{"id":69,"date":"2015-06-03T19:40:19","date_gmt":"2015-06-03T19:40:19","guid":{"rendered":"https:\/\/courses.candelalearning.com\/managacct2x10xmaster\/?post_type=chapter&p=69"},"modified":"2016-01-01T14:06:09","modified_gmt":"2016-01-01T14:06:09","slug":"calculations-for-factory-overhead","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-managacct\/chapter\/calculations-for-factory-overhead\/","title":{"raw":"8.3 Calculations for Overhead","rendered":"8.3 Calculations for Overhead"},"content":{"raw":"
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\r\n\r\nIn a standard cost system, accountants apply the manufacturing overhead to the goods produced using a standard overhead rate. They set the rate prior to the start of the period by dividing the budgeted manufacturing overhead cost by a standard level of output or activity. Total budgeted manufacturing overhead varies at different levels of standard output, but since some overhead costs are fixed, total budgeted manufacturing overhead does not vary in direct proportion with output.\r\n\r\nManagers use a flexible budget <\/strong>to isolate overhead variances and to set the standard overhead rate. Flexible budgets show the budgeted amount of manufacturing overhead for various levels of output.\r\n\r\nLook at Beta Company's flexible budget\u00a0below. Note that Beta's flexible budget shows the variable and fixed manufacturing overhead costs expected to be incurred at three levels of activity: 9,000 units, 10,000 units, and 11,000 units. For product costing purposes, Beta must estimate the expected level of activity in advance and set a rate based on that level. The level chosen is called the standard volume of output. This standard volume of output (or activity) may be expressed in terms of any of the activity bases used in setting standard overhead rates. These activity bases include percentage of capacity, units of output machine-hours, and direct labor-hours, among others.\u00a0\u00a0 Machine-hours are budgeted at 2 machine-hours per product.\u00a0 In our example, standard volume is assumed to be 10,000 units produced. Management expects to use 20,000 machine-hours of services.\u00a0 These will be used as our budgeted amounts.\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
BetaCompany\u00a0\u00a0\u00a0<\/strong><\/td>\r\n<\/tr>\r\n
Flexible manuf. \u00a0overhead budget\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0<\/strong><\/td>\r\n<\/tr>\r\n
Machine-hours<\/td>\r\n18,000<\/td>\r\n20,000<\/td>\r\n22,000<\/td>\r\n<\/tr>\r\n
Units of output<\/td>\r\n9,000<\/td>\r\n10,000<\/td>\r\n11,000<\/td>\r\n<\/tr>\r\n
Variable overhead:<\/td>\r\n<\/td>\r\n<\/td>\r\n<\/td>\r\n<\/tr>\r\n
\u00a0\u00a0 Indirect materials<\/td>\r\n$7,200<\/td>\r\n$8,000<\/td>\r\n$8,800<\/td>\r\n<\/tr>\r\n
\u00a0\u00a0 Power<\/td>\r\n9,000<\/td>\r\n10,000<\/td>\r\n11,000<\/td>\r\n<\/tr>\r\n
\u00a0\u00a0 Royalties<\/td>\r\n1,800<\/td>\r\n2,000<\/td>\r\n2,200<\/td>\r\n<\/tr>\r\n
\u00a0\u00a0 Other<\/td>\r\n18,000<\/td>\r\n20,000<\/td>\r\n22,000<\/td>\r\n<\/tr>\r\n
\u00a0\u00a0\u00a0\u00a0 Total variable overhead<\/td>\r\n$36,000<\/td>\r\n$40,000<\/td>\r\n$44,000<\/td>\r\n<\/tr>\r\n
Fixed overhead:<\/td>\r\n<\/td>\r\n<\/td>\r\n<\/td>\r\n<\/tr>\r\n
\u00a0\u00a0 Insurance<\/td>\r\n$4,000<\/td>\r\n$4,000<\/td>\r\n$4,000<\/td>\r\n<\/tr>\r\n
\u00a0\u00a0 Property taxes<\/td>\r\n6,000<\/td>\r\n6,000<\/td>\r\n6,000<\/td>\r\n<\/tr>\r\n
\u00a0\u00a0 Depreciation<\/td>\r\n20,000<\/td>\r\n20,000<\/td>\r\n20,000<\/td>\r\n<\/tr>\r\n
\u00a0\u00a0 Other<\/td>\r\n30,000<\/td>\r\n30,000<\/td>\r\n30,000<\/td>\r\n<\/tr>\r\n
\u00a0\u00a0\u00a0\u00a0 Total fixed overhead<\/td>\r\n$60,000<\/td>\r\n$60,000<\/td>\r\n$60,000<\/td>\r\n<\/tr>\r\n
Total Overhead (variable + fixed )<\/td>\r\n$96,000<\/td>\r\n$100,000<\/td>\r\n$104,000<\/td>\r\n<\/tr>\r\n
Standard overhead rate ($100,000\/20,000 hours)<\/td>\r\n<\/td>\r\n$5<\/td>\r\n<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nAssume that Beta applies manufacturing overhead using a rate based on machine-hours. According to the flexible manufacturing overhead budget, the expected manufacturing overhead cost at the standard volume (20,000 machine-hours) is\u00a0$ 100,000, so the standard overhead rate is\u00a0$ 5 per machine-hour ($100,000\/20,000 machine-hours).\r\n\r\nKnowing the separate rates for variable and fixed overhead is useful for decision making.\u00a0 We will be using the company's expected volume of 10,000 units.\u00a0 The variable overhead rate is\u00a0$ 2 per machine hour<\/strong> ($ 40,000 variable OH\/20,000 hours), and the fixed overhead rate is\u00a0$ 3 per hour ($ 60,000\/20,000 hours). If the expected volume had been 18,000 machine-hours, the standard overhead rate would have been\u00a0$ 5.33 ($96,000\/18,000 hours). If the standard volume had been 22,000 machine-hours, the standard overhead rate would have been\u00a0$ 4.73 ($104,000\/22,000 hours).\r\n\r\nNote that the difference in rates is due solely to dividing fixed overhead by a different number of machine-hours. That is, the variable overhead cost per unit stays constant ($ 2 per machine-hour) regardless of the number of units expected to be produced, and only the fixed overhead cost per unit changes.\u00a0 Since fixed overhead does not change per unit, we will separate the fixed and variable overhead for variance analysis.\r\n\r\nContinuing with the Beta Company illustration, assume that the company incurred\u00a0$ 108,000 of actual manufacturing overhead costs ($46,000 in variable OH and $62,000 in fixed OH) in a period during which 11,000 units of product were produced. The actual costs would be debited to Manufacturing Overhead and credited to a variety of accounts such as Accounts Payable, Accumulated Depreciation, Prepaid Insurance, Property Taxes Payable, and so on. According to the flexible budget, the standard number of machine-hours allowed for 11,000 units of production is 22,000 hours. Therefore, $ 110,000 of manufacturing overhead is applied to production ($ 5 per machine-hour times 22,000 hours) by debiting Work in Process Inventory and crediting Manufacturing Overhead for $ 110,000.\r\n\r\nThese show that manufacturing overhead has been overapplied to production by the $ 2,000 ($110,000 applied OH - $108,000 actual OH). Because of its fixed component, manufacturing overhead tends to be over applied when actual production is greater than standard production.\u00a0 Now, we will separate the variable and fixed components for analysis.\r\n

\u00a0Variable Overhead Variances<\/h4>\r\nAlthough various complex computations can be made for overhead variances, we use a simple approach in this text. In this approach, known as the two-variance approach to variable overhead variances, we calculate only two variances\u2014a variable overhead spending variance and a variable overhead efficiency variance.\r\n\r\nhttps:\/\/youtu.be\/fKPDFk69Hrk\r\n\r\nVariable Overhead Spending Variance<\/strong> The variable overhead spending variance <\/strong>shows in one amount how economically overhead services were purchased and how efficiently they were used. This overhead spending variance is similar to a price variance for materials or labor. We compare the Variable OH rate for budget and actual using the actual amount of our variable overhead base (machine-hours, direct labor dollars, direct labor hours, etc.)\r\n\r\nVariable OH Spending Variance = (Actual Variable OH per base - Std Variable OH per base) x Actual OH base <\/strong>\r\n\r\nOR\r\n\r\nVariable OH Spending Variance = (Actual OH base x Actual Variable OH per base) - (Actual OH base x Std Variable OH per base)<\/strong>\r\n\r\nFor Beta Company, overhead is applied based on machine hours.\u00a0\u00a0 The Variable OH rate per machine hour is $2 (calculated above) and actual variable overhead was $46,000 for 22,000 actual machine hours giving an actual rate of $2.0909 rounded ($46,000 \/ 22,000 actual machine hours).\u00a0 We can calculate the variable OH spending variance using either of these two methods below:\r\n\r\nVariable OH Spending Variance = (Actual Variable OH per base - Std Variable OH per base) x Actual OH base\r\n\r\n= ($2.0909 per machine hour - $2.00 per machine hour) x 22,000 actual machine hours\r\n\r\n= $0.0909 x 22,000 machine hours\r\n\r\n= $2,000 (rounded) Unfavorable\r\n\r\nOR\r\n\r\nVariable OH Spending Variance = (Actual OH base x Actual Variable OH per base) - (Actual OH base x Std Variable OH per base)\r\n\r\n=\u00a0 $46,000 actual variable OH - (22,000 actual machine hours x $2 standard OH per machine hour)\r\n\r\n= $46,000 - 44,000\r\n\r\n= $2,000 unfavorable\r\n\r\nThe variance is unfavorable because actual variable overhead costs were $46,000, while according to the flexible budget for 11,000 units, they should have been $44,000 meaning Beta spent more on variable overhead than they had planned.Variable Overhead Efficiency Variance<\/strong> The variable efficiency overhead variance <\/strong>is caused by producing at a level other than that used in setting the standard overhead application rate. The variable OH efficiency variance shows whether plant assets produced more or fewer units than expected.\r\n\r\nVariable OH Efficiency Variance = (Actual OH base - Std OH base) x Standard Variable OH per base<\/strong>\r\n\r\nOR\r\n\r\nVariable OH Efficiency Variance = (Actual OH base x Std Variable OH per base) - (Std OH base x Std Variable OH per base)<\/strong>\r\n\r\nFor Beta Company, the Variable OH rate per machine hour is $2 (calculated above) and actual variable overhead was $46,000 for 22,000 actual machine hours.\u00a0 Management expected to use 20,000 hours for 10,000 units produced.\u00a0 We can calculate the variable OH spending variance using either of these two methods below:\r\n\r\nVariable OH Efficiency Variance = (Actual OH base - Std OH base) x Standard Variable OH per base\r\n\r\n= (22,000 actual machine hours - 20,000 standard machine hours ) x $2 per machine hour\r\n\r\n= 2,000 machine hours x $2 per machine hour\r\n\r\n= $4,000 unfavorable\r\n\r\nOR\r\n\r\nVariable OH Efficiency Variance = (Actual OH base x Std Variable OH per base) - (Std OH base x Std Variable OH per base)\r\n\r\n=\u00a0 (22,000 actual hours x $2 per machine hour) - (20,000 standard hours x $2 per machine hour)\r\n\r\n= $44,000 - 40,000\r\n\r\n= $4,000 unfavorable\r\n\r\nThe efficiency variance is unfavorable because we used more machine hours than we had budgeted.\u00a0 Of course, this is because we produced 11,000 units when the budget planned for 10,000 units.\r\n\r\nFixed Overhead Variance<\/strong>\r\n\r\nBecause fixed overhead is not constant on a per unit basis, any deviation from planned production causes the overhead application rate to be incorrect. We can calculate a fixed overhead variance by comparing:\r\n\r\n<\/div>\r\n\u00a0Fixed Overhead variance = Actual fixed overhead - Budgeted fixed overhead<\/strong>\r\n
\r\n\r\nIn the Beta Company illustration, the budgeted fixed overhead was $60,000 (notice the level of production does not matter since fixed costs remain the same regardless of volume) and the actual fixed costs were $62,000.\r\n\r\nFixed Overhead variance = Actual fixed overhead - Budgeted fixed overhead\r\n\r\n= $62,000 actual fixed - $60,000 budgeted fixed\r\n\r\n= $2,000 unfavorable variance\r\n\r\nThis variance is unfavorable since we spent more on fixed costs than we had planned.\r\n\r\nSummary of overhead variances<\/strong> To easily determine the accuracy of the overhead variances, Beta would compare the sum of the variances with the difference between the costs of actual manufacturing overhead and budgeted manufacturing overhead. For Beta Company, the difference between actual and budgeted overhead (budget is based on the expected level of volume of 10,000 units) was:\r\n\r\n\r\n\r\n\r\n\r\n
Actual manufacturing overhead incurred<\/td>\r\n$ 108,000<\/td>\r\n<\/tr>\r\n
Budgeted overhead (at 10,000 units)<\/td>\r\n100,000<\/span><\/td>\r\n<\/tr>\r\n
Total overhead variance (unfavorable)<\/td>\r\n$ 8,000<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nThis difference is made up of the following overhead variances:\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Variable OH Spending Variance<\/td>\r\n$ 2,000 U<\/td>\r\n<\/tr>\r\n
Variable OH Efficiency Variance<\/td>\r\n$ 4,000 U<\/td>\r\n<\/tr>\r\n
Fixed OH Variance<\/td>\r\n$ 2,000 U<\/span><\/td>\r\n<\/tr>\r\n
Total overhead variance (2,000 U + 4,000 U + 2,000 U)<\/td>\r\n$8,000 Unfavorable<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nThe unfavorable spending variance is because we had more variable cost per unit than budgeted.\u00a0 The efficiency variance is unfavorable because we spent more machine hours than budgeted because we produced more units. We spent more on fixed costs than we had anticipated.\r\n\r\n \r\n\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\n<\/div>","rendered":"
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In a standard cost system, accountants apply the manufacturing overhead to the goods produced using a standard overhead rate. They set the rate prior to the start of the period by dividing the budgeted manufacturing overhead cost by a standard level of output or activity. Total budgeted manufacturing overhead varies at different levels of standard output, but since some overhead costs are fixed, total budgeted manufacturing overhead does not vary in direct proportion with output.<\/p>\n

Managers use a flexible budget <\/strong>to isolate overhead variances and to set the standard overhead rate. Flexible budgets show the budgeted amount of manufacturing overhead for various levels of output.<\/p>\n

Look at Beta Company’s flexible budget\u00a0below. Note that Beta’s flexible budget shows the variable and fixed manufacturing overhead costs expected to be incurred at three levels of activity: 9,000 units, 10,000 units, and 11,000 units. For product costing purposes, Beta must estimate the expected level of activity in advance and set a rate based on that level. The level chosen is called the standard volume of output. This standard volume of output (or activity) may be expressed in terms of any of the activity bases used in setting standard overhead rates. These activity bases include percentage of capacity, units of output machine-hours, and direct labor-hours, among others.\u00a0\u00a0 Machine-hours are budgeted at 2 machine-hours per product.\u00a0 In our example, standard volume is assumed to be 10,000 units produced. Management expects to use 20,000 machine-hours of services.\u00a0 These will be used as our budgeted amounts.<\/p>\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n
BetaCompany\u00a0\u00a0\u00a0<\/strong><\/td>\n<\/tr>\n
Flexible manuf. \u00a0overhead budget\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0<\/strong><\/td>\n<\/tr>\n
Machine-hours<\/td>\n18,000<\/td>\n20,000<\/td>\n22,000<\/td>\n<\/tr>\n
Units of output<\/td>\n9,000<\/td>\n10,000<\/td>\n11,000<\/td>\n<\/tr>\n
Variable overhead:<\/td>\n<\/td>\n<\/td>\n<\/td>\n<\/tr>\n
\u00a0\u00a0 Indirect materials<\/td>\n$7,200<\/td>\n$8,000<\/td>\n$8,800<\/td>\n<\/tr>\n
\u00a0\u00a0 Power<\/td>\n9,000<\/td>\n10,000<\/td>\n11,000<\/td>\n<\/tr>\n
\u00a0\u00a0 Royalties<\/td>\n1,800<\/td>\n2,000<\/td>\n2,200<\/td>\n<\/tr>\n
\u00a0\u00a0 Other<\/td>\n18,000<\/td>\n20,000<\/td>\n22,000<\/td>\n<\/tr>\n
\u00a0\u00a0\u00a0\u00a0 Total variable overhead<\/td>\n$36,000<\/td>\n$40,000<\/td>\n$44,000<\/td>\n<\/tr>\n
Fixed overhead:<\/td>\n<\/td>\n<\/td>\n<\/td>\n<\/tr>\n
\u00a0\u00a0 Insurance<\/td>\n$4,000<\/td>\n$4,000<\/td>\n$4,000<\/td>\n<\/tr>\n
\u00a0\u00a0 Property taxes<\/td>\n6,000<\/td>\n6,000<\/td>\n6,000<\/td>\n<\/tr>\n
\u00a0\u00a0 Depreciation<\/td>\n20,000<\/td>\n20,000<\/td>\n20,000<\/td>\n<\/tr>\n
\u00a0\u00a0 Other<\/td>\n30,000<\/td>\n30,000<\/td>\n30,000<\/td>\n<\/tr>\n
\u00a0\u00a0\u00a0\u00a0 Total fixed overhead<\/td>\n$60,000<\/td>\n$60,000<\/td>\n$60,000<\/td>\n<\/tr>\n
Total Overhead (variable + fixed )<\/td>\n$96,000<\/td>\n$100,000<\/td>\n$104,000<\/td>\n<\/tr>\n
Standard overhead rate ($100,000\/20,000 hours)<\/td>\n<\/td>\n$5<\/td>\n<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

Assume that Beta applies manufacturing overhead using a rate based on machine-hours. According to the flexible manufacturing overhead budget, the expected manufacturing overhead cost at the standard volume (20,000 machine-hours) is\u00a0$ 100,000, so the standard overhead rate is\u00a0$ 5 per machine-hour ($100,000\/20,000 machine-hours).<\/p>\n

Knowing the separate rates for variable and fixed overhead is useful for decision making.\u00a0 We will be using the company’s expected volume of 10,000 units.\u00a0 The variable overhead rate is\u00a0$ 2 per machine hour<\/strong> ($ 40,000 variable OH\/20,000 hours), and the fixed overhead rate is\u00a0$ 3 per hour ($ 60,000\/20,000 hours). If the expected volume had been 18,000 machine-hours, the standard overhead rate would have been\u00a0$ 5.33 ($96,000\/18,000 hours). If the standard volume had been 22,000 machine-hours, the standard overhead rate would have been\u00a0$ 4.73 ($104,000\/22,000 hours).<\/p>\n

Note that the difference in rates is due solely to dividing fixed overhead by a different number of machine-hours. That is, the variable overhead cost per unit stays constant ($ 2 per machine-hour) regardless of the number of units expected to be produced, and only the fixed overhead cost per unit changes.\u00a0 Since fixed overhead does not change per unit, we will separate the fixed and variable overhead for variance analysis.<\/p>\n

Continuing with the Beta Company illustration, assume that the company incurred\u00a0$ 108,000 of actual manufacturing overhead costs ($46,000 in variable OH and $62,000 in fixed OH) in a period during which 11,000 units of product were produced. The actual costs would be debited to Manufacturing Overhead and credited to a variety of accounts such as Accounts Payable, Accumulated Depreciation, Prepaid Insurance, Property Taxes Payable, and so on. According to the flexible budget, the standard number of machine-hours allowed for 11,000 units of production is 22,000 hours. Therefore, $ 110,000 of manufacturing overhead is applied to production ($ 5 per machine-hour times 22,000 hours) by debiting Work in Process Inventory and crediting Manufacturing Overhead for $ 110,000.<\/p>\n

These show that manufacturing overhead has been overapplied to production by the $ 2,000 ($110,000 applied OH – $108,000 actual OH). Because of its fixed component, manufacturing overhead tends to be over applied when actual production is greater than standard production.\u00a0 Now, we will separate the variable and fixed components for analysis.<\/p>\n

\u00a0Variable Overhead Variances<\/h4>\n

Although various complex computations can be made for overhead variances, we use a simple approach in this text. In this approach, known as the two-variance approach to variable overhead variances, we calculate only two variances\u2014a variable overhead spending variance and a variable overhead efficiency variance.<\/p>\n