Standard Costing: Factory Overhead

1
Standard CostingFactory Overhead
2
Standard Costs forFactory Overhead
VariableOverhead
FixedOverhead
3
Standard Costs forFactory Overhead
We will use a general model similar to labor and
material to calculate overhead variances.
4
A General Model for Variable Overhead Variance
Analysis
Actual Quantity Actual Quantity
Standard Quantity

Actual OH Rate Standard OH Rate
Standard OH Rate
SpendingVariance
EfficiencyVariance
The total variance is the flexible budget
variance.
5
A General Model for Variable Overhead Variance
Analysis
Actual Quantity Actual Quantity
Standard Quantity

Actual OH Rate Standard OH Rate
Standard OH Rate
SpendingVariance
EfficiencyVariance
Standard Overhead rate is the amount that should
have been paid for the resources acquired.
6
A General Model for Variable Overhead Variance
Analysis
Actual Quantity Actual Quantity
Standard Quantity

Actual OH Rate Standard OH Rate
Standard OH Rate
SpendingVariance
EfficiencyVariance
Standard quantity is the quantityallowed for the
actual good output.
7
A General Model for Variable Overhead Variance
Analysis
Actual Quantity Actual Quantity
Standard Quantity

Actual OH Rate Standard OH Rate
Standard OH Rate
SpendingVariance
EfficiencyVariance
Materials price variance Materials
quantity variance Labor rate variance
Labor efficiency variance
Variable overhead Variable
overhead spending variance
efficiency variance
AQ(AR - SR)
SR(AQ - SQ) AQ Actual Quantity
SR Standard Rate AR Actual Rate
SQ Standard Quantity
8
Establishing the Standard Costfor Variable
Factory Overhead

• Determine the behavioral patterns of variable
  factory overhead costs.
• Select one or more appropriate activity measures
  for applying variable factory overhead to cost
  objects such as products, services, or divisions.
• Ascertain the intended level of operation and
  estimate the total variable factory overhead and
  the corresponding total amount of the selected
  activity measure.
• Compute the standard variable factory overhead
  rate.

9
Determining a Standard Variable Factory Overhead
Rate

• Decide the level of operation.
• Determine total variable factory overhead for the
  operation.
• Select an activity base for variable factory
  overhead and determine the amount for the
  operation.
• Divide the amount in 2 by the amount in 3 to
  arrive at the standard variable overhead rate.

10
Variable Factory OverheadVariances Example
Do you remember theHanson Inc. examplefrom
Chapter 15 thatwe used for materialand
labor? Lets revisit Hansonfor factory
overheadanalysis.
11
Variable Factory OverheadVariances Example
Hanson Inc. applies variable factory overhead
on the basis of direct labor hours. Hanson has
the following variable factory overhead standard
to manufacture one Jerf 1.5 standard hours of
labor per Jerf at a variable overhead rate of
3.00 per direct labor hour. Last month 1,550
hours were worked to make 1,000 Jerfs, and 5,115
was spent for variable factory overhead.
12
Variable Factory OverheadVariances Question 1
What was Hansons actual rate (AR)for variable
factory overhead rate for the month? a. 3.00
per hour. b. 3.19 per hour. c. 3.30 per
hour. d. 4.50 per hour.
13
Variable Factory OverheadVariances Question 1
What was Hansons actual rate (AR)for variable
factory overhead rate for the month? a. 3.00
per hour. b. 3.19 per hour. c. 3.30 per
hour. d. 4.50 per hour.
AR 5,115 1,550 hours AR 3.30 per hour
14
Variable Factory OverheadVariances Question 2
Hansons spending variance (SV)for variable
factory overhead forthe month was a. 465
unfavorable. b. 400 favorable. c. 335
unfavorable. d. 300 favorable.
15
Variable Factory OverheadVariances Question 2
Hansons spending variance (SV)for variable
factory overhead forthe month was a. 465
unfavorable. b. 400 favorable. c. 335
unfavorable. d. 300 favorable.
SV AH(AR - SR) SV 1,550 hrs(3.30 - 3.00)
SV 465 unfavorable
16
Variable Factory OverheadVariances Question 3
Hansons efficiency variance (EV)for variable
factory overhead forthe month was a. 435
unfavorable. b. 435 favorable. c. 150
unfavorable. d. 150 favorable.
17
Variable Factory OverheadVariances Question 3
Hansons efficiency variance (EV)for variable
factory overhead forthe month was a. 435
unfavorable. b. 435 favorable. c. 150
unfavorable. d. 150 favorable.
EV SR(AH - SH) EV 3.00(1,550 hrs - 1,500
hrs) EV 150 unfavorable
18
Variable Factory OverheadVariances Question 3
Hansons efficiency variance (EV)for variable
factory overhead forthe month was a. 435
unfavorable. b. 435 favorable. c. 150
unfavorable. d. 150 favorable.
EV SR(AH - SH) EV 3.00(1,550 hrs - 1,500
hrs) EV 150 unfavorable
1,000 units 1.5 hrs per unit
19
Variable Factory OverheadVariances Summary
Actual Hours Actual Hours
Standard Hours

Actual Rate Standard Rate
Standard Rate
1,550 hours 1,550 hours
1,500 hours

3.30 per hour 3.00 per
hour 3.00 per hour 5,115
4,650
4,500
Spending variance465 unfavorable
Efficiency variance150 unfavorable
20
Interpretation and Implications of Variable
Factory Overhead Variances

• Spending Variance

• Efficiency Variance

A function of the selected activitymeasure. It
does not reflectoverhead control.
Results from paying moreor less than expected
foroverhead items such assupplies and utilities.
21
Fixed Overhead Variances
Now lets turn our attention to fixed overhead.
22
Determining a Standard Variable Factory Overhead
Rate

• Determine the total budgeted fixed factory
  overhead for level of operation.
• Select an activity measure or measures for
  applying fixed factory overhead.
• Calculate the denominator quantity for the
  selected activity measure at the planned level of
  operations.
• Divide the amount in Step 1 by the amount in Step
  3 to determine the standard fixed factory
  overhead rate.

23
Fixed Overhead Variances

• Fixed factory overhead costs are assigned to
  products and services using a standard fixed
  overhead rate (FR)

Assigned Overhead FR Standard Quantity
Budgeted total fixed overhead costsDenominator
quantity for activity measure
FR
24
Fixed Overhead Variances
Actual
Fixed Fixed
Fixed Overhead
Overhead Overhead
Incurred
Budget Applied


SH FR
Spending Variance
VolumeVariance
FR Standard Fixed Overhead RateSH Standard
Hours Allowed
25
Fixed OverheadVariances Example

• Hanson Inc.s budgeted fixed overhead is
  9,000 for the month. The budgeted activity
  measure for the month is 3,000 units.
• Actual production is 3,200 units and actual
  fixed overhead is 8,450 for the month.
• Compute the fixed overhead spending and
  volume variances.
• First, calculate the fixed overhead rate.

26
Fixed OverheadVariances Example
Actual
Fixed Fixed
Fixed Overhead
Overhead Overhead
Incurred
Budget Applied
8,450
9,000
Spending variance550 favorable
27
Fixed OverheadVariances Example
Actual
Fixed Fixed
Fixed Overhead
Overhead Overhead
Incurred
Budget Applied

3,200 units

3.00 per unit
9,600
8,450
9,000
Spending variance550 favorable
Volume variance600 favorable
28
Interpretation of Fixed Factory Overhead Variances

• Spending Variance

• Volume Variance

Results from paying moreor less than expected
foroverhead items.
Results from the inabilityto operate at the
activitybudgeted for the period.
29
Fixed Factory Overhead Variances
Lets look at a graph showing fixed overhead
variances. We will use Hansons numbers from the
previous example.
30
Fixed Factory OverheadVariances Example
Cost
9,000 budgeted fixed OH
Fixed overhead applied to products
Volume
3,000 UnitsBudgeted Activity
31
Interpretation of Fixed Factory Overhead Volume
Variance
A measure offacility use
VolumeVariance
Results when standard quantitydiffer from
budgeted quantity
32
Interpretation of Fixed Factory Overhead Volume
Variance
A measure offacility use
VolumeVariance
Results when standard quantitydiffer from
budgeted quantity
Favorable when standardquantity gt budgeted
quantity
Unfavorable when standardquantity lt budgeted
quantity
33
Factors Contributing to a Fixed Overhead Spending
Variance

• Ineffective budget procedures
• Inadequate control of costs
• Misclassification of cost items

34
Factors Contributing to a Fixed Overhead Volume
Variance

• Management decisions
• Unexpected changes in market demand
• Unforeseen problems in manufacturing operations

35
Three-Way Analysis of Factory Overhead Variances
Variable OHSpendingVariance
Fixed OHSpendingVariance
Variable OHEfficiencyVariance
Fixed OHVolumeVariance
36
Fixed Factory Overhead Variances
Lets return to Hanson Inc to observe three-way
analysis of factory overhead variances.
37
Three-Way Analysis of Factory Overhead Variances
Variable OHSpendingVariance465 U
Fixed OHSpendingVariance550 F
Variable OHEfficiencyVariance150 U
Fixed OHVolumeVariance600 F
Fixed OHVolumeVariance600 F
Variable OHEfficiencyVariance150 U
Total OHSpendingVariance85 F
38
Two-Way Analysis of Factory Overhead Variances
Variable OHSpendingVariance
Fixed OHSpendingVariance
Variable OHEfficiencyVariance
Fixed OHVolumeVariance
39
Fixed Factory Overhead Variances
Now, lets use the same numbers from Hanson Inc
to illustrate two-way analysis of factory
overhead variances.
40
Two-Way Analysis of Factory Overhead Variances
Variable OHSpendingVariance465 U
Fixed OHSpendingVariance550 F
Variable OHEfficiencyVariance150 U
Fixed OHVolumeVariance600 F
Fixed OHVolumeVariance600 F
Total OHControllingVariance65 U
41
Disposition of Variances
2. Prorate variances to work in process
finished goods cost of goods sold
1. Dispose of the variance in the period it
occurs in the income statement.
First, we will look at this method using Hanson
Incs resultsfor the month of June with this
additional dataSales at the standard price
100,000Cost of goods sold at standard cost
60,000Selling price variance 7,000
favorableSelling and administrative expenses
41,000
42
Disposition of Variances
Recall Hansons manufacturing costvariances from
our previous work
43
Disposition of Variances
44
Disposition of Variances
2. Prorate variances to work in process
finished goods cost of goods sold
1. Dispose of the variance in the period it
occurs in the income statement.
We will now look at the secondmethod using this
additional dataFinished goods ending
inventory 20,000 Work-in-process ending
inventory 20,000
45
Disposition of Variances
The selling price variance is added or
subtractedfrom sales at standard in the income
statement.
46
Standard Cost in Service Industries

• Jobs with repetitive tasks lend themselves to
  efficiency measures.
• Computing nonmanufacturing efficiency variances
  requires some assumed relationship between input
  and output activity.

47
Standard Cost in Service Industries
48
Standard costs in the New Manufacturing
Environment
New Manufacturing Environment
ContinuousImprovement
TotalQualityControl
ManagingActivities, not Costs
Flexible budgets used for overhead variance
analysis are prepared using multiplecost drivers
and activity-basedcosting concepts.
49
Standard costs in the New Manufacturing
Environment

• Activity-based costing utilizes multiple activity
  measures and multiple variable overhead rates.
• For each activity center, we will have a separate
  spending and efficiency variance.
• Consider the following activity-based standards
  for Hanson Inc.

Continue
50
Standard costs in the New Manufacturing
Environment
51
Investigation of Variances
52
Investigation of VariancesCauses and
Controllability

• Random variances are variances beyond the control
  of management, either technically or financially.

A prediction error is a deviation from standard
because of an inaccurate estimation of the
amounts of variables used in the standard-setting
process.
53
Investigation of VariancesCauses and
Controllability

• An implementation error is a deviation from the
  standard that occurs during operations as a
  result of operators errors.

Measurement errors are incorrect numbers caused
by improper or inaccurate accounting systems or
procedures.
A modeling error is a deviation from standard
because of failure to include one or more
important relevant variables or inclusion of
wrong or irrelevant variables in the
standard-setting process.
54
Statistical Control Charts
ControlCharts
Display variations in a process and help to
analyze the variationsover time.
Distinguish between random variationsand
variations thatshould be investigated.
Provide a warning signal when variationsare
beyond a specified level.
55
Statistical Control Charts
Upper Control Limit
UCL
DV
Desired Value
Lower Control Limit
LCL
1
2
3
4
5
6
7
8
9
Observations
56
Statistical Control Charts
Warning signals for investigation


UCL





DV

LCL

1
2
3
4
5
6
7
8
9
Observations
57
End of Chapter 16
Lets set the standard alittle higher.