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Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-16
15-30 Performance Reporting: the Use of Standard Cost Variance Information (30
minutes)
Among recommended improvements to the cost-variance report currently used by Zobel
Manufacturing Company to evaluate subunit performance are the following:
(1) The reports should emphasize that the terms “favorable” and “unfavorable” should
not automatically be interpreted, without further consideration, as “good
performance” and “bad performance”. These labels simply reflect the impact of the
calculated amount on the operating profit of the current period. Thus, a “favorable”
the performance indicators, providing excessive “slack” in determining standard
costs for manufacturing operations).
(3) Short-term financial performance (measured, for example, by the type of cost-
variance report used by the ABC Manufacturing Company), while important, is not
inclusive enough to achieve operational control. As such, the performance report
might be made more “balanced” by including one or more non-financial
performance indicators, such as quality indicators, on-time delivery, or
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-30 (Continued)
(5) Related to (4) above, the current profit-variance report does not admit to shared
responsibility. For example, excessive consumption of direct materials could be
traceable to poor quality materials purchased by the purchasing manager. As such,
at least a portion of some of the other manufacturing cost variances would be
attributable to the purchasing, not the manufacturing, function.
(6) Of significant concern is the need to incorporate flexible budgets into the cost-
variance report. Currently, there is no way to evaluate efficiency (consumption of
particularly since they are likely the responsibility of different individuals in the
organization.
(8) It is not clear from the sample report, but it may be the case that ABC Company
uses a single activity measure (e.g., machine hours) as the basis for applying
overhead costs to products (product-costing purpose) and for developing the
flexible-budget for control purposes. To the extent that the chosen measure (or
measures) does (do) not accurately predict changes in manufacturing support
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-18
15-31 Variable Factory Overhead Variances; Journal Entries (30 minutes)
1. Standard variable overhead rate per direct labor hour (DLH):
= Budgeted Total Variable Overhead ÷ Budgeted Total Direct Labor Hours
= $15,000 ÷ 2,500 hours = $6.00 per direct labor hour (DLH)
Standard direct-labor hours (DLH) per unit:
Variable Overhead Variance Analysis
FB Based on FB Based on
Actual Cost Inputs Output
(AQ × AP) (AQ × SP) (SQ x SP)
2,700 hrs. × $5.7777/hr. 2,700 × $6.00/hr. (4,800 × 0.5) × $6.00/hr.
= $15,600 = $16,200 = $14,400
Spending variance Efficiency variance
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-19
15-31 (Continued)
2. To Record Favorable Variable Overhead Spending Variance:
Dr. Factory Overhead (or, Variable Factory
Overhead) 600
3. The factory had a favorable variable overhead spending variance. This could be a
result of conscientious efforts of workers and the manager of the factory in
conserving uses of variable factory items. Alternatively, it could have been due, at
least in part, to the use of an inappropriate activity measure (direct labor hours) for
assigning variable factory overhead costs.
The $1,800 unfavorable variable overhead efficiency variance is a result of using
more direct labor hours (DLHs) to manufacture the output of the period (2,700 hours
the consumption of variable factory overhead cost.
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-20
15-32 Fixed Overhead Variances; Journal Entries (30 minutes)
1. Standard fixed factory overhead application rate per direct labor hour (DLH):
= Budgeted Fixed Factory Overhead ÷ Total Direct Labor Hours, Practical
Capacity
Standard direct-labor hours (DLH) per unit:
= Budgeted Total Direct Labor Hours ÷ Practical Capacity Units
Fixed Overhead Variance Analysis
Applied
Actual Cost Budget (SQ × SP)
4,800 units× 0.5 hrs. ×$36/hr.
$92,000 $90,000 = $86,400
Spending variance Production volume variance
2. Fixed factory overhead (FOH) flexible-budget variance
= FOH spending variance = $2,000U
3. To Record Unfavorable Fixed Overhead Spending Variance:
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-32 (Continued)
To Record Unfavorable Production Volume Variance:
4. The $2,000 unfavorable fixed factory overhead spending variance could be a result
of unexpected fluctuations, overspending, or budgeting errors in one or more fixed
overhead items. However, since the amount is small (2.22% of the budget amount),
it is unlikely that the management needs to spend any time or resources to
investigate this variance.
the text, this variance generally has shared responsibility (with marketing,
purchasing, etc.).
Note that when the denominator activity level is set at practical capacity, then
resulting production volume variances can be interpreted as the cost of unused
capacity. The disclosure of this information over time can help managers make
better decisions regarding capacity-related spending.
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-22
15-33 Three-Variance Factory Overhead Analysis (30-40 minutes)
1. Standard variable factory overhead rate per direct labor hour (DLH):
= Budgeted Total Variable Factory Overhead ÷ Budgeted Total Direct Labor
Hours
Standard fixed factory overhead rate per DLH:
= Budgeted Total Fixed Factory Overhead ÷ Practical Capacity Labor Hours
= Practical Capacity Labor Hours ÷ Practical Capacity, in Units = 0.5 DLH/unit
Three-Variance Overhead Analysis
Flexible Budget Flexible Budget
Based on Inputs Based on Output Applied
Actual Cost AQ × SP (SQ × SP) (SQ × SP)
$ 15,600 2,700 × $6 = $ 16,200 2,400 × $6 = $14,400
+ 92,000 + 90,000 + 90,000 2,400 × $42
$107,600 $106,200 $104,400 = $100,800
15-23
15-33 (Continued)
2.Total overhead spending variance = variable overhead spending variance + fixed
overhead spending variance
= $600F + $2,000U = $1,400U
Total overhead efficiency variance = variable overhead efficiency variance
In sum, the only difference between the three-way and four-way analysis is that in
the former, the spending variances for fixed and for variable overhead (reported in
the latter) are combined into a single overhead spending variance.
Three- and Four-Variance Factory Overhead Analysis: Summary
Overhead Spending Variance:
Variable Overhead Spending Variance $ 600F
Fixed Overhead Spending Variance 2,000U $1,400U
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-24
15-34 Two-Variance Analysis of the Total Overhead Variance (30 minutes)
1. Standard variable factory overhead rate per direct labor hour (DLH) $ 6.00
Standard fixed factory overhead rate per DLH 36.00
Standard factory overhead rate per DLH $42.00
Standard DLHs per unit = 0.5 DLH
Two-Variance Overhead Analysis
Flexible Budget Based Overhead
Actual Cost on Output Applied
$ 15,600 2,400 × $6 = $14,400
2. Total Controllable (Flexible) Budget Variance for Overhead:
a) Variable Overhead Spending Variance $ 600F
b) Variable Overhead Efficiency Variance $1,800U
c) Fixed Overhead Spending Variance $2,000U $3,200U
Production Volume Variance 3,600U
component is the same in the two-variance, the three-variance, and the four-
variance breakdown of the total overhead variance.
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-34 (Continued)
3. The two-variance breakdown of the total overhead variance reports two important
factors concerning overhead costs. The flexible-budget (controllable) variance
measures the difference between the actual overhead incurred and the overhead
that should have been incurred based on the actual output of the period. (This latter
The production volume variance, when the fixed overhead application rate is based
on practical capacity, reports the effectiveness of the organization in using available
capacity. Over time, this variance can signal to managers the existence of excess
capacity or the need for capacity expansion. In short, this variance helps managers
control capacity-related resource spending.
15-35 Factory Overhead Variances; Spreadsheet Application (40-45 minutes)
Standard MH per unit: 10,000 MH 5,000 units = 2 MH per unit
1 & 2: Variable factory overhead variances
Flexible Budget Based Flexible Budget Based
on Inputs (i.e., actual on Output (i.e., standard
Actual machine hours) allowed machine hours)
$32,500 9,800 × $3 = $29,400 (4,700 × 2) × $3 = $28,200
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-26
15-35 (Continued-1)
3 & 4: Fixed overhead variances:
Budgeted fixed overhead (given) $21,000
Denominator volume (machine hours) 10,000
Standard fixed overhead rate per machine hour $2.10
Actual Budget Standard Applied
$21,400 $21,000 (4,700 × 2) × $2.10 = $19,740
5. Variable overhead spending variance (1, above) = $3,100U
Fixed overhead spending variance (3, above) = 400U
6. Total overhead spending variance (5, above) = $3,500U
Variable overhead efficiency variance (2, above) = 1,200U
Note: An Excel spreadsheet solution file for this assignment is embedded below. You
can open this “object” by doing the following:
1. Right click anywhere in the worksheet area below.
2. Select “worksheet object” and then select “Open.”
3. To return to the Word document, select “File” and then “Close and return
to...” while you are in the spreadsheet mode. The screen should then
return you to this Word document.
Ex. 15-3
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-27
15-36 Overhead at Two Activity Levels, and 4-Way versus 2-Way Analysis of the
Total Overhead Variance (60 minutes)
1. Budgeted fixed overhead:
Total standard overhead at 85% level of theoretical capacity
= 21,250 machine hours (MH) × $14.00/MH = $297,500
2. Standard overhead application rates, 2013:
Variable factory overhead rate per machine hour (MH), 2013 = budgeted variable
overhead, 2012 standard direct machine hours allowed for output achieved, 2012
=
$61,250 21,250 MH = $2.8824/MH (rounded to four decimal places)
3. Factory overhead flexible budget for 2013:
Flexible budget for variable factory overhead, based on output in 2013
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-36 (Continued-1)
4. Variable Factory Overhead Variances, 2013:
Actual variable factory overhead incurred = Total standard variable factory overhead
for the units manufactured +/– Total variable overhead variance:
Total standard variable factory overhead (see 3 above) = $63,412
Total variable overhead variance:
FB based on Inputs FB based on Output
Actual Cost (i.e., standard VOH cost (i.e., standard VOH cost
Incurred for the MH Worked) for standard MH allowed)
23,000MH × $2.8824/MH 22,000MH × $2.8824/MH
$70,412 = $66,294 = $63,412
a. Spending Variance b. Efficiency Variance
Alternative calculations:
a. Variable overhead spending variance = AQ × (AP − SP)
= 23,000 MH × ($3.06134− $2.8824)/MH
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-29
15-36 (Continued-2)
Fixed Factory Overhead Variances, 2013:
Actual fixed factory overhead incurred = budgeted fixed overhead +/– fixed
overhead spending (budget) variance
Budgeted fixed overhead = $236,250
Fixed factory overhead budget variance (given) 5,000 U
Actual fixed factory overhead incurred $241,250
Fixed Overhead Variances:
Actual Budget Applied
$241,250 $236,250 $231,000
Spending Variance Production Volume Variance
5. Two-Way Breakdown of Total Overhead Variance:
a. Factory overhead flexible-budget variance = Variable overhead spending
variance + variable overhead efficiency variance + fixed overhead spending
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
15-30
15-36 (Continued-3)
Alternatively, we can calculate the total controllable (flexible-budget) variance and
the production volume variance directly, as follows:
a. Total overhead variance = actual overhead − standard overhead applied to
production (based on allowed machine hours for the 11,000 units
produced)
b. Total flexible (control) budget variance = actual overhead – flexible budget (FB)
for total overhead based on output (i.e., based on allowed MH for the 11,000
units produced)
Notes:
1See part 4 above
2See part 2 above ($2.8824/MH variable overhead rate + $10.50/MH fixed
overhead rate)
