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Overhead Analysis: Learning Objectives
Overhead Analysis: Learning Objectives
Overhead Analysis
Learning Objectives
The purpose of this chapter is to expand upon the subject of variance analysis for factory
overhead. The chapter describes variable factory overhead in detail and also illustrates
variance analysis for fixed factory overhead. Appendix 7A shows journal entries for a
standard cost system. Studying the chapter will enable you to
1. Analyze the details of variable overhead variances.
2. Apply variable overhead analysis to bases other than direct labor hours.
3. Calculate the variable overhead variances.
4. Describe fixed factory overhead as a standard cost.
5. Describe the fixed factory overhead variances.
6. Calculate the fixed factory overhead variances.
7. Describe how a standard cost system is used.
8. Prepare journal entries using a standard cost system. (Appendix 7A)
.
9 Prepare an income statement on the basis of standard cost. (Appendix 7A)
Chapter Topics
The major topics included in this chapter are
Chapter 6 illustrated the calculation of variable factory overhead variances on a total basis. This
chapter considers the individual items that may comprise variable factory overhead. It also
illustrates the use of bases other than direct labor hours for the application of variable overhead.
Fixed factory overhead presents special problems. Fixed overhead is applied to production as
though it were a variable cost. Of course, it is not a variable cost. This chapter illustrates the
computation of fixed overhead variances and considers the problems in applying fixed factory
overhead as a standard cost.
186 Part Two Managerial Accounting for Planning and Controlling
A standard cost was defined in Chapter 6 as the budget of one unit. A standard cost system is
used to charge standard cost into the manufacturing process. Through the double entry process,
variances are isolated for later analysis. This chapter describes the standard cost system, and
Appendix 7A illustrates its application.
Per
DLH
Supplies $ .30
Power .70
Maintenance .50
Total $1.50
The firm determined the rate for each item by estimating the total amount expected to be spent on
each item and dividing that by the total direct labor hours expected for the year. In this example,
the standard for direct labor is two direct labor hours per unit. In its most recent month, Hadd
Company budgeted production of 25,000 units but produced only 22,000 units. It used 45,000
direct labor hours, incurring a total variable overhead cost of $70,200. The variable overhead
variances are shown in Exhibit 7.1.
Although the company budgeted for 25,000 units, the flexible budget for overhead must be
based on actual production of 22,000 units. Since standard hours allowed is two hours per unit,
the flexible budget for 22,000 units is 44,000 hours. At a standard overhead rate of $1.50 per
hour, the flexible budget for variable overhead is $66,000. Since the total cost was $70,200, the
total variance was $4,200 unfavorable. Using the techniques shown in Chapter 6, the exhibit
illustrates a $1,500 unfavorable efficiency variance and a $2,700 unfavorable spending
variance.
Efficiency Variance
The efficiency variance is calculated as shown in Chapter 6. In short, the flexible budget re¬
quired 44,000 direct labor hours. The company used 45,000 direct labor hours. Therefore, it was
1,000 hours inefficient. At a variable overhead rate of $1.50 per hour, the efficiency variance is
$1,500 unfavorable (1,000 hours x $1.50). As discussed in Chapter 6, overhead in itself is not
inefficient. The overhead rate, in this case, is based on direct labor hours. Since the direct labor
hours exceeded the budget, more overhead costs were incurred than budgeted. In effect, the
inefficiency of direct labor resulted in an unfavorable efficiency variance for variable overhead.
Spending Variance
The spending variance is the difference between the actual cost incurred for variable overhead
items and the cost that should have been incurred, based on the actual number of hours, at the
standard overhead rate. Exhibit 7.1 shows that the company spent $70,200 for various items
included in variable overhead. Based on the fact that actual direct labor hours totaled 45,000, the
company should have incurred a total variable overhead cost of $67,500. (It already is recog¬
nized that $1,500 more was spent than should have been because of inefficiency in direct labor.)
Instead, it spent $70,200, resulting in a $2,700 unfavorable spending variance. At this point,
management needs more detailed information regarding the spending variance of each of the
three overhead items so that it can determine what problems, if any, exist relative to variable
overhead and discuss these problems with the individuals responsible. The accounting system is
designed to accumulate data on each item. A performance report for each is shown in Exhibit
7.2.
The $2,700 unfavorable spending variance is more meaningful when analyzed in relation to
each item. Spending for supplies was $300 less than budgeted for 45,000 hours. However, the
other two items, power and maintenance, exceeded the flexible budget by $1,800 and $1,200,
respectively. The manager responsible should analyze the power and maintenance variances to
determine why they occurred. Perhaps utility rates were increased by the power company after
the overhead rate of $.70 per hour had been calculated. If so, the variance can be explained
simply by the increase in utility rates, and nothing can be done about it. Management should
consider revising the overhead rate for power in that event. On the other hand, a primary reason
for an unfavorable variance in power is that power is being wasted. If the power cost for the
entire factory is being considered, as assumed in this example, determining the responsibility for
wasted power is somewhat difficult. If it is possible to look at power usage by department, then
the supervisor of each department can be held responsible for power usage and should be able to
explain any excess usage. If the reason for the variance is wasted power, management might
want to emphasize the need to conserve energy and institute programs to try to meet its goal of
energy conservation.
The maintenance variance of $1,200 unfavorable should be analyzed to determine why it
occurred. Again, the overhead rate may not be appropriate and may need to be revised. How¬
ever, the variance may have been caused by an excessive number of machine breakdowns. If so,
management should try to find the causes of this problem. Some breakdowns are expected, but a
good maintenance program should preclude excessive breakdowns. If maintenance is not being
conducted on a timely basis, breakdowns may occur more frequently than they should. If so, the
individual responsible needs to explain why regular maintenance is not being conducted.
Supervisors and their superiors, then, can use the individual overhead variances to determine
reasons for their occurrence. This process is one way of controlling overhead costs. For simplic¬
ity, the example used only three items. However, variable overhead consists of a number of
items; and it is necessary to prepare performance reports showing details of each. Only in this
way can overhead costs be controlled on a company-wide basis.
Machine Hours As mentioned above, machine hours are sometimes used as the base when
utilities and maintenance represent a major portion of variable overhead cost. A strong relation¬
ship usually exists between machine hour usage and utilities and maintenance costs.
To illustrate, assume that Valley Company uses machine hours as a base for applying variable
factory overhead. The variable rate is $.40 per machine hour, and it takes .5 machine hour to
finish one unit. In a recent month, the company produced 20,000 finished units. The variable
overhead variances, based on a flexible budget of 20,000 finished units, are shown in Exhibit
Chapter 7 Overhead Analysis
The method of calculation in the exhibit does not differ from that used when direct labor hours
are used as the base. The interpretation also is the same. In this case, the company produced
20,000 units. At a standard rate of .5 hour per unit at $.40 per hour, the company should have
used 10,000 machine hours at a cost of $4,000; but actually it used 9,500 hours. Therefore, there
is a favorable efficiency variance of 500 hours. At $.40 per hour, this results in a favorable
variance of $200. As with direct labor hours, the overhead items themselves are not efficient.
Rather, because it took less time than expected to produce 20,000 units, the amount of overhead
cost at the standard rate was correspondingly less.
The spending variance is $500 unfavorable. Since the company required only 9,500 hours to
produce 20,000 units, it should have spent only $3,800. Instead, it spent $4,300. The possible
reasons for this spending variance are similar to those enumerated in the discussion of direct
labor as the base. The overhead items themselves may have cost more than originally expected.
In addition, there may have been waste in the use of overhead items, such as power. As previ¬
ously described, management can obtain detailed analysis of the spending variance by each item
if necessary.
Units Produced Variable factory overhead may be applied on the basis of units produced.
Under this method, overhead costs are not related to either direct labor hours or machine hours.
That means there is no efficiency variance, only a spending variance.
The procedure for using units produced as the base is illustrated by the example of Madden
Company, which applies overhead at the rate of $.75 per finished unit. In a recent month, the
company budgeted for 10,000 units of production but produced only 8,000 units, incurring
overhead costs of $6,350. As before, a flexible budget for 8,000 units must be prepared. For
overhead, we compute variances as shown in Exhibit 7.4.
Since the company produced 8,000 units, the overhead should have cost $6,000. Instead,
actual overhead cost $6,350, resulting in an unfavorable spending variance of $350. This
amount is also the total variance, since there is no efficiency variance. Remember that in the
previous illustrations, the variable overhead efficiency variances resulted from the fact that more
overhead was required because either direct labor or machine usage was inefficient, that is, more
labor hours or machine hours were used than budgeted. That is not true in this case. Overhead
190 Part Two Managerial Accounting for Planning and Controlling
Actual Units
Actual Cost Incurred x Standard Rate
(ACI) (AU x SR)
8,000 units x $.75 =
$6,350 $6,000
| A
cost is incurred because a unit is produced. Therefore, there is nothing to be efficient or ineffi¬
cient. An efficiency variance for direct labor still may be computed; but under the assumption
used in Exhibit 7.4, it does not affect the amount of overhead required.
$450,000
$3 per DFH
150,000 DLH
Chapter 7 Overhead Analysis 191
In this case, the standard fixed overhead is $3 per direct labor hour. Since two direct labor hours
are required to produce one finished unit (150,000 hours -t- 75,000 units), the standard fixed
overhead per unit is $6. This figure is applicable only if the company produces exactly 75,000
units and if total fixed overhead is $450,000. If more units are produced, fixed overhead cost per
unit decreases. If fewer than 75,000 units are produced, fixed overhead cost per unit increases.
Furthermore, if actual fixed overhead cost is more or less than $450,000, unit cost will differ
from $6.
Nevertheless, for product costing, as well as for control purposes, fixed overhead must be
calculated as a standard cost; and the problems arising when more or less is produced than
budgeted must be considered in the variance analysis. Because of these considerations, the
significance of fixed overhead variances differs from that of variable overhead variances. Man¬
agement must clearly understand their significance in order to make proper decisions regarding
cost control.
.w*
Budgeted Fixed
Actual Cost Incurred Overhead Cost
(ACI) (BFOC)
$455,000 $450,000
▲
Therefore, under variable costing, only a budget variance will exist. On the other hand, under
absorption costing, fixed overhead is applied to production. A volume variance arises when
actual production differs from budgeted production. In that case, the amount of fixed overhead
applied does not equal the amount budgeted.
It is important to understand the nature and reason for the volume variance. For Holley Com¬
pany, expected production was 75,000 units. At two direct labor hours per unit, this production
level would have required 150,000 direct labor hours. With a fixed overhead application rate of
$3 per DLH, budgeted fixed overhead would have been fully absorbed if actual units produced
had been as expected—75,000 units. However, assume only 70,000 units were produced. Stan¬
dard direct labor hours allowed to produce this quantity are 140,000. Consequently, the total
amount of fixed overhead applied to units produced during the period is $420,000. This calcula¬
tion is illustrated in Exhibit 7.6.
Notice that in the exhibit, fixed overhead was applied on 140,000 direct labor hours, resulting
in a total application of $420,000. Budgeted fixed overhead was $450,000. Based on the budget
alone, overhead has been underapplied by $30,000. This difference is the volume variance. The
designation of unfavorable is somewhat misleading. It does not mean that the firm spent $30,000
more than it should have. Overspending or underspending is accounted for with the budget
variance. Rather, it means that $30,000 of budgeted cost was not absorbed into the product. The
unfavorable designation indicates the mathematical difference between the amount budgeted and
the amount applied. It also indicates an underutilization of facilities; that is, planned production
was 75,000 units, but actual production was only 70,000 units.
It is important to understand the use of the term flexible budget in the calculation above.
Remember that fixed overhead, in fact, does not increase or decrease based on changes in
activity. However, fixed overhead is applied on the basis of standard hours allowed for the
flexible budget. In other words, fixed overhead applied is based on direct labor hours allowed for
units produced, and the number of direct labor hours allowed is based on the standard. There¬
fore, the flexible budget enters into the calculation of the volume variance simply because the
overhead application is based on a variable item, direct labor hours, while the total budgeted
fixed overhead does not vary with direct labor hours.
Assume that Holley Company had the budget previously described but actually produced
77,000 units. The fixed overhead volume variance in this instance is calculated as shown in
Exhibit 7.7.
Since the company produced 77,000 units, standard hours allowed total 154,000. That means
fixed overhead was applied to 154,000 hours—at $3 per hour, an application of $462,000. The
budget for fixed overhead is only $450,000. This overapplication results in a favorable volume
variance of $12,000. The favorable designation does not mean that less money was spent than
budgeted. Again, it is a mathematical designation indicating that the amount applied was
$12,000 more than the budget. It also indicates that the use of facilities exceeded expectations—
77,000 units rather than 75,000 units were produced.
Another way to compute the volume variance is to determine the difference in budgeted
activity and activity allowed for the flexible budget and multiply this difference by the fixed
overhead rate. For example, in Exhibit 7.6, the budget was for 150,000 direct labor hours, and
standard hours allowed for the flexible budget totaled 140,000 direct labor hours. The underap¬
plication of 10,000 hours, at $3 per hour, resulted in an unfavorable volume variance of
$30,000. In Exhibit 7.7, the 154,000 hours allowed for the flexible budget exceeded the budg¬
eted activity of 150,000 hours by 4,000 hours. At $3 per direct labor hour, this difference
represents a volume variance that is $12,000 favorable. Again, the variance is favorable because
the amount applied exceeds the amount of the budget.
costs were incurred. Excess costs incurred over the budgeted amount are represented by
the $5,000 unfavorable budget variance. The additional $30,000 unfavorable variance is the
volume variance, which is due strictly to the difference between the budgeted cost and the
applied cost.
Thus, the underapplied overhead of $35,000 results from two factors: (1) the company did not
produce as many units as it expected, and (2) the company spent more than it budgeted. For cost
control purposes, only the budget variance is significant. The volume variance is related more to
production and marketing control. Management is interested in knowing why less was produced
than budgeted, as well as the effect of this underproduction on profit, but these matters are not
relevant to underspending or overspending on the amount produced. Exhibit 7.9 helps summa¬
rize the discussion of fixed overhead.
The firm expected to incur $450,000 of fixed overhead costs and to produce 75,000 units; so
these amounts served as the basis for determining the fixed factory overhead rate. Because the
production estimate of 75,000 units turned out to be 5,000 units greater than the 70 000 units
actually produced, only $420,000 of the $450,000 budget was applied, thus resulting in a
$30,000 unfavorable volume variance.
Regardless of production and budgeted costs, the fact is that $455,000 of fixed factory over¬
head costs were actually incurred. This represents a $5,000 unfavorable budget variance because
it exceeded the amount budgeted. Since only $420,000 was applied, the total variance of
$35,000 unfavorable represents the amount of underapplied fixed factory overhead.
It should also be pointed out that if the firm were using variable costing, there would be
no volume variance. The entire $455,000 would be shown on the income statement as a period
cost. Since this exceeds the budget of $450,000, there still is a $5,000 unfavorable budget
variance. But the third bar in Exhibit 7.9 would not appear under variable costing because
fixed factory overhead is not a product cost under variable costing and therefore is not applied
to production.
Chapter 7 Overhead Analysis
$445,000 $5,000 U
Budget Variance j
$450,000 $30,000 U
Volume Variance |
$420,000
one unit. Through the use of variance analysis, management can determine deviations from the
standard. Significant variances indicate the possibility that problems exist.
The standard cost system does have some difficulty with fixed overhead analysis. However,
as long as management understands the nature of the fixed overhead variances, it should have no
problems in using a standard cost for fixed overhead. Thus, management can arrive at a single
unit cost figure that should be incurred in the production process. If actual costs are different
from this expected amount, adjustments may be needed.
Another advantage of the standard cost system is that it makes inventory calculations easier. It
is not necessary to use FIFO, LIFO, or weighted-average inventory systems; rather all units are
inventoried at standard cost. A single figure therefore can be used. At the end of the accounting
period, it is necessary only to count the number of physical units and multiply by the standard
cost per unit. Differences between standard and actual cost are accounted for as variances, as
described previously.
The standard cost system can be included as a part of the double entry system. In this case, the
variances are isolated in separate accounts. An illustration applying the standard cost system to
the double entry process is provided in Appendix 7A.
Summary
A meaningful analysis of variable overhead variances requires that the total overhead
cost be detailed according to individual items. Only in this way can management deter¬
mine which overhead costs are under control and which need more attention.
The variable overhead efficiency variance can be based on direct labor hours; direct
labor dollars, or direct labor cost; or machine hours. This variance is a direct result of
efficiency or inefficiency in direct labor or use of machinery. When units are used as a
base for applying variable overhead, there is no variable overhead efficiency variance.
The variable overhead spending variance is the result of the firm’s having spent more
or less on overhead items than allowed on the basis of actual units of input, such as
direct labor hours. Management is interested in a detailed analysis of the spending vari¬
ance so that it can uncover those specific items that may be problem areas.
Under absorption costing, the fixed overhead total variance consists of a budget vari¬
ance and a volume variance. The total variance represents the difference between fixed
overhead budgeted and fixed overhead applied. An unfavorable volume variance does
not represent an incurrence of cost greater than should have been, nor does a favorable
volume variance represent a reduction in cost. Rather, the volume variance represents
the difference between the amount budgeted and the amount of cost charged (through
the application process) to Work-in-Process Inventory.
A standard cost system is a means for charging production with standard costs. Work-
in-Process Inventory is charged for the standard cost of direct materials and direct labor.
In addition, the variable and fixed overhead application rates are used to determine the
overhead charge to Work-in-Process Inventory. The rates are multiplied by the standard
hours allowed for the flexible budget. Any variances from standard for materials, labor,
or overhead are isolated. Appendix 7A illustrates the procedures for using a standard
cost system, including the recording of variances in separate accounts.
Chapter 7 Overhead Analysis 197
The chapter described a standard cost system. This appendix illustrates the record-keeping proc¬
ess by which manufacturing costs are charged to production at standard. Any differences from
standard cost are recorded in variance accounts. Unfavorable variances are recorded as debits
and favorable variances as credits. The illustration uses Wiggins Company, whose standard
costs are as follows:
Unit Cost
The fixed factory overhead rate of $2 per hour is based on the company’s estimate of $50,000 of
total fixed factory overhead and 25,000 direct labor hours ($50,000 4- 25,000 DLH = $2 per
DLH). To illustrate the system, this appendix presents a series of summary entries for the year,
along with explanations. Although the company’s master budget had predicted sales of 50,000
units, the company produced and sold only 46,000 units.
Entry 1: Purchase of Raw Materials The company purchased 110,000 pounds of raw materials
at $.63 per pound. The entry is
Notice that Raw Materials Inventory is debited for $66,000, the total standard cost of material
purchased (110,000 pounds x $.60). The materials price variance of $3,300 is shown as a
debit. In effect, the actual cost of $69,300 exceeded the standard cost of $66,000 by $3,300. The
debit to Materials Price Variance reflects this increase in cost. The credit of $69,300 to Accounts
Payable represents the actual cost of the amount purchased and therefore the amount owed
(110,000 pounds x $.63).
Entry 2: Use of Direct Materials In producing 46,000 finished units, the company actually
used 91,500 pounds of direct materials. The standard quantity allowed for the flexible budget is
92,000 pounds (46,000 units x 2 pounds per unit). The entry is
Work-in-Process Inventory 55,200
Materials Usage Variance 300
Raw Materials Inventory 54,900
198 Part Two Managerial Accounting for Planning and Controlling
The debit to Work-in-Process Inventory is for $55,200, the standard cost of the standard quantity
allowed for 46,000 units (92,000 pounds x $.60). The credit to Materials Usage Variance
represents a reduction in cost because the amount used was less than required by standard. The
credit to Raw Materials Inventory represents the standard cost of the actual pounds of raw
materials taken from the inventory (91,500 pounds X $.60 per pound).
Entry 3: Incurrence of Direct Labor Costs The company used 23,500 direct labor hours, at a
cost of $165,000, in producing 46,000 finished units. The entry is
Labor Efficiency
23,500 Actual Hours
23,000 Standard Hours Allowed
500 Hours over Standard Hours Allowed
x$7 Standard Rate per Hour
$3,500 U
Labor Rate
$165,000 Actual Cost Incurred
164,500 Actual Hours X Standard Rate (23,500 X $7)
$ 500 U
Work-in-Process Inventory is debited for the standard cost of direct labor based on the standard
hours allowed for 46,000 units — 23,000 hours (.5 hour per unit X 46,000 units). At a standard
cost of $7 per hour, the debit totals $161,000 (23,000 hours x $7 per hour). The amount actu¬
ally paid to workers is shown as a credit for $165,000 to Accrued Payroll. In this case, both labor
variances are unfavorable, so they are shown as debits. In effect, this increases the direct labor
cost over the amount recorded at standard. If either of the labor variances had been favorable, it
would be shown as a credit in the entry.
Entry 4: Application of Variable Overhead The variable factory overhead application rate is
$.80 per hour. Under a standard cost system, variable factory overhead is charged to Work-in-
Process Inventory on the basis of the standard hours allowed for the flexible budget. As de¬
scribed above, 23,000 standard direct labor hours are allowed for 46,000 units. The entry is
Work-in-Process Inventory is debited for $18,400, the standard cost of variable factory overhead
(23,000 DLH x $.80 per hour). The credit to Variable Factory Overhead is for the same
amount.
Entry 5: Incurrence of Variable Overhead During the year, the company incurred the follow¬
ing variable factory overhead costs: indirect materials, $4,000; utilities, $3,150; and indirect
labor, $11,500. The entry is
The debit to Variable Factory Overhead for $18,650 is for the actual costs incurred. The credits
represent the individual cost items.
Entries 4 and 5 represent the typical entries for applying and incurring variable overhead
costs. After making Entries 4 and 5, you can compute the total underapplied or overapplied
variable overhead as follows:
The $250 underapplied overhead represents the total variable overhead variance and is $250
unfavorable. Under a standard cost system, we want to determine the specific elements of the
underapplication and record the appropriate variances. That is done in the next entry.
Overhead Efficiency
23,500 Actual Hours
23,000 Standard Hours Allowed
500 Hours over Standard Hours Allowed
X $. 80 Standard Rate per Hour
$400 U
Spending
$18,650 Actual Cost Incurred
18,800 Actual Hours X Standard Rate (23,500 Hours X $.80)
$ 150 F
200 Part Two Managerial Accounting for Planning and Controlling
If a standard cost system were not used, the difference between variable factory overhead ap¬
plied and variable factory overhead incurred would be adjusted directly to Cost of Goods Sold,
as was done in Chapter 3. Here, however, we calculate the overhead efficiency variance and the
overhead spending variance separately and record them. The overhead efficiency variance is
unfavorable—overhead costs were increased because of this variance. It is reflected as a debit.
The variable overhead spending variance is favorable; so it represents a reduction in overhead
costs and is recorded as a credit. In a later entry, these variances will be closed to Cost of Goods
Sold.
Entry 7: Application of Fixed Overhead Fixed factory overhead is applied at the rate of $2 per
direct labor hour. Since we are using a standard cost system, fixed overhead is applied on the
basis of standard hours allowed for the flexible budget. This was shown earlier as 23,000 direct
labor hours. The entry is
The debit to Work-in-Process Inventory is $46,000 (23,000 hours x $2 per hour). This entry is
the typical one for applying fixed factory overhead, whether or not a standard cost system is
being used.
Entry 8: Incurrence of Fixed Overhead The company incurred fixed factory overhead costs as
follows: depreciation on plant and equipment, $12,000, and managers’ salaries, $40,000. The
entry is
This is a typical entry for recording the actual fixed overhead costs incurred.
At this point, the amount of fixed overhead costs underapplied or overapplied can be deter¬
mined as follows:
Under a standard cost system, the $6,000 underapplied fixed factory overhead represents the
total fixed factory overhead variance of $6,000 unfavorable.
Entry 9: Recognition of Fixed Overhead Variances Based on the data given, the volume
variance and budget variance can be calculated and recorded. The entry is
Volume
$50,000 Budgeted Fixed Overhead Cost
46,000 Applied
$ 4,000 U
Budget
$52,000 Actual Cost Incurred
50,000 Budgeted Fixed Overhead Cost
$ 2,000 U
If a standard cost system had not been used, the difference between fixed overhead applied and
fixed overhead incurred would have been shown as a debit to Cost of Goods Sold. Under a
standard cost system, however, we wish to know the components of the total underapplication.
They are calculated above as a $4,000 volume variance and a $2,000 budget variance. These
amounts are recorded as debits, because they represent increases in total cost over the amount
applied. They will be closed to Cost of Goods Sold in a later entry.
Entry 10: Transfer of Completed Units As mentioned previously, the company sold 46,000
units. The entry to transfer the cost of units completed from Work-in-Process Inventory to
Finished Goods Inventory is
All the manufacturing costs charged to Work-in-Process Inventory have been at standard. There¬
fore, the cost of finished goods transferred out of Work-in-Process Inventory also must be at
standard. The standard cost per finished unit is $6.10. The total cost of goods transferred from
Work-in-Process Inventory is $280,600 (46,000 units X $6.10 per unit).
Entry 11: Sale of Product The selling price per unit is $10. Entry 11 records the sale of 46,000
finished goods for $460,000. An entry also is needed to record cost of goods sold. The entries
are
Cost of Goods Sold is debited for $280,600, the standard cost of finished goods that have been
sold (46,000 units x $6.10 per unit); and Finished Goods Inventory is credited for the same
amount. Accounts Receivable is debited for $460,000, and Sales is credited. Instead of two
separate entries, the data above could be recorded in one compound entry.
Entry 12: Closing Out of Variances The variances from standard may be either allocated to
appropriate accounts or adjusted to Cost of Goods Sold. Unless the amount is significant and
would distort the financial statements, the usual procedure is to adjust the variances to Cost of
Goods Sold. In effect, the variance accounts are closed out. Therefore, variances with debit
202 Part Two Managerial Accounting for Planning and Controlling
Wiggins Company
Income Statement
for the Year Ended December 31, 19X6
Sales. $460,000
Variable Costs:
Cost of Goods Sold (at Variable Standard Cost) $234,600*
Add: Net Unfavorable Variable Cost Variances 7,250t
Cost of Goods Sold. $241,850
Selling and Administrative Expenses . . . 69,000
Total Variable Costs. 310,850
Contribution Margin. $149,150
Fixed Costs:
Factory Overhead (at Standard) . $ 46,000
Add: Net Unfavorable Fixed Overhead Variances 6,000$
Total Factory Overhead . $ 52,000
Selling and Administrative Expenses . . . 80,000
Total Fixed Costs. 132,000
balances are credited for their balances, and variances with credit balances are debited for their
balances. The entry is
There were only two favorable variances—materials usage and variable overhead spending.
They totaled $450. The unfavorable variances totaled $13,700. Therefore, Cost of Goods Sold is
debited (increased) by the net unfavorable variance of $13,250 ($13,700 - $450).
For external reporting purposes, variances are not shown on the income statement. The net
variance is adjusted to Cost of Goods Sold. Therefore, cost of goods sold on the income state¬
ment reflects the total cost of goods sold, including any adjustment for variances. Internally,
management prepares income statements using the contribution margin approach and variable
costing. On these internal statements, the net variance is shown so that management can see the
total effect of deviations from the standard. The individual variance calculations are reflected in
performance reports. For Wiggins Company, a contribution approach income statement for the
year ended 19X6 is shown as Exhibit 7.10.
Notice that variable cost of goods sold has been increased by the net unfavorable variable cost
variances of $7,250. Fixed costs have been increased by the net unfavorable fixed overhead of
$6,000. Thus, the income statement reflects the actual costs incurred by the company and indi¬
cates to management how these actual costs differed from the standard.
Another interesting point is that the company has used absorption costing for recording its
costs and therefore has the appropriate information to prepare the income statement on an ab¬
sorption costing basis for external purposes. Yet, the accounting system also has provided data
so that an income statement using a variable costing basis can be easily prepared. This point
illustrates that no conflict need be involved in using absorption costing for external purposes and
variable costing for internal purposes.
Review Problem
Travis Manufacturing Company budgeted production of 40,000 units for June. Actual produc¬
tion totaled 42,000 units and required 21,350 direct labor hours. The standard allowed is .5
hour per finished unit. Fixed factory overhead was budgeted at $50,000. Overhead application
rates per direct labor hour were $2.50 fixed and $.90 variable. Actual overhead costs incurred
were $51,500 fixed and $19,300 variable.
Required:
Calculate the following variances:
a. Efficiency, spending, and total variable overhead variances.
b. Budget, volume, and total fixed overhead variances.
Solution:
a.
ACI AH x SR SHA x SR
(f hr. x 42,000 units) x $.90 =
21,350 hr. x $.90 = 21,000 hr. x $.90 =
$19,300 $19,215 $18,900
A A A
Key Terms
Questions
7-2 A portion of a departmental performance report for variable overhead prepared on a flex¬
ible budget basis is shown below:
Budget Actual Variance
The supervisor was heard to say, “Everything else was within 1 or 2 percent of budget, and
the maintenance and utilities variances offset each other. So there’s no problem.’’ Do you
agree with that statement? Explain.
7-3 Name four bases that can be used for applying variable factory overhead.
7-4 In a highly automated manufacturing company, what is probably the most appropriate
base to use in applying variable overhead? Why?
7-5 Since an unfavorable materials usage variance indicates possible waste in the use of di¬
rect materials, and since an unfavorable labor efficiency variance indicates possible waste in
the use of direct labor, why doesn’t an unfavorable variable overhead efficiency variance indi¬
cate possible waste in the use of overhead items? Where is such waste indicated? Explain.
7-6 Explain why there is no variable overhead efficiency variance when units are used as the
basis for applying variable overhead.
Chapter 7 Overhead Analysis 205
7-8 Which fixed overhead variance reflects the fact that more was spent on fixed overhead
items than was planned?
7-9 Upon looking at a performance report that showed a $40,000 unfavorable fixed overhead
volume variance, a manufacturing division supervisor was heard to say, “This is outrageous!
This overspending has got to stop!” Comment.
7-10 Why is there no fixed overhead volume variance when variable costing is used?
7-11 If a firm consistently has a significant unfavorable fixed overhead volume variance,
would it be appropriate to increase the fixed overhead application rate? Explain.
7-12 How does a standard cost system differ from an actual/normal cost system? How are
they similar?
7-13 How does a standard cost system make the journal entry process for cost accounting
easier?
7-14 How does a standard cost system help in taking a physical inventory?
Exercises
7-15 Variable Overhead Variance Clark Company developed the following variable over¬
head budget for expected production requiring 30,000 direct labor hours:
Standard hours allowed for actual production were 38,000 direct labor hours. Actual costs
were indirect materials, $18,000; indirect labor, $20,500; and utilities, $8,000. Determine the
variable overhead variances, based on the flexible budget.
Supplies $ .85
Indirect Labor 1.00
Power .40
Total $2.25
The standard direct labor efficiency standard is 1.5 hours per tent. In March, the company
produced 10,000 tents using 16,000 direct labor hours. Actual variable overhead costs were
supplies, $14,000; indirect labor, $15,850; and power, $5,800.
a. Calculate the spending variance, efficiency variance, and total variable overhead vari¬
ance.
b. Prepare a performance report that shows the spending variance for each overhead item.
7-17 Variable Overhead Variances Tamber Manufacturing Company applies variable fac¬
tory overhead at the rate of $3.50 per machine hour. Last month, production required 3,450