Chapter Fifteen: Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
Chapter Fifteen: Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives
Distinguish between the product-costing and
control purposes of standard costs for manufacturing
(factory) overhead
Calculate and properly interpret standard cost
variances for overhead using flexible budgets
Record factory overhead costs and associated
standard cost variances
Apply standard costs to service organizations
15-2
Learning Objectives (continued)
Analyze overhead variances in an activity-based cost
(ABC) system
Understand decision rules that can be used to guide
the variance-investigation decision
15-3
Manufacturing (Factory) Overhead
Costs: Examples
Fixed
Variable
Overhead Overhead
Factory
Factory managers’
managers’
salaries
salaries
Energy
Energy costs
costs Plant
Plant and
and equipment
equipment
Indirect
Indirect materials
materials depreciation
depreciation
Indirect
Indirect labor
labor Plant
Plant security
security guards
guards
Equipment
Equipment repair
repair Insurance
Insurance and and property
property
and
and maintenance
maintenance taxes
taxes for
for factory
factory
building
building and
and equipment
equipment
15-4
Standard Variable Overhead Costs:
Product Costing vs. Control
Variable
(Exhibit 15.1)
Overhead
Cost
Activity Variable
(e.g., DLHs)
SQ = Standard allowed DLHs for units produced
SP = Standard variable overhead rate/DLH 15-5
Variable Overhead Variance Analysis
(Exhibit 15.4)
Variable
Overhead
Cost Product Costing &
Control (SQ x SP)
SQ x SP
Efficiency
Variance Total
AQ x SP Variance
Spending
AQ x AP Variance
Activity Variable
(e.g., DLHs)
AQ SQ
SQ = Standard allowed DLHs for units produced; AQ = Actual DLHs worked;
overhead rate/DLH; SP = Standard variable overhead rate/DLH; AP = Actual variable
overhead rate/DLH
15-6
Variable Overhead Variance Analysis:
Equation Approach
15-7
Variable Overhead Variance Analysis:
Equation Approach (continued)
15-8
Variable Overhead Variance Analysis:
Example Calculations
Schmidt Machinery Co. applies variable factory
overhead on the basis of DLHs. Hanson has the
following variable factory overhead standard to
manufacture one unit of product:
5.0 standard DLHs per unit @ a standard variable
overhead rate of $12.00 per DLH
In October 2010, 3,510 hours were worked to
make 780 units, and $40,630 was spent for
variable factory overhead
15-9
Variable Overhead Variance Analysis: Example
Calculations (continued)
15-10
Variable Overhead Variance Analysis:
Alternative Presentation Format
Total Variable Overhead Variance = Actual Variable
Overhead – Flexible Budget for Variable Overhead
= $40,630 - $46,800 = $6,170 F
Variable Overhead Spending Variance = AQ x (AP – SP)
= 3,510 DLHs x ($11.5755 – $12.00)/DLH
= $1,490 F
Variable Overhead Efficiency Variance = SP x (AQ – SQ)
= $12.00/DLH x (3,510 – 3,900) DLHs
= $4,680 F
15-11
Interpretation of Variable Overhead Variances
Spending Variance Efficiency Variance
15-12
Standard Fixed Overhead Cost:
Planning vs. Control
Fixed
Overhead Product Costing:
Cost Standard Fixed OH
Applied = SQ x SP
Control Budget
(Lump Sum)
Activity Variable
(e.g., DLHs)
SQ = Standard allowed DLHs for units produced
SP = Standard fixed overhead rate/DLH
15-13
Product Costing: Determining the
Standard Fixed Overhead Application Rate
Determine
Determinethe
thetotal
totalbudgeted
budgetedfixed
fixedmanufacturing
manufacturing
overhead
overheadfor forthe
theupcoming
upcomingperiod
period
Select
Selectan
anactivity
activityvariable
variablefor
forapplying
applyingfixed
fixedfactory
factory
overhead
overheadcosts
coststotooutputs
outputs
Choose
Chooseaadenominator
denominatorvolume
volumelevel
levelfor
forthe
theselected
selected
activity
activityvariable(e.g.,
variable(e.g.,“practical
“practicalcapacity”)
capacity”)
Divide
Dividethe
theamount
amountin inStep
Step11by
bythe
theamount
amountin in Step
Step33
to
todetermine
determinethe thestandard
standardfixed
fixedfactory
factoryoverhead
overhead
application
applicationrate
ratefor
forproduct-costing
product-costingpurposes
purposes
15-14
Fixed Overhead Variance Analysis (Exhibit 15.5)
Fixed
Overhead Product Costing: Standard
Cost Fixed OH Applied = SQ x SP
Actual FOH Spending
Variance (U) Total
Budgeted FOH Production Variance
Volume (U)
Applied FOH Variance (U)
Activity Variable
SQ Den. Vol. (e.g., DLHrs)
SQ = Standard allowed DLHs for units produced
SP = Standard fixed overhead rate/DLH
15-15
Calculating Fixed Overhead Variances
15-16
Example: Calculating Fixed Overhead Variances
15-18
Fixed Overhead Variance Analysis:
Alternative Presentation Format
Total Fixed Overhead Variance = Actual Fixed Overhead –
Fixed Overhead Applied to Production
= $130,650 - $93,600 = $26,400 U (also called
Underapplied fixed overhead)
Fixed Overhead Spending (Budget) Variance
= Actual Fixed Overhead – Budgeted Fixed Overhead
= $130,650 - $120,000 = $10,650 U
Fixed Overhead Production Volume Variance
= Budgeted Fixed Overhead – Applied Fixed Overhead
= $120,000 - $93,600 = $26,400 U
15-19
Fixed Overhead Production Volume Variance:
Alternative Calculation
15-20
Interpretation of Fixed Overhead Variances
Spending (Budget) Production Volume
Variance Variance
15-21
Causes of Fixed Overhead Variances
Spending (Budget) Variance:
Ineffective budget procedures
Inadequate control of costs
Misclassification of cost items
15-22
Alternative Analysis: Three-Way Breakdown of the
Total Overhead Variance
15-23
Schmidt Company: Three-Way vs. Four-Way
Analysis of Total Factory Overhead Variance
15-24
Two-Way Analysis of Total
Factory Overhead Variance
15-25
Schmidt Company: Two-Way Analysis of
Total Factory Overhead Variance
15-26
Disposition of Standard Manufacturing Cost Variances
Schmidt Company
Manufacturing Cost Variances
From Chapter 14:
DM purchase price variance $ 4,350 U
DM usage variance 10,350 U
DL rate variance 7,020 U
DL efficiency variance 15,600 F
From Chapter 15:
Variable factory overhead spending variance 1,490 F
Variable factory overhead efficiency variance 4,680 F
Fixed overhead spending variance 10,650 U
Fixed overhead production volume variance 26,400 U
Net manufacturing cost variance $ 37,000 U
15-27
Alternative 1: Close Net
Manufacturing Cost Variance to CGS
Dr. CGS (net variance) $37,000
Dr. DL Efficiency Variance 15,600
Dr. VOH Efficiency Variance 4,680
Dr. VOH Spending Variance 1,490
Cr. DM Purchase Price Variance $4,350
Cr. DM Quantity (Efficiency) Variance 10,350
Cr. DL rate variance 7,020
Cr. FOH spending variance 10,650
Cr. FOH Production Volume Variance 26,400
15-28
Income Statement after Disposition of Net
Manufacturing Cost Variance
15-29
Alternative 2: Prorate (Allocate)
Net Manufacturing Cost Variance
If the net variance is considered material, then the
variance should be allocated (prorated) to the
Inventory and CGS accounts
Allocation should be based on the relative amount of
this period’s standard cost in the end-of-period balance
of each affected account
For external-reporting purposes, the provisions of FAS
#151 regarding the treatment of “abnormal amounts”
of idle-capacity expense must be followed
15-30
Effects on Absorption Costing Income of Denominator-
Level Choice for Allocating Fixed Overhead Costs
The issue: management’s ability to manage (or “
smooth”) reporting earnings
This ability is related to alternative treatments
(dispositions) of the production volume variance
The amount of fixed overhead cost absorbed into
inventory or released as an expense on the income
statement is affected by the denominator chosen for
the fixed overhead application rate
Income manipulation can occur if the production-
volume variance is written off entirely to CGS
15-31
Standard Costs Applied to
Service Organizations
• Jobs with repetitive tasks lend themselves to
efficiency measures
• Computing non-manufacturing efficiency
variances requires some assumed relationship
between input and output activity
Examples
15-32
Service Applications (continued)
15-33
Overhead Cost Variances in ABC Systems
Traditional Approach to Product Costing
(Exhibit 15.11, partial):
Cost Item Variable Per Fixed
Direct materials $20 Unit
Direct labor 30 DLH
Indirect materials 2 DLH
Repair and Maintenance 5 DLH
Receiving $5,000
Engineering Support 30,000
Setup 75,000
15-34
Traditional Financial-Performance Report
(Exhibit 15.12)
Flexible
Budget Flexible
Actual Based on Budget
Cost Item Cost Output Variance
Direct materials $50,000 $40,000 $10,000 U
Direct labor 36,000 30,000 6,000 U
Indirect materials 3,000 2,000 1,000 U
Repair and Maintenance 6,500 5,000 1,500 U
Receiving 3,000 5,000 2,000 F
Engineering Support 30,000 30,000 30,000
Setup 50,000 75,000 25,000 F
Total $178,500 $187,000 $8,500 F
15-35
Flexible Budget Using ABC
(Exhibit 15.13)
Flexible
Cost Item Budget
Direct materials $40,000 (2,000 x $20)
Direct labor 30,000 (2,000 x 0.5 x $30)
Indirect materials 2,000 (1,000 x $2)
Repair and Maintenance 6,000 (300,000 X $0.01 +$3,000)
Receiving 3,500 (2 x $1,500 + $500)
Engineering Support 30,000 ($30,000 per period)
Setup 50,000 (2 x $25,000)
Total $161,500
15-36
Financial-Performance Report Using ABC
(Exhibit 15.14)
Actual Flexible
Cost Item Cost Budget Variance
Direct materials $50,000 $40,000 $10,000 U
Direct labor 36,000 30,000 6,000 U
Indirect materials 3,000 2,000 1,000 U
Repair and Maintenance 6,500 6,000 500 U
Receiving 3,000 3,500 500 F
Engineering Support 30,000 30,000
Setup 50,000 50,000
Total $178,500 $161,500 $17,000 U
15-37
Flexible-Budget Analysis under ABC When
There is a Standard Batch Size for
Production Activity
• this situation provides the opportunity for
a more detailed analysis
• variable setup costs under ABC:
• convert actual output to standard # of
batches
• convert the above to standard setup
hours
15-38
Flexible-Budget Analysis under ABC When
There is a Standard Batch Size for
Production Activity (continued)
• flexible budget cost for variable overhead
= standard allowed hours x standard
variable overhead cost per setup hour
• calculate flexible-budget variance for
variable setup costs
• decompose flexible-budget variance into
spending and efficiency components
15-39
Extensions of ABC Analysis: GPK and Resource
Consumption Accounting (RCA)
• GPK (~ flexible standard costing) is a detailed
German cost-accounting system
• RCA = comprehensive cost-management
system represented (approximately) as a
cross between GPK and ABC
• These systems rely on a large number of
cost centers and cost pools
• Most appropriate with highly routine and
repetitive operations
15-40
The Variance-Investigation Decision
Larger variances, in
How do I know which dollar amount or as
variances to a percentage of the
investigate? standard, are
investigated first.
15-41
The Variance Investigation Decision
(continued)
Uncontrollable (random) variances:
– Random Error
Controllable (systematic) variances:
– Prediction error
– Modeling error
– Measurement error
– Implementation error
15-42
Role of Control Charts to Help Distinguish Random
vs. Systematic Cost Variances
Control
Charts
15-44
Control Charts (continued)
15-45
Appendix: Variance Investigation Decisions Under
Uncertainty
States of Nature
Action Random Nonrandom
Investigate I I+C
Do not investigate none L
Where: I = cost of an investigation
C = the cost to correct a variance
L = present value of losses by not
correcting the variance
15-46
Appendix: Variance Investigation Decisions—
Indifference Probability
15-47
Chapter Summary
15-48
Chapter Summary
(continued)
For product-costing purposes, we defined the total
overhead variance for the period as the difference
between the actual overhead costs incurred and the
overhead costs applied to production using the
overhead application rate
15-49
Chapter Summary (continued)
The total overhead variance for the period can be
decomposed using a four-way, three-way, or two-way
analysis:
Four-way analysis = variable overhead spending variance +
variable overhead efficiency variance + fixed overhead
spending (budget) variance + fixed overhead production
volume variance
Three-way analysis = total overhead spending variance +
variable overhead efficiency variance + fixed overhead
production volume variance
Two-way analysis = flexible (controllable) budget variance +
fixed overhead production volume variance
15-50
Chapter Summary (continued)
We discussed how to record standard overhead costs in the
accounting records and how standard cost variances for
product-costing purposes are disposed of at the end of the
accounting period