the flexible budget for
8,000 hours here.
Flexible Budget Performance Report
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Overhead Variance Analysis
This $15,000F variance is due to lower activity.
Activity
This $3,350Uvariance is due
to poor cost control.
Cost control
Static Flexible ActualOverhead Overhead OverheadBudget at Budget at at
10,000 Hours 8,000 Hours 8,000 Hours
89,000$ 74,000$ 77,350$
Flexible Budget Performance Report
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The Measure of Activity– A Critical Choice
Three importantfactors in selecting an
activity base for an overheadflexible budget
Activity base andvariable overhead
should becausally related.
Activity base andvariable overhead
should becausally related.
Activity base shouldnot be expressed
in dollars orother currency.
Activity base shouldnot be expressed
in dollars orother currency.
Activity base shouldbe simple and
easily understood.
Activity base shouldbe simple and
easily understood.
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Variable Overhead Variances –A Closer Look
If flexible budgetis based onactual hours
If flexible budgetis based on
standard hours
Only a spendingvariance can be
computed.
Both spendingand efficiency
variances can be computed.
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ColaCo’s actual production for the period required 3,200 standard machine hours. Actual variable overhead incurred for the period was $6,740. Actual machine hours worked were 3,300. The
standard variable overhead cost per machine hour is $2.00.
Compute the variable overhead spending variance
first using actual hours. Then use standard hours allowed to calculate the variable overhead
efficiency variance.
Variable Overhead Variances – Example
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Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours
AH × SRAH × AR
Spending Variance
Spending variance = AH(AR – SR)
Variable Overhead Variances
AH = Actual hoursAR = Actual variable overhead rateSR = Standard variable overhead rate
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Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours
3,300 hours×
$2.00 per hour= $6,600$6,740
Spending Variance= $140 unfavorable
Variable Overhead Variances – Example
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Variable Overhead Variances –A Closer Look
Spending Variance
Results from paying moreor less than expected foroverhead items and from
excessive usage ofoverhead items.
Now, let’s use the standard hours allowed,
along with the actual hours, to compute the
efficiency variance.
Now, let’s use the standard hours allowed,
along with the actual hours, to compute the
efficiency variance.
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AH × SR
AH × AR
Spending variance = AH(AR - SR)
Efficiency variance = SR(AH - SH)
SH × SR
Spending Variance
EfficiencyVariance
Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
Variable Overhead Variances
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3,300 hours 3,200 hours × × $2.00 per hour $2.00 per hour
Variable Overhead Variances – Example
$6,740 $6,600 $6,400
Spending variance$140 unfavorable
Efficiency variance$200 unfavorable
$340 unfavorable flexible budget total variance$340 unfavorable flexible budget total variance
Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
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Efficiency Variance
Controlled bymanaging the
overhead cost driver.
Variable Overhead Variances –A Closer Look
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Quick Check
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the spending variance?a. $450 Ub. $450 Fc. $700 Fd. $700 U
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the spending variance?a. $450 Ub. $450 Fc. $700 Fd. $700 U
Copyright © 2006. The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the spending variance?a. $450 Ub. $450 Fc. $700 Fd. $700 U
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the spending variance?a. $450 Ub. $450 Fc. $700 Fd. $700 U
Quick Check
Spending variance = AH (AR - SR)
= Actual variable overhead incurred – (AH SR)
= $10,950 – (2,050 hours $5 per hour)
= $10,950 – $10,250
= $700 U
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Quick Check
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the efficiency variance?a. $450 Ub. $450 Fc. $250 Fd. $250 U
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the efficiency variance?a. $450 Ub. $450 Fc. $250 Fd. $250 U
Copyright © 2006. The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the efficiency variance?a. $450 Ub. $450 Fc. $250 Fd. $250 U
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the efficiency variance?a. $450 Ub. $450 Fc. $250 Fd. $250 U
Quick Check
Efficiency variance = SR (AH – SH)
= $5 per hour (2,050 hours – 2,100 hours)
= $250 F
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2,050 hours 2,100 hours × × $5 per hour $5 per hour
Quick Check Summary
Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
$10,950 $10,250 $10,500
Spending variance$700 unfavorable
Efficiency variance$250 favorable
$450 unfavorable flexible budget total variance$450 unfavorable flexible budget total variance
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Activity-based Costingand the Flexible Budget
It is unlikely that allvariable overhead will bedriven by a single activity.
It is unlikely that allvariable overhead will bedriven by a single activity.
Activity-based costingcan be used when multiple
activity bases drivevariable overhead costs.
Activity-based costingcan be used when multiple
activity bases drivevariable overhead costs.
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Overhead Rates and Overhead Analysis
Overhead from theflexible budget for the
denominator level of activityPOHR =
Recall that overhead costs are assigned to products and services using a predetermined
overhead rate (POHR):
Assigned Overhead = POHR × Standard Activity
Denominator level of activity
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The predetermined overhead ratecan be broken down into fixed
and variable components.
The variablecomponent is useful
for preparing and analyzingvariable overhead
variances.
The fixedcomponent is useful
for preparing and analyzingfixed overhead
variances.
Overhead Rates and Overhead Analysis
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Normal versus Standard Cost Systems
In a normal costsystem, overhead isapplied to work inprocess based onthe actual numberof hours worked
in the period.
In a standard costsystem, overhead isapplied to work inprocess based onthe standard hours
allowed for the outputof the period.
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Budget Variance
VolumeVariance
FR = Standard Fixed Overhead RateSH = Standard Hours AllowedDH = Denominator Hours
SH × FR
Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
Fixed Overhead Variances
DH × FR
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ColaCo prepared this budget for overhead:
Overhead Rates and OverheadAnalysis – Example
Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
3,000 6,000$ ? 9,000$ ?
4,000 8,000 ? 9,000 ?
ColaCo applies overhead basedon machine-hour activity.
ColaCo applies overhead basedon machine-hour activity.
Let’s calculate overhead rates.
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Rate = Total Variable Overhead ÷ Machine Hours
This rate is constant at all levels of activity.
Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
3,000 6,000$ 2.00$ 9,000$ ?
4,000 8,000 2.00 9,000 ?
ColaCo prepared this budget for overhead:
Overhead Rates and OverheadAnalysis – Example
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Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
3,000 6,000$ 2.00$ 9,000$ 3.00$
4,000 8,000 2.00 9,000 2.25
Rate = Total Fixed Overhead ÷ Machine Hours
This rate decreases when activity increases.
ColaCo prepared this budget for overhead:
Overhead Rates and OverheadAnalysis – Example
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Total Variable Total FixedMachine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
3,000 6,000$ 2.00$ 9,000$ 3.00$
4,000 8,000 2.00 9,000 2.25
The total POHR is the sum ofthe fixed and variable ratesfor a given activity level.
ColaCo prepared this budget for overhead:
Overhead Rates and OverheadAnalysis – Example
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ColaCo’s actual production required 3,200 standard machine hours. Actual fixed overhead was $8,450. The predetermined overhead rate is
based on 3,000 machine hours.
Fixed Overhead Variances – Example
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Overhead Variances
Now let’s turn our attention to calculating
fixed overhead variances.
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Fixed Overhead Variances – Example
Budget variance$550 favorable
$8,450 $9,000
Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
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Fixed Overhead Variances –A Closer Look
Budget Variance
Results from spendingmore or less thanexpected for fixedoverhead items.
Now, let’s use the standard hours allowed
to compute the fixed overhead volume
variance.
Now, let’s use the standard hours allowed
to compute the fixed overhead volume
variance.
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3,200 hours × $3.00 per hour
Budget variance$550 favorable
Fixed Overhead Variances – Example
$8,450 $9,000 $9,600
Volume variance$600 favorable
SH × FR
Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
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Volume Variance – A Closer Look
VolumeVariance
Results when standard hoursallowed for actual output differsfrom the denominator activity.
Unfavorablewhen standard hours< denominator hours
Favorablewhen standard hours> denominator hours
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Volume Variance – A Closer Look
VolumeVariance
Results when standard hoursallowed for actual output differsfrom the denominator activity.
Unfavorablewhen standard hours< denominator hours
Favorablewhen standard hours> denominator hours
Does not measure over- or under spending
It results from treating fixedoverhead as if it were a
variable cost.
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Quick Check
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the budget variance?a. $350 Ub. $350 Fc. $100 Fd. $100 U
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the budget variance?a. $350 Ub. $350 Fc. $100 Fd. $100 U
Copyright © 2006. The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the budget variance?a. $350 Ub. $350 Fc. $100 Fd. $100 U
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the budget variance?a. $350 Ub. $350 Fc. $100 Fd. $100 U
Quick Check
Budget variance
= Actual fixed overhead – Budgeted fixed overhead
= $14,800 – $14,450
= $350 U
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Quick Check
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the volume variance?a. $250 Ub. $250 Fc. $100 Fd. $100 U
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the volume variance?a. $250 Ub. $250 Fc. $100 Fd. $100 U
Copyright © 2006. The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the volume variance?a. $250 Ub. $250 Fc. $100 Fd. $100 U
Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the volume variance?a. $250 Ub. $250 Fc. $100 Fd. $100 U
Quick Check
Volume variance
= Budgeted fixed overhead – (SH FR)
= $14,450 – (2,100 hours $7 per hour)
= $14,450 – $14,700
= $250 F
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2,100 hours × $7.00 per hour
Budget variance$350 unfavorable
$14,800 $14,450 $14,700
Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
Volume variance$250 favorable
SH × FR
Quick Check Summary
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Overhead Variances
Let’s look at a graph showing fixed overhead
variances. We will use ColaCo’s
numbers from the previous example.
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Fixed Overhead Variances
Activity
Cost
3,000 Hours ExpectedActivity
$9,000 budgeted fixed OH
Fixed overhead
applied to products
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Fixed Overhead Variances
$8,450 actual fixed OH
Activity
Cost
3,000 Hours ExpectedActivity
$9,000 budgeted fixed OH
Fixed overhead
applied to products
$8,450 actual fixed OH$550Favorable
Budget Variance
{
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{
Fixed Overhead Variances
$8,450 actual fixed OH
3,200 machine hours × $3.00 fixed overhead rate
$600FavorableVolume
Variance
$9,600 applied fixed OH
3,200 Standard
Hours
Activity
Cost
3,000 Hours ExpectedActivity
$9,000 budgeted fixed OH
Fixed overhead
applied to products
$550Favorable
Budget Variance
{ $8,450 actual fixed OH
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Overhead Variances and Under- or Overapplied Overhead Cost
In a standardcost system:
Unfavorablevariances are equivalent
to underapplied overhead.
Favorablevariances are equivalentto overapplied overhead.
The sum of the overhead variancesequals the under- or overapplied
overhead cost for a period.
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Thank You!!!