Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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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 overhead flexible-budget variance of a period may continue into the
future with the consequence that the organization continues to suffer from
unfavorable 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
15-3 Possible contributing factors to a variable overhead spending variance include:
▪ Prices paid to acquire one or more variable overhead items differ from those
specified as standard prices.
overhead.
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
variable overhead cost of efficiency or inefficiency in the use of the activity measure
used to construct the flexible-budget.
15-5 A fixed overhead spending variance is defined as the difference between the actual
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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example:
▪ A factory manager was given a bonus or raise that was not in the original
budget.
▪ Additional salaried employees, not envisioned when the original budget 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.
▪ Choice of denominator activity level (e.g., if budgeted activity, rather than
practical capacity, is used, the amount of the production volume variance will
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
the production volume variance is directly a function of the selected denominator
level assumed when the application rate was developed. A high denominator level
increases an otherwise unfavorable production volume variance (or decreases an
otherwise favorable volume variance). On the other hand, a low denominator level
increases an otherwise favorable production volume variance (or decreases an
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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otherwise unfavorable production volume variance).
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. 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
analysis.
▪ A more detailed analysis confuses users of accounting reports.
▪ Total overhead costs are not significant in a relative sense
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–
the period. In short, when dealing with fixed overhead, the (“lump–sum”) amount
used for control purposes and the amount applied to production will be identical only
if the actual output of the period exactly equals the denominator activity level.
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
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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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 variance is favorable, then the CGS account would be decreased,
that is credited, at the end of the year). This practice can be defended for
several reasons. One, it is the most expedient (and therefore least costly)
standard overhead costs contained in the end–of-period balance in these
accounts. Note that when we expand the analysis to include direct materials,
any price variance that occurs during the period should be allocated to the
materials inventory account, the materials quantity (efficiency) variance, the
WIP Inventory account, the Finished Goods Inventory account, and CGS.
Similarly, any fixed overhead spending variance should, in theory, be partially
allocated to the production volume variance for the period. The proration
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
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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consequence of abnormally low production or an idle plant.
result in “reasonable” allocations across outputs. Additional guidance for income–
tax purposes regarding the use of alternative denominator-volume levels for
determining income under the absorption-costing approach is given in Treasury
Regulation § 1.471-11: Inventories of Manufacturers.
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 allocation rates and the end–of-period disposition of any volume
15–12 Factors that need be considered include:
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
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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BRIEF EXERCISES
15–14 The budgeted supervisory salary per month is:
$360,000 ÷ 12 months = $30,000 per month
Thus, the flexible-budget variance for the production supervisory salaries in
August is:
15–15 Standard indirect labor cost per unit:
= $144,000/year ÷ (5,000 units/month × 12 months/year)
= $2.40/unit
15–16 Fixed overhead variances for the year:
(a) Spending Variance = Actual fixed overhead costs – Budgeted fixed overhead
= $245,000–$250,000 = $5,000F
(b) Production Volume Variance = Budgeted fixed overhead – Applied fixed
overhead
= $250,000 – (20,000 units × 2 hrs./unit × $5/hr.)
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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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
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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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. CGS 43,000
Dr. Variable Overhead Spending Variance 4,000
Dr. Fixed Overhead Spending Variance 5,000
Cr. Production Volume Variance 50,000
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
Dr. CGS (70% × $43,000) 30,100
15–21 Factory Overhead Variance: Two-Variance Decomposition
(a) Total Overhead Variance = actual overhead − overhead applied to production
= $323,000 − (20,000 units × 2 hrs./unit × $7.00/hr.)
= $323,000 − $280,000
= $43,000U
(b) Total Flexible-Budget Variance = Actual overhead – Flexible-budget for
Overhead based on Output
= $323,000 − [($2/hr.× 2hrs./unit × 20,000 units) +
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15–21 (Continued)
(c) Production Volume variance = budgeted fixed overhead − applied fixed
overhead
= $250,000 − (20,000 units × 2 hrs./unit × $5.00/hr.)
$50,000 during the year)
15–22 Summary Journal Entries:
(a) Actual Overhead Costs
Dr. Factory (or, Manufacturing) Overhead 323,000
Cr. Accumulated Depreciation—Factory 150,000
Cr. Salaries Payable 95,000
(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:
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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(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
EXERCISES
15–24 Flexible Overhead Budgets for Control; Spreadsheet Application (40–45
minutes)
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. 15-24.xlsx
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15–25 Journal Entries for Factory Overhead Costs and Standard Cost Variances;
Spreadsheet Application (50–60 minutes)
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. 15-25.xlsx
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15–26 Graphical Analysis—Variable Overhead Variances (20–25 minutes)
Solution:
(A) = Variable Overhead Costs per Machine Hour (label)
(B) = Machine Hours (i.e., the activity measure used to apply variable overhead
(G) = Variable overhead spending variance = AQ × (AP − SP)
(H) = Standard variable overhead cost applied to production = Flexible budget for
variable overhead based on units produced (i.e., based on standard allowed
machine hours) = SQ × SP
(B)
(A)
(C)
(D)
(E)
(F)
Area (G)
Area (H)
Area (I)
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15–27 Graphical Analysis—Fixed Overhead Variances (30–40 minutes)
Solution:
(A) = Fixed Overhead Cost (label)
(B) = Machine Hours = Activity Measure for Applying Fixed Overhead Cost (label)
(C) = Applied Fixed Overhead Cost
(I) = Actual Fixed Overhead Costs Incurred During the Period
(J) = Fixed Overhead Production Volume Variance (= D × (G − F))
(K) = Total Fixed Overhead Variance = (J) + (L)
(L) = Fixed Overhead Spending (Budget) Variance = (I) − (E)
(L)
(K)
(I)
(H)
(A)
(C)
(B)
(F) (G)
Slope of Line = (D)
(E)
(J)
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15–28 Flexible Budget and Variances for Depreciation (20 minutes)
1. Budgeted depreciation, factory equipment for September:
$360,000 12 = $30,000
2. Spending Variance—Equipment Depreciation Expense:
Actual depreciation for the month $28,000
3. Production Volume Variance—Portion Pertaining to Depreciation:
Budgeted depreciation for the month $30,000
Total standard depreciation expense applied:
Total chargeable hours for the month = 9,000
Interpretation: Because chargeable hours (i.e., “activity” or “volume”) were less
than anticipated, a portion of the budgeted depreciation expense for equipment
did not get charged to the output of the period.
4. Reasons for the favorable spending variance regarding equipment depreciation
expense include:
▪ The company disposed of some of its equipment during the period
Chapter 15 – Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15–29 Fixed Overhead Rate, Denominator Level, and 2-Variance Analysis of Fixed
Overhead Variance (20-25 minutes)
1. Standard fixed factory overhead rate = budgeted total overhead cost per machine
hour − budgeted variable overhead cost per machine hour = $4.90 − $3.00 =
2. Denominator activity level (used to set the standard fixed overhead allocation rate)
= Budgeted Fixed OverheadFixed Overhead Allocation Rate per MH = $7,125
3. Two-Way Analysis (Breakdown) of Total Overhead Variance