Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
CHAPTER 15: OPERATIONAL PERFORMANCE MEASUREMENT:
INDIRECT-COST VARIANCES AND RESOURCE-CAPACITY
MANAGEMENT
QUESTIONS
15-1 The total factory overhead can be the same as the standard amount allowed for the
current period’s output while one or more of the components of the total factory
overhead have significant variances. For example, a firm can have a substantial
unfavorable factory overhead flexible-budget variance and an approximately equal
flexible-budget variances.
15-2 This question pertains to text Exhibits 15.1 and 15.3. As indicated in Exhibit 15.1, the
amount of variable overhead applied to production for a period (product-costing
purpose) is exactly equal to the amount of variable overhead in the flexible budget
overhead in the control budget for the period.
15-3 Possible contributing factors to a variable overhead spending variance include:
15-4 Because an alternative activity measure usually is used as the basis for applying
manufacturing overhead to production, a variable overhead efficiency variance can be
a result of efficiencies or inefficiencies regarding the use of this activity measure. For
example, a favorable overhead efficiency variance for a firm that uses machine hours
to apply overhead can be a result of the firm’s use of fewer machine hours than the
15-5 A fixed overhead spending variance is defined as the difference between the actual
fixed overhead and budgeted fixed overhead cost for the period. A fixed overhead
spending variance can be a result of unanticipated changes in spending, for example:
A factory manager was given a bonus or raise that was not in the original
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Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
budget.
New machinery and equipment, with attendant depreciation charges, was
prepared, were added during the period.
15-6 A production volume variance results when actual output differs from the output level
assumed when the fixed overhead application rate was developed. Among reasons for
this discrepancy are:
Unexpected stoppage or slowdown of operations because of unscheduled
equipment maintenance, strike, or workers’ slow-down.
likely be smaller—in the extreme, it would be zero).
15-7 Even though the denominator level a firm selected determined the fixed overhead
application rate, the selected denominator level has no effect on either the amount or
the direction of the fixed overhead flexible-budget variance for the operation. The fixed
overhead flexible-budget variance for a period is the difference between the actual
fixed overhead cost and the budgeted fixed overhead cost for the period. Neither of
these amounts is affected by the fixed overhead application rate for the period; both
can be thought of as being “lump-sum” amounts.
The production volume variance of a period is the difference between the budgeted
fixed overhead (“lump-sum” amount) and the total fixed overhead applied to
15-8 The “denominator activity level” refers to the size of the denominator when
determining the standard fixed overhead application rate for product-costing purposes.
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Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
Various options for the volume of the denominator are possible, including budgeted
volume, practical capacity, and theoretical capacity. Most writers today recommend
the use of practical capacity for at least two reasons:
Logical consistency between the numerator and denominator in the
(i.e., overhead items).
15-9 Among reasons that a firm may use a 2-variance instead of 3-variance or 4-variance
analysis of overhead variances are:
Information provided by the simpler 2-variance analysis is thought to meet the
needs of management, that is, the information is thought to be “good enough.”
However, as indicated in Exhibit 15.3, the amount of fixed overhead in the flexible
budget is likely to be different from the amount of fixed overhead assigned to
production for the period. The flexible budget for fixed overhead includes a “lump-sum”
amount (control purpose) while the amount of fixed overhead applied to production is
equal to the product of a predetermined (i.e., standard) fixed overhead allocation rate
and the standard allowed activity units for the production in the period. The difference
15-10 If a standard cost system is used, variances related to overhead costs can be
recorded formally in the accounting records. Such variances, however, are considered
“temporary accounts,” which at the end of the year must be closed out. There are two
primary methods for doing this at the end of the year:
(1) Closing the net variance to cost of goods sold (for example, if the net overhead
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Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
use. Two, one can argue that the incremental information that results from the
period under the proration method would go to the CGS account anyway.
Similarly, any fixed overhead spending variance should, in theory, be partially
allocated to the production volume variance for the period. The proration
method is required in some contexts (e.g., any government contract work for
which the contractor must comply with the standards set by the Cost
Accounting Standards Board [CASB]). Others would defend this approach
because the resulting data approximate actual-cost results.
One variation of the allocation method is to use the total end-of-period dollar
balance (not standard costs from this period) in relevant accounts to determine
allocation percentages. This method is simpler to implement, but would result in a
different end-of-year allocation of the net manufacturing cost variance for the year
compared to the conceptually correct method noted above.
We note here that both financial reporting and income tax considerations are
associated with the end-of-period variance disposition question:
(1) For external reporting purposes, accountants need to follow the provisions of
generally accepted accounting principles (FASB ASC 330-10-30-6 and -7,
www.fasb.org, which specify that abnormal amounts of idle facility expense should
be recognized as current-period charges and not capitalized as part of inventory
cost. One implication of this reporting requirement is that the amount of fixed
overhead allocated to each unit of production is not increased as a consequence of
abnormally low production or an idle plant.
Regulation § 1.471-11: Inventories of Manufacturers.
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Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-11 For external reporting purposes, accountants need to follow the provisions of generally
accepted accounting principles (FASB ASC 330-10-30 -6 and -7, previously,
Statement of Financial Standards No. 151:Inventory Costs—An Amendment of ARB
No. 43, Chapter 4, available at www.fasb.org) regarding the setting of overhead
15-12 Factors that need be considered include:
Magnitude of the variance
15-13 Any significant variance, be it favorable or unfavorable, should be investigated. It
might be argued that significant favorable variances should not be investigated since
such variances serve to increase operating income for the period. Nonetheless, an
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Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
BRIEF EXERCISES
15-14 The budgeted supervisory salary per month is:
$360,000 ÷ 12 months = $30,000 per month
15-15 Standard indirect labor cost per unit:
= $144,000/year ÷ (5,000 units/month × 12 months/year)
= $144,000/year ÷ 60,000 units/year
= $2.40/unit
15-16 Fixed overhead variances for the year:
(a) Spending (Budget) Variance for Fixed Overhead
(b) Production Volume Variance = Budgeted fixed overhead – Applied fixed
overhead
or, = (denominator output volume – actual units produced) × fixed overhead
rate/unit produced
That is, fixed overhead was underapplied by $50,000 during the period.
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Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-17 Variable overhead variances for the year:
(a) Spending variance = Actual variable overhead − Flexible budget based on
Inputs
= ($3.90/unit × 20,000 units) − (41,000 hours. × $2.00/hr.)
(b) Efficiency variance = Flexible-budget based on Inputs– Flexible budget based
on output
= $82,000 − (20,000 units × 2 hrs./unit × $2.00/hr.)
= $82,000 − $80,000
15-18 Summary journal entries for the year:
Actual Overhead Costs:
Dr. Factory (or, Manufacturing) Overhead 323,000
Cr. Accumulated Depreciation—Factory 150,000
Overhead Costs Applied to Production:
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-19 To Record Factory Overhead Variances:
Dr. Production Volume Variance 50,000
Dr. Variable Overhead Efficiency Variance 2,000
Cr. Variable Overhead Spending Variance 4,000
Cr. Fixed Overhead Spending Variance 5,000
Cr. Factory (or, Manufacturing) Overhead 43,000
To Close the Net Overhead Variance to CGS at Year-End:
Dr. Cost of Goods Sold 43,000
Cr. Variable Overhead Efficiency Variance 2,000
15-20 To Allocate the Net Factory Overhead Variance at Year-End:
Dr. WIP Inventory (10% of $43,000) 4,300
Dr. Finished Goods Inventory (20% of $43,000) 8,600
15-21 Factory Overhead Variance—Two-Variance Decomposition:
(a) Total Overhead Variance = actual overhead − overhead applied to production
(b) Total Flexible-Budget Variance = Actual overhead – Flexible-budget for
or, = Variable overhead flexible-budget variance + fixed
overhead flexible-budget variance
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Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-21 (Continued)
(c) Production Volume variance = budgeted fixed overhead − applied fixed
overhead
year)
15-22 Summary Journal Entries:
(a) Actual Overhead Costs:
Dr. Factory (or, Manufacturing) Overhead 323,000
Overhead Costs Applied to Production:
Dr. WIP Inventory (20,000 units × 2 hrs./unit × $7.00/hr.) 280,000
(b) To Record Overhead Variances Using a Two-Variance Approach:
Dr. Production Volume Variance 50,000
15-23 End-of-Year Journal Entry to Close Out Variance Accounts:
(a) Net Variance Closed to CGS:
Dr. CGS 43,000
(b) Net Variance Allocated to Ending Inventories and CGS:
Dr. WIP Inventory (10% × $43,000) 4,300
Dr. Finished Goods Inventory (20% × $43,000) 8,600
Dr. CGS (70% × $43,000) 30,100
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EXERCISES
15-24 Flexible Overhead Budgets for Control; Spreadsheet Application (40–45 minutes)
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