Planning of Variable and

Fixed Overhead Costs

Effective planning of variable overhead costs
involves undertaking only those variable
overhead activities that add value for
customers using the product or service.
The key challenge with planning fixed overhead
is choosing the appropriate level of capacity or
investment that will benefit the company over
an extended time period.
 Standard Costing

Direct Cost Cost Object

Standard input
Standard cost
per input unit × allowed for
one output unit
 Budgeted Variable
Overhead Allocation Rates

Step 1:
Choose the time period used to compute the budget.
Pasadena Co. uses a twelve-month budget period.
Step 2:
Select the cost-allocation base. Pasadena budgets
26,000 labor-hours for a budgeted output of
13,000 suits in year 2004.
 Budgeted Variable
Overhead Allocation Rates
Step 3:
Identify the variable overhead costs.
Pasadena’s budgeted variable
manufacturing costs for 2004 are $312,000.
Step 4:
Compute the rate per unit of
each cost-allocation base.
$312,000 ÷ 26,000 hours = $12/hour
 Budgeted Variable
Overhead Allocation Rates

What is the budgeted variable overhead

cost rate per output unit (dress suit)?
2.00 hours allowed per output unit × $12
budgeted variable overhead cost rate per
input unit = $24 per suit (output unit)
 Variable Overhead
Cost Variances

The following data are for 2004 when

Pasadena produced and sold 10,000 suits:
Output units: 10,000
Labor-hours:
Actual results: 21,500
Flexible-budget amount: 20,000
 Variable Overhead
Cost Variances

Labor-hours per output unit:

Actual results: 21,500 ÷ 10,000 = 2.15
Flexible-budget amount: 20,000 ÷ 10,000 = 2.00
Variable manufacturing overhead costs:
Actual results: $244,775
Flexible-budget amount: $240,000
 Variable Overhead
Cost Variances

Variable manufacturing overhead

cost per labor-hour:
Actual results:
$244,775 ÷ 21,500 = $11.3849
Flexible-budget amount:
$240,000 ÷ 20,000 = $12.00
 Variable Overhead
Cost Variances

Variable manufacturing overhead

cost per output unit:
Actual results:
$244,775 ÷ 10,000 = $24.4775
Flexible-budget amount:
$240,000 ÷ 10,000 = $24.00
 Flexible-Budget Analysis

The variable overhead flexible-budget variance

measures the difference between the actual
variable overhead costs and the flexible-budget
variable overhead costs.
Actual results: $244,775
– Flexible-budget amount $240,000 = $4,775 U
 Flexible-Budget Analysis
Budgeted Inputs
Actual
Allowed for Actual
Costs Incurred
Outputs at Budgeted Rate
21,500 × $11.3849
20,000 × $12.00
= $244,775
= $240,000

$4,775 U
Flexible-budget variance
 Flexible-Budget Analysis
Actual Quantity Budgeted Inputs
of Inputs at Allowed for Actual
Budgeted Rate Outputs at Budgeted Rate
21,500 × $12.00 20,000 × $12.00
= $258,000 = $240,000

$18,000 U
Variable overhead efficiency variance
 Flexible-Budget Analysis
Actual Actual Quantity
Costs of Inputs at
Incurred Budgeted Rate
21,500 × $11.3849 21,500 × $12.00
= $244,775 = $258,000

$13,225 F
Variable overhead spending variance
 Variable Overhead Variances

Flexible-budget variance
$4,775 U

Efficiency variance Spending variance

$18,000 U $13,225 F
 Efficiency Variance
In the Pasadena Co.’s example, the 21,500 actual
direct manufacturing labor-hours are 7.5% greater
than the flexible-budget amount of 20,000 direct
manufacturing labor-hours.
(21,500 – 20,000) ÷ 20,000 = 7.5%
Actual variable overhead costs of $244,775
are only 2% greater than the flexible-budget
amount of $240,000.
 Efficiency Variance

Because actual variable overhead costs increase

less than labor-hours, the actual variable
overhead cost per labor-hour ($11.3849) is
lower than the budgeted amount ($12.00).
The key cause for Pasadena’s unfavorable
efficiency variance is the higher-than-budgeted
labor-hours used.
 Budgeted
fixed overhead cost rate
 Budgeted Fixed
Overhead Allocation Rates

Step 1:
Choose the time period used to compute the budget.
The budget period is typically twelve months.
Step 2:
Select the cost-allocation base.
Pasadena budgets 26,000 labor-hours for a budgeted
output of 13,000 suits in year 2004.
 Budgeted Fixed
Overhead Allocation Rates

Step 3:
Identify the fixed overhead costs. Pasadena’s fixed
manufacturing budget for 2004 is $286,000.
Step 4:
Compute the rate per unit of each
cost-allocation base. $286,000 ÷ 26,000 = $11
 Budgeted Fixed
Overhead Allocation Rates
What is the budgeted fixed overhead cost rate
per output unit (dress suit)?
2.00 hours allowed per output unit
×
$11 budgeted fixed overhead cost rate per input unit
=
$22 per suit (output unit)
 Flexible-Budget Variance
Flexible Budget:
Actual Costs
Budgeted
Incurred – Fixed Overhead
$300,000
$286,000

$14,000 U
Fixed overhead spending variance
Fixed overhead flexible-budget variance
 Production-Volume Variance
Flexible Budget: Fixed Overhead Allocated Using
Budgeted Budgeted Input Allowed for
Fixed Overhead
– Actual Output Units Produced
$286,000 $220,000

$66,000 U
Production-volume variance
10,000 × 2.00 × $11 = $220,000
 Fixed Overhead Variances

Fixed overhead variance

$80,000 U

Volume variance Spending variance

$66,000 U $14,000 U
 Interpreting the Production-
Volume Variance

Management may Production volume

have maintained some variance focuses
extra capacity. only on costs.

This variance results from “unitizing” fixed costs.

Interpreting the Production-
Volume Variance
Had Pasadena manufactured
13,000 suits instead of 10,000,
allocated fixed overhead
would have been = $286,000
(13,000 × 2.00 × $11).

No production-volume variance
would have occurred.
 the 4-variance
analysis approach reconciles
the actual overhead incurred
with the overhead amounts
allocated during the period.
 Integrated Analysis

A 4-variance analysis presents spending and

efficiency variances for variable overhead
costs and spending and production-volume
variances for fixed overhead costs.
Managers can reconcile the actual overhead
costs with the overhead amounts allocated
during the period.
 Integrated Analysis
Actual variable Flexible budget:
overhead costs budgeted inputs
incurred
– allowed × budgeted rate
$244,775 $240,000

Flexible-budget variance
$4,775 U
Underallocated variable overhead
 Integrated Analysis
Actual variable Actual inputs
overhead costs ×
incurred – budgeted rate
$244,775 $258,000

Variable overhead
spending variance
$13,225 F
 Integrated Analysis
Actual inputs Flexible budget:
× budgeted inputs
budgeted rate – allowed × budgeted rate
$258,000 $240,000

Variable overhead
efficiency variance
$18,000 U
 Integrated Analysis
Actual fixed Budgeted fixed
overhead costs overhead
incurred – costs
$300,000 $286,000

Fixed overhead
spending variance
$14,000 U
 Integrated Analysis
Budgeted fixed Budgeted inputs allowed
overhead ×
costs – budgeted rate
$286,000 $220,000

Volume variance
$66,000 U
 Integrated Analysis
Actual manufacturing overhead incurred:
Variable manufacturing overhead $244,775
Fixed manufacturing overhead 300,000
Total $544,775
Overhead allocated:
Variable manufacturing overhead $240,000
Fixed manufacturing overhead 220,000
Total $460,000
Amount underallocated $ 84,775
 Integrated Analysis

4-Variance Analysis:
Variable manufacturing overhead:
Spending variance $13,225 F
Efficiency variance 18,000 U
Fixed manufacturing overhead:
Spending variance 14,000 U
Volume variance 66,000 U
Total $84,775 U
 Integrated Analysis
3-Variance Analysis
Variable and fixed manufacturing overhead:
Spending variance
$13,225 F + $14,000 U = $ 775 U
Variable manufacturing overhead:
Efficiency variance 18,000 U
Fixed manufacturing overhead:
Volume variance 66,000 U
Total $84,775 U
 Integrated Analysis
2-Variance Analysis
Variable and fixed manufacturing overhead:
Spending variance $ 775 U
Variable manufacturing overhead:
Efficiency variance 18,000 U
Flexible-budget variance: $18,775 U
Fixed manufacturing overhead
Volume variance: 66,000 U
Total $84,775 U
 Journal Entries for Overhead
Costs and Variances

What is the journal entry to record variable

manufacturing overhead?
Variable Manufacturing
Overhead Control 244,775
Accounts Payable 244,775
To record actual variable manufacturing overhead
costs incurred
 Journal Entries for Overhead
Costs and Variances
What is the journal entry to allocate variable
manufacturing overhead?
Work in Process Control 240,000
Variable Manufacturing
Overhead Allocated 240,000
To record variable manufacturing overhead cost
allocated: (2.00 × 10,000 × $12)
What is the journal entry to isolate variances?
 Journal Entries for Overhead
Costs and Variances
Variable Manufacturing
Overhead Allocated 240,000
Variable Overhead
Efficiency Variance 18,000
Variable Manufacturing
Overhead Control 244,775
Variable Overhead
Spending Variance 13,225
To isolate variances for the accounting period
 Journal Entries for Overhead
Costs and Variances

What is the journal entry to record fixed

manufacturing overhead?
Fixed Manufacturing
Overhead Control 300,000
Accumulated
Depreciation, etc. 300,000
To record actual fixed manufacturing
overhead costs incurred
 Journal Entries for Overhead
Costs and Variances
What is the journal entry to allocate fixed
manufacturing overhead?
Work in Process Control 220,000
Fixed Manufacturing
Overhead Allocated 220,000
To record fixed manufacturing overhead cost
allocated: (2.00 × 10,000 × $11)
What is the journal entry to isolate variances?
 Journal Entries for Overhead
Costs and Variances
Fixed Manufacturing
Overhead Allocated 220,000
Fixed Overhead
Spending Variance 14,000
Fixed Overhead
Volume Variance 66,000
Fixed Manufacturing
Overhead Control 300,000
To isolate variances for the accounting period
 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