Sol14 4e

CHAPTER 14: FLEXIBLE-BUDGETSFACTORY OVERHEAD
QUESTIONS
14-1 a. Yes, the factory manager has done a good job in controlling factory overhead
costs if all factory overhead costs are fixed. Even though the actual
production is only at the 85 percent level of the budgeted production level,
the total fixed factory overhead should remain unchanged as long as the
operation falls within the relevant range of operations.
b. No, the total factory overhead cost incurred during the period should have
been less than the budgeted amount. The variable factory overhead cost
should have been approximately 85 percent of the budgeted variable factory
overhead, or $51,000, and the total factory overhead around $71,000.
14-2 Both the variable factory overhead efficiency variance and the direct labor
efficiency variance will be in the same direction. The variable factory overhead
efficiency variance will be favorable if the firm has a favorable direct labor
efficiency variance and unfavorable if its direct labor efficiency variance is
unfavorable.
Furthermore, the relative amount of the variable factory overhead efficiency
variance to the direct labor efficiency variance will be the same as the ratio of
the variable factory overhead rate per direct labor hour to the standard hourly
wage rate per direct labor hour.
14-3 The total factory overhead spending variance is a term used in a 3-variance
analysis of the total overhead variance to represent the sum of the variable
overhead spending variance and the fixed overhead spending variance.
The determination of the variable factory overhead efficiency variance is
independent of the procedure or factors involved in determining any of the
factory overhead spending variances.
14.4A factory overhead flexible-budget variance is the difference between the amount
of factory overhead incurred in a period and the flexible-budget for factory
overhead based on output (i.e., based on units produced or, equivalently, based
on standard activity units allowed for the output of the period). This variance is
also referred to as the controllable (overhead) variance. This variance can be
decomposed into three variances: fixed overhead spending variance; variable
overhead spending variance; and, variable overhead efficiency variance.
14-5 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 organization would be more likely to benefit from the good
fortune in the future if it knows the factors that led to the favorable variance.
Thus, managers should also investigate the cause or causes that led to all
significant variances, whether they are favorable or unfavorable.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e

2008
14-1
The McGraw-Hill Companies
14-6 The total factory overhead can be the same as the standard amount allowed for
the current periods 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 factory overhead flexible-budget variance and an
approximately equal favorable production volume variance. The contributing
factors to the unfavorable factory overhead flexible-budget variance and to the
favorable production volume variance are likely to be different. Unless corrected,
factors that led to the significant 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.
14-7 Among reasons that a firm may use a 2-variance instead of 3-variance or 4variance 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
enough.
The firms accounting system does not support the detailed data needed for a
3-variance or 4-variance analysis.
It is too costly to generate additional data needed for a more detailed
analysis.
A more detailed analysis confuses users of accounting reports.
Total overhead costs are not significant in a relative sense.
14-8 This question pertains to text Exhibits 14.1 and 14.3. As indicated in Exhibit
14.1, 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 based on outputs (control purpose). In short, there is no
difference between the total variable factory overhead applied to the units
manufactured and the total standard variable factory overhead in the control
budget for the period.
However, as indicated in Exhibit 14.3, the amount of fixed factory overhead in
the flexible-budget is likely to be different from the amount of fixed factory
overhead assigned to production for the period. The flexible-budget for fixed
overhead includes a lump-sum amount (control purpose) while the amount of
fixed overhead applied to production is equal to the product of a predetermined
(i.e., standard) fixed overhead allocation rate and the standard allowed activity
units for the production in the period. The difference is a result of the
discrepancy between the activity units assumed when the fixed overhead
application rate was determined, what we call the denominator activity level,
and the number of units actually manufactured during the period. In short, when
dealing with fixed factory 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.
14-9 Even though the denominator level a firm selected determined the fixed factory
overhead application rate, the selected denominator level has no effect on either
the amount or the direction of the fixed factory overhead flexible-budget variance
for the operation. The fixed factory overhead flexible-budget variance for a
14-2
The McGraw-Hill Companies 2008
period is the difference between the actual fixed factory overhead cost and the
budgeted fixed factory overhead cost for the period. Neither of these amounts is
affected by the fixed factory overhead application rate for the period; both can be
thought of as being lump-sum amounts.
The production volume variance of a period is the difference between the
budgeted fixed factory overhead (lump-sum amount) and the total fixed factory
overhead applied to production of the period based on the fixed factory
overhead application rate. Consequently, 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 otherwise
unfavorable production volume variance).
14-10 A price variance is the difference between the actual price paid to acquire a
resource and the standard cost for the resource. The standard costs to acquire
factory overhead items are not used in calculating factory overhead variances. In
its place, one or more activity measures such as direct labor hours, machine
hours, number of set-ups, and number of orders are used in the calculations of
factory overhead variances. These costs are not standard costs for the
acquisitions of the factory overhead items. It is precisely because of this reason
that we refer to overhead spending, and not overhead cost, variances. If
spending on variable overhead cost is different from planned, the accountant
can perform an analysis for individual variable overhead costs, such as
electricity. Note, however, that this would require more detailed information:
standard electricity cost per kilowatt hour and standard number of kilowatts per
unit produced.
The variable overhead efficiency variance, a component of the total overhead
variance for the period, is the result of inefficient (or efficient) uses of the activity
measure used to construct the flexible (control) budget for the period for the
factory overhead; it is not a result of using more (or less) than the standard
amount of individual factory overhead costs. That is, the variable overhead
efficiency variance is controlled by controlling the use of the activity variable, not
individual variable overhead components. Finally, note that the variable
overhead efficiency variance each period is likely attributed in part to the
imperfect relationship between the activity variable chosen and the incurrence of
variable overhead costs.
14-11 Possible contributing factors to a variable overhead spending variance include:
Prices paid to acquire one or more variable factory overhead items differ from
those specified as standard prices.
Quantities of one or more factory overhead items used in the operation differ
from the standard quantity as determined by the activity measure for applying
factory overhead.
14-12 Because an alternative activity measure usually is used as the basis for applying
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 14-3
factory overhead to production, a variable factory overhead efficiency variance

can be a result of efficiencies or inefficiencies regarding the use of this activity
measure. For example, a favorable factory overhead efficiency variance for a
firm that uses machine hours to apply factory overhead can be a result of the
firms use of fewer machine hours than the standard machine hours for the units
manufactured. In short, the variable overhead efficiency variance does not
measure efficiency regarding consumption of variable overhead costs (electricity,
indirect labor, etc.); it represents an impact on variable overhead cost of
efficiency or inefficiency in the use of the activity measure used to construct the
flexible-budget.
14-13 A fixed factory overhead spending variance is defined as the difference between
the actual fixed factory overhead and the budgeted fixed factory overhead for the
period. A fixed factory overhead spending variance can be a result of
unanticipated changes in spending, for example:
A factory manager was given a bonus or raise that was not in the original
budget.
New machinery and equipment, with attendant depreciation charges, was
acquired during the period but not envisioned in the original budget for the
period.
Clean-up fees or expenses for an unexpected accident.
Failure to properly forecast property taxes for the year (such forecasts are
embodied in the fixed overhead budget for the coming year).
Insurance premiums for factory and equipment were different than
anticipated.
Additional salaried employees, not envisioned when the original budget was
prepared, were added during the period.
14-14 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.
Changes in market demand for the products of the firm.
Lost (decreased) production traceable to poor-quality materials purchased
and used in production during the period.
Poor production scheduling.
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 smallerin the extreme, it would be zero).
14-15 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:
14-4
logical consistency between the numerator and denominator in the

determination of the fixed overhead allocation ratethe numerator
represents spending for the amount of capacity (resources) available while
the denominator represents, in practical terms, the amount of capacity
available.
The resulting volume variance for a period can be thought of as a measure of
capacity utilization and, as such, can be used to inform managerial
judgments regarding the spending on and utilization of manufacturing support
resources (i.e., overhead items).
14-16 Among characteristics that distinguish service firms from manufacturing firms
are:
1.
2.
3.
4.
Absence of output inventory

Predominance of fixed costs
Labor-intensiveness, and
Lack of a common measure for outputs
The production volume of a service firm always equals its sales volume because
it has no output inventory. A production volume variance is not a result of
changes in inventory levels as in the case of some manufacturing firms. The
production volume variance of a service firm measures direct effects that
deviations from the planned activity have on the revenue and operating income
of the period.
Predominance of fixed costs in the total cost structure of many service firms
makes fixed overhead variances important variances for managers to monitor.
Improvements or deteriorations in operating results often are the result of
productive or unproductive uses of resources whose costs are fixed in the short
run.
Labor-intensiveness increases the importance of labor-related measures such
as labor rate and efficiency variances. Many service firms do not measure
materials variances because of the relative insignificance of materials in their
operations.
Lack of a common measure for the output of a service firm often leads
management of the firm to rely primarily on input-based performance measures.
With each patient requiring different care, for example, hospitals often use one
or more input measures such as number of patient-days, number of
admissions/discharges, and number of procedures performed as the basis for
activity analysis and construction of flexible (control) budgets.
14-17 Many firms no longer track and report direct materials price variances because
of the importance and advantages of maintaining long-term relationships with
suppliers. Long-term contractual agreements with suppliers stress reliability of
on-time delivery of quality materials or components at an agreed-upon price

structure. Thus, price variances for material purchases should be small in
amount.
Furthermore, favorable price variances often result from purchasing materials
either in large quantities or of low quality. A favorable price variance obtained
through either practice can substantially increase the total costs to the firm.
14-18 If a standard cost system is used, variances related to overhead costs can be
recorded formally in the accounting records. Such variances, however, are
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)
method to use. Two, one can argue that the incremental information that
results from the more-complicated proration (allocation) method is small
relative to cost involved. Three, some accountants would argue that
variances inherently represent inefficiencies and, as such, should not be
carried forward on the balance sheet (through adjustment to inventory
accounts). Four, when companies maintain minimal inventories, the bulk of
the adjustment for the period under the proration method would go to the
CGS account anyway.
(2) Prorating (allocating) the variance among accounts that contain standard
manufacturing costs. For factory overhead costs, this means that the net
variance can be allocated among WIP inventory, Finished Goods Inventory,
and Cost of Goods Sold (CGS) based on the amount of the current periods
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
method is required in some contexts (e.g., any government contract work for
which the contractor must comply to the standards set by the Cost
Accounting Standards Board [CASB]). Others would defend this approach
because the resulting data approximate actual-cost results.
One variation of the allocation method is to use the total end-of-period dollar
balance (not standard costs from this period) in relevant accounts to determine
allocation percentages. This method is simpler to implement, but would result in
a different end-of-year allocation of the net manufacturing cost variance for the
year compared to the conceptually correct method noted above.
14-19 Factors that need be considered include:
14-6
Magnitude of the variance

Trend of the variance over time
Likelihood that an investigation will eliminate future occurrences of the
variance
Cost and benefit of investigating the variance
BRIEF EXERCISES
14-20 The budgeted supervisory salary per month is:
$360,000
= $30,000 per month
12 months
Thus, the flexible-budget variance for the production supervisory salaries in

August is:
$29,000 $30,000 = $1,000 favorable
14-21 Standard indirect labor cost per unit:
$144,000 per year

= $2.40 per unit
5,000 units per month x 12
Total actual indirect labor cost incurred in April

Total standard indirect labor cost for the 4,500 units
manufactured in April:
4,500 units x $2.40/units =
Indirect labor flexible-budget variance
$10,100
10,800
$ 700 F
14-22 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 x 2 hrs./unit x $5/hr.)
= $250,000 $200,000 = $50,000U
or, = (denominator activity volume SQ) x fixed overhead rate/machine
hr.
= (50,000 hrs. 40,000 hrs.) x $5.00/hour = $50,000U
or, = (denominator output volume actual units produced) x fixed
overhead rate/unit produced
= (25,000 units 20,000 units) x $10.00/unit = $50,000U
That is, fixed overhead was underapplied by $50,000 during the period.
14-23 Variable overhead variances for the year:
14-8
(a) Spending variance = Actual variable overhead - Flexible-budget based on

Inputs
= ($3.90/unit x 20,000 units) (41,000 hours. x $2.00/hr.)
= $78,000 $82,000
= $4,000F
or,
= AQ x (AP SP)
= 41,000 hrs. x ($1.90244 $2.00)/hr.
= $4,000F (rounded)
(b) Efficiency variance = Flexible-budget based on Inputs Flexible-budget

based on output
= $82,000 (20,000 units x 2 hrs./unit x $2.00/hr.)
= $82,000 $80,000
= $2,000U
or,
= SP x (AQ SQ)
= $2.00/hr. x (41,000 40,000)
= $2,000U
14-24 Summary journal entries for the year:

Actual Overhead Costs
Dr. Factory Overhead
Cr. Accumulated DepreciationFactory
Cr. Salaries Payable
Cr. Utilities Payable
$323,000
$150,000
$ 95,000
$ 78,000
Overhead Costs Applied to Production

Dr. WIP Inventory (20,000 units x 2 hrs. x $7.00/hr.)
Cr. Factory Overhead
$280,000
$280,000
14-25 To Record Factory Overhead Variances

Dr. Production Volume Variance
Dr. Variable Overhead Efficiency Variance
Cr. Variable Overhead Spending Variance
Cr. Fixed Overhead Spending Variance
$50,000
$ 2,000
$ 4,000
$ 5,000
$43,000
14-25 (Continued)
To Close the Net Overhead Variance to CGS at Year-End
Dr. CGS
Dr. Variable Overhead Spending Variance
Dr. Fixed Overhead Spending Variance
Cr. Production Volume Variance
Cr. Variable Overhead Efficiency Variance
$43,000
$ 4,000
$ 5,000
$50,000
$ 2,000
14-26 To Allocate the Net Factory Overhead Variance at Year-End

Dr. WIP Inventory (10% of $43,000)
Dr. Finished Goods Inventory (20% of $43,000)
Dr. CGS (70% x $43,000)
$ 4,300
$ 8,600
$30,100
$ 4,000
$ 5,000
$50,000
$ 2,000
14-27 Factory Overhead Variance: Two-Variance Decomposition

(a) Total Overhead Variance = actual overhead - overhead applied to production
= $323,000 $280,000
= $43,000U
(b) Total Flexible-budget Variance = Actual overhead Flexible-budget for
Overhead based on Output
= $323,000 [($2/hr. x 2hrs./unit x 20,000 units) +
$250,000]
= $323,000 $330,000 = $7,000F
or,
= Variable overhead flexible-budget variance + fixed

overhead flexible-budget variance
= [$78,000 (20,000 x $2 x 2)] + [$245,000 $250,000]
= $2,000F + $5,000F = $7,000F
(c) Production Volume variance = budgeted fixed overhead - applied fixed

overhead
= $250,000 $200,000
= $50,000U (i.e., fixed overhead was underapplied by
$50,000 during the year)
14-10
14-28 Summary Journal Entries

(a) Actual Overhead Costs
Dr. Factory Overhead
Cr. Accumulated DepreciationFactory
Cr. Salaries Payable
Cr. Utilities Payable
$323,000
$150,000
$ 95,000
$ 78,000
Overhead Costs Applied to Production

Dr. WIP Inventory (20,000 units x 2 hrs. x $7.00/hr.)
$280,000
$280,000
(b) To Record Overhead Variances Using a Two-Variance Approach

Cr. Total Flexible-Budget Variance
$50,000
$ 7,000
$ 43,000
14-29 End-of-Year Journal Entry to Close Out Variance Accounts

(a) Net Variance Closed to CGS:
Dr. CGS
Dr. Total Flexible-Budget Variance
$43,000
$ 7,000
$50,000
(b) Net Variance Allocated to Ending Inventories and CGS:

Dr. WIP Inventory (10% x $43,000)
Dr. Finished Goods Inventory (20% x $43,000)
Dr. CGS (70% x $43,000)
Dr. Total Flexible-Budget Variance
$ 4,300
$ 8,600
$30,100
$ 7,000
$50,000
EXERCISES
14-30
Variable Factory Overhead Variances (2025 minutes)
1. Standard Variable factory overhead rate per direct labor hour:

BudgetedTotal Variable FactoryOverhead
BudgetedTotal Direct Labor Hours
= $15,000/2,500 hours = $6.00 per direct-labor hour

Standard direct-labor hours per unit:
BudgetedTotal DirectLabor Hours
Budgeted Total Units
= 2,500 hours/5,000 units = 0.50 hours/unit

Variable Overhead Variance Analysis
Actual Cost
(AQ x AP)
2,700 hrs. x $5.7777/hr.
= $15,600
FB Based on
Inputs
(AQ x SP)
2,700 x $6.00/hr.
= $16,200
FB Based on
Output
(SQ x SP)
(4,800 x 0.5) x $6.00/hr.
= $14,400
Spending variance
Efficiency variance
= $600 F
= $1,800 U
or, = AQ x (AP SP)
or,
= (AH SH) x SR
= 2,700 x ($5.7777 - $6.00)
= (2,700 2,400) x $6.00/hr.
= $600F
= $1,800U
Flexible Budget
Based on Output
$14,400
Actual Cost
$15,600
Flexible-budget variance = $15,600 $14,400
= $1,200U
14-12
14-30 (Continued)
2. To Record Favorable Variable Overhead Spending Variance:
Dr. Factory Overhead (or, Variable Factory
Overhead)
$ 600
$ 600
To Record Unfavorable Variable Overhead Efficiency Variance:

$1,800
Cr. Factory Overhead (or, Variable Factory Overhead)
$1,800
3. The factory had a favorable variable factory 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 to manufacture the output of the period (2,700 hours to
make 4,800 units of output) than the standard labor hours allowed (2,400 hours) for
this level of output. As long as direct labor hours worked is related to variable
overhead costs incurred, then the efficiency variance indicates the cost to the
company (in terms of variable overhead) of using 300 extra labor hours this period.
The $1,200 unfavorable flexible-budget variance indicates that the firm did not
exercise good overall control regarding variable factory overhead costs. Again, this
is a valid conclusion provided that direct labor-hour is a reasonably good activity
measure for the consumption of variable factory overhead cost.
14-31 Fixed Factory Overhead Variances (2025 minutes)

1. Standard Fixed factory overhead application rate per direct labor hour (DLH):
BudgetedFixedFactoryOverhead
Total DirectLabor Hours, PracticalCapacity
= $90,000/2,500 hours = $36.00 per DLH

Standard direct-labor hours (DLH) per unit:
Budgeted Total Direct Labor Hours
Practical Capacity Units
= 2,500 hours/5,000 units = 0.5 DLHs per unit

Fixed Overhead Variance Analysis
Applied
Budget
Actual Cost
$36/hr.
$92,000
(SQ x SP)
4,800 units x 0.5 hrs. x
$90,000
Spending variance
= $86,400
Production Volume variance
= $92,000 $90,000
= $90,000 $86,400
= $2,000U
= $3,600U
or, = SP x (Denominator Volume SQ)
= $36/hr. (2,500 hrs. 2,400 hrs.)
= $36/hr. x 100 hrs. = $3,600U
2. Fixed factory overhead (FOH) flexible-budget variance

= FOH spending variance = $2,000U
3. To Record Unfavorable Fixed Overhead Spending Variance
Cr. Factory Overhead (or, Fixed Factory Overhead)
14-14
$ 2,000
$2,000
14-31 (Continued)
To Record Unfavorable Production Volume Variance:
Cr. Factory Overhead (or, Fixed Factory Overhead)
$ 3,600
$ 3,600
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 $3,600 unfavorable production volume variance is a result of the lower output
for the period (4,800 units) as compared to the volume of output (5,000 units)
assumed when the fixed overhead allocation rate was determined. The production
manager is responsible for the unfavorable variance if the reason for the lower
output is a result of activities or events in the factory such as equipment failure,
inefficient workers, or high defective rates. However, the factory is doing its job if the
lower production is a result of the decreased demand for its product. As indicated in
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.
14-32 Three-Variance Factory Overhead Analysis (2025 minutes)

1. Standard Variable factory overhead rate per direct labor hour:
BudgetedTotal Variable Factory Overhead
BudgetedTotal DirectLabor Hours
= $15,000/2,500 hours =
$6.00/DLH
Standard fixed factory overhead rate per direct labor hour:

BudgetedTotal FixedFactory Overhead
Practical Capacity Labor Hours
= $90,000/2,500 hrs. =
$36.00/DLH
Standard factory overhead rate per direct labor hour (DLH)
$42.00/DLH
Standard direct-labor hours (DLH) per unit:

Practical CapacityLaborHours
PracticalCapacity, in Units
0.5 DLH per unit
Three-Variance Overhead Analysis

Flexible Budget
Based on Inputs
AQ x SP
Flexible Budget
Based on Output
(SQ x SP)
Applied
(SQ x SP)
$ 15,600
92,000
2,700 x $6 =$ 16,200
+ 90,000
2,400 x $6 = $14,400
+ 90,000
2,400 x $42
$107,600
$106,200
$104,400
= $100,800
Actual Cost
+
Spending variance
Efficiency Variance
= $107,600 $106,200
= $1,400U
= $106,200 $104,400
= $1,800 U
14-16
Production Volume
Variance
= $104,400 $100,800
= $3,600U
14-32 (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
= $1,800U (that is, there is no fixed overhead efficiency variance)
Production Volume Variance = $3,600U (the same as under the four-way analysis
of the overhead 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
Factory overhead spending variance:
Variable overhead spending variance
$ 600F
Fixed overhead spending variance
2,000U
Factory overhead efficiency variance:
Variable overhead efficiency variance
Factory overhead production volume variance:
Fixed overhead production volume variance
Total Overhead Variance
=
$1,400U
$1,800U
$3,600U
$6,800U
14-33 Two-Variance Analysis of the Total Overhead Variance (2025 minutes)

1. Standard variable factory overhead rate per direct labor hour
$ 6.00
Standard fixed factory overhead rate per direct labor hour
Standard factory overhead rate per direct labor hour
36.00
$42.00
Standard direct-labor hours per unit = 0.5 DLH

Two-Variance Overhead Analysis
Actual Cost
$ 15,600
+ 92,000
$107,600
Flexible Budget Based

on Output
2,400 x $6 = $14,400
+ 90,000
$104,400
Spending variance
= $107,600 $104,400
= $3,200U
Overhead
Applied
2,400 x $42
= $100,800
Production Volume Variance

= $104,400 $100,800
= $3,600U
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
3,600U
$6,800U
That is, three items from the four-variance analysis (viz., variable overhead
spending variance, variable overhead efficiency variance, and fixed overhead
spending variance) are combined into one variance, the Total Controllable (Flexible)
Budget Variance, under the two-variance analysis. The production volume variance
component is the same in the two-variance, the three-variance, and the fourvariance breakdown of the total overhead variance.
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 term is referred to as the Flexible-budget Based on Output.) To motivate
cost-control on the part of managers, the total Flexible-budget Variance is
sometimes (as in this exercise) referred to as the total controllable overhead
varianceit signals to managers the need to control costs vis--vis the amounts
reflected in the flexible-budget based on outputs for the period.
14-18
14-33 (Continued)
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.
14-34
Factory Overhead Variance: Four Variance Analysis (40 Minutes)
1. Total Factory Overhead Application Rate:

Fixed factory overhead application rate:
Total machine hours at practical capacity:
Number of units of output at practical capacity =
40,000
Machine hours per unit
Standard machine hours @ practical capacity
2
80,000
Fixed factory overhead rate per machine hour = budgeted

Fixed Overhead/machine hours @ practical capacity =
$360,000/80,000 machine hours =
$4.50
Variable factory overhead rate per machine hour (given)
Total overhead application rate per machine hour
3.00
$7.50
2. Total Flexible Budget (FB) for Overhead Based on Units Produced:

Total standard machine hours allowed for the units produced
42,000 units produced x 2 machine hours per unit =
84,000 hours
Manufacturing overhead in the flexible budget for 42,000 units:

Variable factory overhead = $3.00/hr. x 84,000 hrs. =
$252,000
Fixed factory overhead (lump-sum amount)
360,000
Total FB for Overhead based on Units Produced
$612,000
3. Production Volume Variance for 2007:

Fixed Overhead:
Actual Cost
Budget
$360,000
Applied
$378,000
= 84,000 hrs. x $4.50/hr.
Production volume variance

= $360,000 $378,000
= $18,000F
or, Production Volume Variance = SP x (Denominator Volume SQ)
= $4.50/machine hr. x (80,000 84,000) machine hours
= $18,000F
14-20
14-34 (Continued-1)
4. & 5.
Actual
VOH
hrs.
FB Based on
Inputs
FB Based on
Output
$3 x 85,000 hrs.
$3 x 84,000 hrs. $3 x 84,000
= $255,000
= $252,000
360,000
$615,000
360,000
612,000
FOH
$625,000
Spending Variance
Efficiency Variance
= $625,000 $615,000
= $10,000U
Applied
= $252,000
$4.50 x 84,000 hrs.
= 378,000
$630,000
Prod. Volume Variance
= $615,000 $612,000
= $3,000U
Total factory overhead incurred
$625,000
FB for Overhead Based on Inputs (i.e., actual machine hours):

Variable factory overhead:
85,000 x $3 =
$255,000
Fixed factory overhead:
360,000
Factory overhead spending variance
$ 10,000U
5. FB for Overhead Based on Inputs (i.e., actual machine hours)

FB for Overhead Based on Output (from 2. above)
(Variable) Factory Overhead Efficiency Variance
615,000
$615,000
612,000
$
3,000U
or, Efficiency Variance = SP x (AQ SQ)

= $3.00/machine hr. x (85,000 84,000) hours
= $3,000U
14-34 (Continued-2)
6.
VOH
Actual
FB Based
on Inputs
(AQ x SP)
$250,000
$255,000
Spending Variance
FOH
FB Based
on Output
(SQ x SP)
Applied
$252,000
Efficiency Variance
= $250,000 $255,000
= $255,000 $252,000
= $5,000F
= $3,000U
$375,000
$360,000
$378,000
Spending (Budget) Variance
= $375,000 $360,000
= $360,000 $378,000
= $15,000F
= $18,000F
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 the Word document.
14-22
14-35 Factory Overhead Flexible Budget and Variance Analysis (40 minutes)
1. Total factory overhead in the master budget (given)
$180,000
Less: Budgeted fixed factory overhead (given)
60,000
Budgeted total variable factory overhead
$120,000
Total machine hours (MH) in the master budget
37,500
Standard variable factory overhead rate per machine hour
$3.20
Standard machine hours per unit:
37,500 MH/150,000 units = 0.25 MH
Flexible Budget (FB) for the 10,800 units produced during the period
Budgeted variable factory overhead:
Number of units manufactured in March
10,800
Standard machine hours per unit
x
0.25
Total standard MH for the units manufactured
2,700
Variable factory overhead rate per MH
x $ 3.20
Total budgeted variable factory overhead
Budgeted fixed factory overhead per month
$60,000 12 =
FB for overhead based on 10,800 units produced in March =
2. Total factory overhead incurred (given)
FB for factory overhead based on output
Factory overhead flexible-budget (controllable) variance
$8,640
5,000
$13,640
$13,000
13,640
$ 640F
3. Total factory overhead spending variance

a. Variable factory overhead spending variance:
Variable factory overhead incurred ($13,000 $4,500)
FB for variable overhead based on Inputs:
Actual machine hours (MH) worked
2,850
Standard VOH rate per MH
x $ 3.20
Variable factory overhead spending variance
Fixed factory overhead spending variance:
Fixed factory overhead incurred
Budgeted fixed factory overhead for the month
Fixed factory overhead spending variance
$8,500
9,120
$ 620F
$4,500
5,000
$ 500F
14-35 (Continued)
b. Variable factory overhead efficiency variance:
Machine hours worked at standard VOH rate (from 3a)
Total standard variable factory overhead for the output
Variable factory overhead efficiency variance
$9,120
8,640
$ 480U
c. Fixed factory overhead production volume variance:

Budgeted fixed factory overhead for the month =
$60,000 12 =
Fixed factory overhead applied to the units manufactured:
Total standard MH for the units manufactured
=
2,700
Standard fixed factory overhead per MH =
Budgeted total fixed overhead Total Budgeted
machine hours (MH) = $60,000 37,500
Factory overhead production volume variance
$1.60
$5,000
4,320
$ 680U
Alternatively, the production volume variance can be computed using the

difference between the budgeted units (in general, the denominator activity level)
and the units actually manufactured during the month:
Units actually manufactured in March
Budgeted units to manufacture per month
= 150,000 12 =
Difference in units
Standard fixed overhead cost/unit = $1.60 x 0.25 MH =
Factory overhead production volume variance
=
10,800
12,500
1,700U
$ 0.40
$ 680U
Alternatively, the production volume variance = standard fixed overhead rate per
MH x (denominator hours SQ)
= $1.60/MH x ([37,500/12] 2,700) MH = $1.60 x (3,125 2,700)
= $1.60/MH x 425MH = $680U
4. Variable factory overhead spending variance (answer 3a)
Fixed factory overhead spending variance (answer 3a)
Variable factory overhead efficiency variance (answer 3b)
Factory overhead FB (controllable) variance (answer 2)
14-24
$620F
500F
480U
$640F
14-35 (Continued)
5. Management of the Lopez Co. should consider using practical capacity as the
denominator volume (denominator activity volume) when establishing its standard
fixed overhead allocation rate. This procedure, contrary to the use of budgeted
activity for the upcoming period, does not spread the cost of unused facilities over
the units produced during the period. Rather, the cost of unused capacity is
reflected in the production volume variance for the period. This variance can be
monitored over time to provide managers with feedback regarding capacity
utilization. Note, too, that when the fixed overhead rate is calculated using practical
capacity as the denominator, the numerator (budgeted spending for capacity-related
costs) is consistent with the denominator (capacity supplied).
14-36 Three-Variance and Two-Variance Analyses (10-15 minutes)

1. a. Total factory overhead spending variance:
Variable overhead spending variance (see 3a, 14-35)
Fixed overhead spending variance (see 3a, 14-35)
$ 620F
500F
Factory overhead spending variance
$1,120F
b. Factory overhead efficiency variance (see 3b, 14-35)
$480U
or, VOH efficiency variance = SP x (AQ SQ)

= $3.20/MH x (2,850 [10,800 units x 0.25MH/unit])
= $3.20/MH x (2,850 2,700) MH
= $3.20/MH x 150 MH = $480U
c. Production volume variance (see 3c, 14-35)
$680U
2. a. Factory overhead controllable (flexible-budget) variance:

Factory overhead spending variance (1a, above)
$1,120F
Factory overhead efficiency variance (1b, above)
480U
Factory overhead controllable variance (see 2, 14-35)

b. Production volume variance (see 3c, 14-35)
$640F
$680U
3. In all cases (four-way, three-way, and two-way variance decompositions) the total
overhead variance for the month of March is the same, $40U, as follows:
Total factory overhead variance = total actual factory overhead factory overhead
applied to production
= $13,000 (10,800 units x 0.25 MH/unit x [$180,000/37,500MH])
= $13,000 (10,800 units x 0.25 MH/unit x $4.80/MH)
= $13,000 (2,700 MH x $4.80/MH)
= $13,000 $12,960 = $40U
14-26
14-37 Flexible Budget and Variances for Depreciation (1520 minutes)

1.
Budgeted depreciation, factory equipment for September:

$258,000 12 =
2.
$21,500
Spending VarianceEquipment Depreciation Expense:

Actual depreciation for the month
$20,500
Budgeted depreciation for the month
21,500
Spending varianceEquipment Depreciation
$ 1,000F
3. Production Volume VariancePortion Pertaining to Depreciation:

Budgeted depreciation for the month
$21,500
Total standard depreciation expense applied:

Total chargeable hours for the month =
8,170
Standard depreciation per chargeable hour:

Total budgeted depreciation Total budgeted
hours = $258,000 103,200 hours =
$2.50
Production Volume Variance Pertaining to Depreciation
20,425
$ 1,075U
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

The company changed the method used to calculate depreciation
An accounting error was found regarding the amount of capitalized cost of
the equipment (i.e., the actual cost is less than what was originally recorded)
The estimated residual value of the equipment was increased, or
The length of the period for calculating depreciation was increased.
14-38 Four-Variance Analysis of Total Overhead Variance (30 minutes)

Fixed factory overhead application rate: $18,000 4,500 = $4.00/DLH
Actual fixed factory overhead: $40,000 $24,150 = $15,850;
Actual variable OH rate/DLH = $24,150/4,200DLHs = $5.75/DLH
Actual
(AQ x AP)
Standard Cost
Flexible Budget
Applied to
Based on Outputs
Production
(SQ x SP)
(SQ x SP)
Flexible Budget
Based on Inputs
(AQ x SP)
Variable (4,200 x $5.75)

(4,200 x $5.00)
(4,000 x $5.00)
Overhead
= $24,150
= $21,000
= $20,000
Spending
Efficiency
Variance = $3,150U Variance = $1,000U
Actual
Fixed
Overhead
Lump-sum
Amount
(4,000 x $5.00)
= $20,000
N/A
Lump-Sum
Amount
Applied
(SQ x SP)
(4,000 x $4.00)
$18,000
= $16,000
Production Volume
Variance = $2,000U
$15,850
$18,000
Spending
N/A
Variance = $2,150F
(4,000 x
$9.00)
$40,000
$36,000
Total
Overhead
Total Overhead Variance = $4,000U (from a product-costing
standpoint this is referred to as total underapplied overhead of $4,000)
Four-Variance Decomposition of Total Overhead Variance for December:
(1) Variable Overhead Spending Variance =
$3,150U
(2) Variable Overhead Efficiency Variance =
$1,000U
(3) Fixed Overhead Spending Variance
$2,150F
(4) Production Volume Variance
$2,000U
$4,000U
14-28
14-39 Graphical Analysis: Variable Overhead Variances (2025 minutes)

(A)
(C)
(D)
Area (G)
Area (I)
Area (H)
(B)
(E)
(F)
Solution:
(A) = Variable Overhead Costs per Machine Hour (label)
(B) = Machine Hours (i.e., the activity measure used to apply variable overhead
costs) (label)
(C) = Actual variable overhead cost per machine hour = AP
(D) = Standard variable overhead cost per machine hour = SP
(E) = Standard machine hours allowed (in total) for output achieved = SQ
(F) = Actual machine hours worked (in total) for output achieved = AQ
(G) = Variable overhead spending variance = AQ x (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 x SP
(I) = Variable Overhead Efficiency Variance = SP x (AQ SQ)
Sum of areas (G), (H), and (I) = actual variable overhead cost for the period = AP x
AQ
14-40 Graphical AnalysisFixed Overhead Variances (3040 minutes)

(A)
(C)
Slope of Line = (D)
(H)
(K)
(J)
(I)
(E)
(L)
(E)
(B)
(F)
(G)
Solution:
(A) = Fixed Overhead Cost (label)
(B) = Machine Hours = Activity Measure for Applying Fixed Overhead Cost (label)
(C) = Applied Fixed Overhead Cost
(D) = Standard Fixed Overhead Application Rate (per Machine Hour)
(E) = Budgeted Fixed Overhead (Lump-Sum Amount)
(F) = Denominator Activity Level (for setting the fixed overhead allocation rate)
(G) = Standard Allowed Machine Hours for Units Produced this Period
(H) = Standard Fixed Overhead Applied to Units Produced = (G) x (D)
(I) = Actual Fixed Overhead Costs Incurred During the Period
(J) = Fixed Overhead Production Volume Variance (= D x (G F))
(K) = Total Fixed Overhead Variance = (J) + (L)
(L) = Fixed Overhead Spending (Budget) Variance = (I) - (E)
14-30
14-41 Fixed Overhead Rate, Denominator Level, and 2-Variance Analysis of Fixed
Overhead Variance (15 minutes)
1. Standard fixed factory overhead rate = budgeted total overhead cost per machine
hour budgeted variable overhead cost per machine hour = $4.50 $3.00 =
$1.50/MH
2. Denominator activity level (used to set the standard fixed overhead allocation rate)
= Budgeted Fixed Overhead/Fixed Overhead Allocation Rate per MH = $7,200
$1.50/MH = 4,800MH
3. Two-Way Analysis (Breakdown) of Total Overhead Variance
Standard OH
Actual
VOH
FOH
Total OH
$28,800
Standard Cost
Flexible Budget
Applied to
Based on Outputs
Production
3,500 x $3 = $10,500
3,500 x $3 = $10,500
$ 7,200
3,500 x $1.50 = $ 5,250
$ 17,700
$15,750
Flexible-budget
(Controllable)
Variance = $11,100U
Production Volume
Variance = $1,950U
Total Factory Overhead Variance = $13,050U

=
Underapplied Overhead
Note: from a product-costing standpoint, we use the term over/under-applied

overhead; for control purposes, the term total factory overhead variance is
typically preferred.
14-42 Performance Reporting: the Use of Standard Cost Variance Information

(2025 minutes)
Among recommended improvements to the cost-variance report currently used by ABC
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
cost variance is not necessarily good and an unfavorable variance is not
necessarily bad.
(2)
The current use of cost-variance information by managers at the ABC

Manufacturing Company seems to be punitive, that is, an attempt to fix blame for
not achieving budgeted costs. This negative use of variance information will most
likely lead to dysfunctional behavioral consequences (e.g., employees gaming
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 costvariance 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
manufacturing cycle-time, depending on the critical success factors associated
with the strategy the company is pursuing.
(4)
The current variance report does not report for manufacturing overhead
controllable vs. non-controllable variances. For example, some decisions,
which have cost implications, are made by the next-higher level of management in
the plant. The cost variance reports to individual line managers should include
only items over which these managers exercise control.
(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 costvariance report. Currently, there is no way to evaluate efficiency (consumption of
resources relative to output); the use of the master budget amounts to calculate
cost variances compounds efficiency and effectiveness dimensions of performance.
The use of a flexible budget (based on output achieved) results in a better
assessment of efficiency of operations since the actual costs incurred during the
period are compared to the budgeted costs that should have been incurred given
the actual output achieved during the period.
14-32
14-42 (Continued)
(7) Level of detail. Variable-cost variances can be decomposed into price and
efficiency effects. It would seem as if the performance report would be improved by
at least allowing for the possibility of including these component variances,
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
(factory overhead) costs, noise is introduced into the variance-decomposition
process. That is, a portion of any calculated variance for overhead is attributable to
the method used to generate estimates of standard costs, against which actual
costs are compared.
14-43 Overhead at Two Activity Levels and 4-Way versus 2-Way Analysis of the
Total Overhead Variance (4550 minutes)
1. Budgeted fixed factory overhead:
Total standard factory overhead at 80% level of theoretical capacity
=
20,000 machine hours (MH) x $12.60/MH =
Budgeted variable factory overhead at 80% level of operation
Budgeted fixed factory overhead (at both 80% and 100%)
$252,000
72,000
$180,000
2. Standard overhead application rates, 2007:

Variable factory overhead rate per machine hour (MH), 2007 = budgeted variable
overhead, 2006 standard direct machine hours allowed for output achieved, 2006
=
$72,000 20,000 MH = $3.60/MH
Fixed factory overhead rate per machine hour, 2007 = Budgeted fixed factory
overhead, 2007 denominator activity hours, 2007 = $180,000 (25,000 MH x
90%) =
$180,000 22,500 MH = $8.00/MH
3. Factory overhead flexible budget for 2007:
Flexible budget for variable factory overhead, based on output in 2007
= (11,300 units x 2 MH/unit) x $3.60/MH =
= 22,600 MH x $3.60/MH
=
$ 81,360
Total fixed factory overhead (same as 2006)
180,000
Total flexible budget for factory overhead, 2007
$261,360
4. Variable Factory Overhead Variances, 2007:

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) =
Total variable overhead variance:
Total factory overhead flexible-budget variance
$12,000U
Fixed factory overhead flexible-budget variance
Actual variable factory overhead incurred
5,000U
$81,360
7,000U
$88,360
14-43 (Continued-1)
Actual Cost
Incurred
$88,360
FB based on Inputs
(i.e., standard VOH cost
for the MH Worked)
23,000MH x $3.60/MH
= $82,800
a. Spending Variance
FB based on Output
(i.e., standard VOH cost
for standard MH allowed)
22,600MH x $3.60/MH
= $81,360
b. Efficiency Variance
= $88,360 $82,800
= $82,800 $81,360
= $5,560U
= $1,440U
Alternative calculations:
a. Variable overhead spending variance = AQ x (AP SP)
= 23,000 MH x ($3.8417391 $3.60)/MH
= 23,000 MH x $0.2417391/MH = $5,560U
b. Variable overhead efficiency variance = SP x (AQ SQ)
= $3.60/MH x (23,000 22,600) MH
= $3.60 x 400 MH =
$1,440U
Fixed Factory Overhead Variances, 2007:
Actual fixed factory overhead incurred = budgeted fixed overhead +/ fixed
overhead spending (budget) variance
Budgeted fixed overhead =
Fixed factory overhead budget variance (given)
$180,000
5,000 U
Actual fixed factory overhead incurred
$185,000
Fixed Overhead Variances:

Actual
$185,000
Budget
$180,000
Spending Variance
= $5,000U
Applied
$180,800
= $800F
14-43 (Continued-2)
Alternative calculation:
Fixed overhead production volume variance, 2007 =
= SP x (denominator volume SQ)
= $8.00/MH x (22,500 MH 22,600 MH)
= $8.00/MH x 100 MH = $800
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
variance = $5,560U + $1,440U + $5,000U
$12,000U
b. Factory overhead production volume variance
$800F
$11,200U
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 11,300 units
produced)
= ($88,360 + $185,000) 1 (22,600 MH x $11.60/MH)2
= $273,360 $262,160 = $11,200U (i.e., underapplied overhead)
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 11,300
units produced)
=
=
=
$273,360 ($180,000 + [22,600 MH x $3.60/MH])

$273,360 ($180,000 + $81,360)
$273,360 $261,360 = $12,000U
c. Production volume variance = FB based on output Applied Overhead

=
$261,360 $262,160 = $800F
Notes:
1
See part 4 above
2
See part 2 above ($3.60/MH variable overhead rate + $8.00/MH fixed
overhead rate)
14-44 Flexible Overhead Budgets for Control (4045 minutes)

Note: An Excel spreadsheet solution file for this assignment is embedded below. You
can open this object by doing the following:
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
the Word document.
14-45 Journal Entries: Factory Overhead Costs and Standard Cost Variances
(5060 minutes)
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
the Word document.
14-46 2-Variance Analysis and Direct Labor Variance (3040 minutes)

1. Break-down of total direct labor variance for April:
Actual
(AP x AQ)
$6.20 x 14,000
= $86,800
FB Based on Inputs
(SP x AQ)
FB Based on Output
(SP x SQ)
? x 14,000 hours
Rate Variance
$2,800 U
? x 15,000 hours
Efficiency Variance
?
Standard direct labor hourly wage rate, SP:

FB Based on Inputs (hours worked)
Actual direct labor hours worked, AQ
Standard direct labor rate per hour, SP =
= $86,800 $2,800 = $84,000

14,000
$6.00
Direct labor efficiency variance:

FB Based on Inputs (i.e., based on actual hours worked) =
FB Based on Output (i.e., SP x SQ) = $6.00 x 15,000
=
Direct labor efficiency variance
$84,000
90,000
$ 6,000F
Alternatively, we can calculate the Direct Labor Efficiency Variance as:

SP x (AQ SQ) = $6.00 x (14,000 15,000) hours =
$6,000F
14-46 (Continued)
2. and 3.
Total
Actual Overhead
$32,000
Controllable
Variance
= $500U
Total Overhead
Variance = $1,750F
Flexible Budget Based on

Outputs (Allowed DLHs)
= $9,000 + (SQ x SPv)
= $9,000 + (15,000 x
$1.50/hr.) = $31,500
Total Applied Overhead=

(SQ x SPt) = 15,000 hrs. x
$2.25/hr. =$33,750
Production Volume
Variance = $2,250F
Legend: SQ = standard labor hours allowed for units produced = 15,000

AQ = actual labor allowed for units produced = 14,000
SPt = standard total overhead cost = $2.25/DLH
SPv = standard variable overhead cost = $2.25/DLH
($9,000/12,000DLHs) = $1.50/DLH
Total Overhead Variance = Actual Overhead - Standard Overhead Applied to
Production
= $32,000 $33,750 = $1,750F
Total Overhead Variance = Controllable (Flexible Budget) Variance + Production
Volume Variance
= $500U + $2,250F = $1,750F
4. When variable overhead costs are related to the number of direct labor hours
worked, then to the extent there is a direct-labor efficiency variance there will a
variable overhead efficiency variance in the same direction. The former variance
reflects the impact on manufacturing costs of using a nonstandard amount of direct
labor hours based on the production for a given period. The latter variance
represents the impact on variable overhead cost of using a nonstandard amount of
direct labor hours for the period. Note, however, the key assumption that there is a
strong relationship between number of labor hours worked (activity) and variable
overhead cost. This reinforces the need for selecting the appropriate activity
measure for applying variable overhead costs.
14-47 Three-Variance Breakdown of Total Overhead Variance (3040 minutes)

1., 2., and 3.
Total Actual
Overhead
$32,000
Spending
Variance
= $2,000U
Total Applied
Overhead=
(SQ x SPt) =
15,000 hrs. x
$2.25/hr. =$33,750
Total Overhead
Variance = $1,750F
Controllable Variance
= $500U
Flexible Budget Based on

Inputs (actual DLHs)
= $9,000 + (AQ x SPv)
= $9,000 + (14,000 x
$1.50/hr.) = $30,000
Efficiency
Variance
$1,500F
Production Volume
Variance = $2,250F
on Output (allowed
DLHs)
= $9,000 + (SQ x SPv)
= $9,000 + (15,000 x
$1.50/hr.) = $31,500
4. Reconciliation of two-variance and three-variance analysis of the total overhead

variance:
(1) Total Overhead Variance = Actual Applied
$1,750F
(2) Two-Way Breakdown of Total Overhead Variance (Ex. 14-46):

Total Flexible-budget (Controllable) Variance
=
=
=
$500U
$2,250F
$1,750F
(3) Three-Way Breakdown of Total Overhead Variance (Ex. 14-47):

Total Overhead Spending Variance
Variable Overhead Efficiency Variance
Production Overhead Variance
=
=
=
=
$2,000U
$1,500F
$2,250F
$1,750F
14-48
Four-Variance Analysis of Total Overhead Variance (40-45 minutes)
Actual
Variable Overhead
= (AQ x AP) =
$21,980
Spending Variance
= AQ x (AP - SP)
= $980U
Total Variable Overhead

Variance = $520F
Controllable Variance
= $520F
Flexible Budget
Based on Inputs =
(AQ x SP) =
$21,000
Efficiency
Variance =
Applied Variable
Overhead
= (SQ x SP)
$22,500
Never a variance
Flexible Budget
Based on Output =
(SQ x SP)
$22,500
SP x (AQ - SQ)
= $1,500F
Legend: SQ = standard labor hours allowed for units produced = 15,000

AQ = actual labor hours worked during the period = 14,000
SP = standard variable overhead cost per labor hour = $1.50
AP = actual variable overhead cost per labor hour worked = $1.57
Total Variable Overhead Variance = Spending Variance + Efficiency Variance
Actual Fixed Overhead

$32,000 $21,980 =
$10,020
Spending Variance
= $1,020U
Total Fixed Overhead

Variance = $1,230F
Budgeted Fixed
Overhead (LumpSum) = $9,000
Applied Fixed Overhead =

(SQ x SP) = 15,000 x $0.75
= $11,250
Production Volume
Variance = SP x (SQ
Denominator Volume) =
$2,250F
Legend: SQ = standard direct labor hours allowed for units produced = 15,000
SP = standard fixed overhead cost per direct labor hour = $9,000/12,000 hours =
$0.75/hour
Denominator Volume = number of labor hours used to calculate the predetermined fixed
overhead application rate = 12,000 hours
Total Fixed Overhead Variance = Spending (Budget) Variance + Production Volume
Variance
14-49 Working Backwards: Total Factory Overhead (3040 minutes)

1.
Flexible Budget
Based on Output (i.e.,
standard allowed MH)
Actual
Costs
hours)
VOH:
?
FOH:
?
Applied Overhead
(based on standard
allowed machine
$600,000
$300,000
Flexible-budget Variance
$600,000
$360,000
$120,000F
Total factory overhead applied to production, 2007:
Variable factory overhead (given)
Fixed factory overhead (given)
$600,000
360,000
Favorable total factory overhead variance
120,000
Actual factory overhead cost incurred, 2007
2.
$840,000
Flexible Budget
Based on Output
(i.e., actual machine hours)
Actual
Costs
hours)
V:
F:
$960,000
Applied Overhead
(based on standard
allowed machine
$600,000
$300,000
$600,000
$360,000
$120,000 F
Flexible Budget for overhead based on output:
Variable factory overhead
Fixed factory overhead
Total favorable flexible-budget variance
Total factory overhead incurred, 2007
$600,000
300,000
$900,000
120,000
$780,000
14-49 (Continued)
3. Budgeted fixed overhead
Total fixed overhead applied to the units manufactured
Production volume variance (for both)
$300,000
360,000
$ 60,000F
4. a. Standard allowed machine hours for this periods production = flexible-budget for
variable overhead based on output standard variable overhead rate per
machine hour
= $600,000 $10.00/MH = 60,000MH
b. variable overhead efficiency variance = SP x (AQ SQ)
= $10.00/MH x (50,000 60,000) MH
= $10.00/MH x 10,000MH = $100,000F
c. variable overhead spending variance = AQ x (AP SP)
= 50,000MH x ([$504,000/50,000MH] $10.00/MH)
= 50,000MH x ($10.08/MH $10.00/MH)
= 50,000MH x $0.08/MH
= $4,000U
d. fixed overhead spending variance = total flexible-budget (controllable) variance
variable overhead efficiency variance variable overhead spending variance
= $120,000F $100,000F $4,000U
= $24,000F
Check: total flexible-budget (controllable) variance = variable overhead efficiency
variance + variable overhead spending variance + fixed overhead spending
variance
= $100,000F + $4,000U + $24,000F
= $120,000F
14-50 Factory Overhead Variances (3040 minutes)

Standard MH per unit: 10,000 MH 5,000 units = 2 MH per unit
1 & 2: Variable factory overhead variances
Flexible Budget
on Inputs (i.e., actual
machine hours)
9,500 x $3 = $28,500
Actual
$32,500

on Output (i.e., standard
allowed machine hours)
(4,500 x 2) x $3 = $27,000
Spending Variance
Efficiency Variance
= $32,500 $28,500
= $28,500 $27,000
= $4,000U (1)
= $1,500U (2)
3 & 4: Fixed factory overhead variances:

Budgeted fixed overhead (given)
$20,000
10,000
Denominator volume (machine hours)

Standard fixed overhead rate per machine hour
Actual
$21,400
Budget
$20,000
Spending Variance
$2.00
Standard Applied
(4,500 x 2) x $2 = $18,000
= $21,400 $20,000
= $20,000 $18,000
= $1,400U (3)
= $2,000U (4)
5. Variable factory overhead spending variance (1, above) =
$4,000U
Fixed factory overhead spending variance (3, above) =
1,400U
Total factory overhead spending variance
$5,400U
14-50 (Continued)
6. Total factory overhead spending variance (5, above) =
Variable factory overhead efficiency variance (2, above) =
Factory overhead controllable variance
$5,400U
1,500U
$6,900U
1.
2.
3.
Right click anywhere in the worksheet area below.

Select worksheet object and then select Open.
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 the Word document.
14-51 ABC Costing (3040 minutes)

Standard MH per unit = 32,000 MH 6,400 units = 5 MH per unit
No. of units manufactured during the period = standard allowed MH standard MH/unit
= 30,000MH 5MH/unit = 6,000 units
Budgeted no. of units/setup = 6,400 units 32 set-ups = 200 units/set-up
Standard no. of setups for the units manufactured = 6,000 200 = 30
FB based on Inputs
(i.e., based on actual
standard
1.
VOH:
Setup
MH
FOH:
Total OH
Actual
activity units)
28 x $600 =
35,000 x $5 =
$480,000
allowed activity units)
$ 16,800
175,000
264,000
$455,800
Spending Variance
= $24,200U
FB based on Output
(i.e., based on
30 x $600 =
30,000 x $5 =
$ 18,000
150,000
264,000
$432,000
Efficiency Variance
= $23,800U
Flexible-budget (Controllable) Variance

= $48,000U
FB based on Inputs
(i.e., on actual
standard
2.
units)
VOH:
Setup
MH
FOH:
Total OH
Actual
FB Based on Output
(i.e., based on
activity units)
28 x $2,600 =
35,000 x $5 =
$480,000
Spending Variance
= $32,200U
$ 72,800
175,000
200,000
$447,800
allowed activity
30 x $2,600 =
30,000 x $5 =
Efficiency Variance
= $19,800U
Flexible-Budget Variance
= $52,000U
$ 78,000
150,000
200,000
$428,000
14-51 (Continued)
3. Standard variable overhead application rate = budgeted variable manufacturing
overhead in the master budget practical capacity (MH)
Setup cost
$64,000 + ($600 x 32) =
Applied based on machine hours
32,000 x $5.00 =
Total variable factory overhead @ practical capacity =
Practical capacity (machine hours)
Standard variable factory overhead rate/MH
FB based on Inputs
(i.e., on actual
activity units)
Actual
$ 83,200
160,000
$243,200
32,000
$7.60
FB Based on Output
(i.e., on standard
allowed activity
units)
VOH:
FOH:
Total OH
$480,000
35,000 x $7.60 = 266,000

200,000
$466,000
Spending Variance
= $14,000U
30,000 x $7.60 = 228,000

200,000
$428,000
Efficiency Variance
= $38,000U
Flexible-Budget Variance
= $52,000U
Notice that assumptions made regarding the number and type of activity measures
used to apply standard overhead costs to production can affect both the total flexiblebudget (controllable) variance and the components of this variance. For this reason,
the activities used to construct flexible-budgets for control purposes should be carefully
selected.
14-52 ABC and Practical Capacity (4045 minutes)

to... while you are in the spreadsheet mode. The screen should then return
you to this document.
14-53 Fixed Overhead Variances (15 minutes)

1. Budgeted monthly salary = $324,000/year 12 mos./year =
$27,000
Actual salary in September
28,000
Budget (spending) variance
$1,000U
2. $0. There is no efficiency variance for fixed overhead. The efficiency variance for
overhead refers to the effect on overhead costs of efficiency or inefficiency in the
use of the activity measure(s) used to construct the flexible-budget for variable
overhead cost.
3. Units manufactured during the month
Standard fixed ovh. rate/unit = ($324,000/year 180,000 units) =
15,750
$1.80
Total fixed overhead applied to production
$28,350
Budgeted monthly fixed overhead cost
27,000
$ 1,350F
4. For product-costing purposes, companies must unitize fixed overhead costs.

This is done by dividing budgeted fixed overhead (i.e., capacity-related
manufacturing costs) by some level of activity, called the denominator volume.
Thus, strictly speaking, the resulting fixed overhead cost per unit is valid only at
the denominator activity level. For this reason, when actual activity is different
from the denominator activity level a production volume variance will occur.
This variance represents the difference between total budgeted fixed overhead
cost and the amount of fixed overhead cost assigned to production. As such, the
variance is referred to as over/under-applied fixed overhead.
14-54 Flexible Budgets with ABC (30 minutes)

(1) Budgeted manufacturing support costs:
Output Level
4,000
5,000
Unit-level support costs:
Electricity
Maintenance labor
Total unit-level support
6,000
$4,000
$6,000
$10,000
$5,000
$7,500
$12,500
$6,000
$9,000
$15,000
Batch-level support costs:

Production set-ups
Incoming inspections
Total batch-level support
$6,000
$1,000
$7,000
$7,200
$1,500
$8,700
$8,400
$2,000
$10,400
Product-level support costs:

Engineering support
$24,000
$30,000
$36,000
Facilities-level support costs:

Factory depreciation
Property taxes/insurance
Total facilities-level support
$15,000
$5,000
$20,000
$15,000
$5,000
$20,000
$15,000
$5,000
$20,000
Total Manufacturing Support
$61,000
$71,200
$81,400
Note: An Excel spreadsheet solution file for part (1) of this assignment is embedded
below. You can open this object by doing the following:
1. Right click anywhere in the worksheet area.
you to this document.
14-54: Cameron Corporation
Inputs
Unit-level support costs:
Electricity
Maintenance labor
$1.00 per machine hour

$1.50 per machine hour
14-54 (Continued)
2. When a single activity measure is used to construct the flexible (control) budget for
factory overhead costs, then all component overhead costs must be categorized as
variable or fixed with respect to changes in this single activity measure. For
example, some overhead costs that are characterized as fixed under the
conventional approach (e.g., with respect to changes in machine hours) are not
fixed in terms of changes in other activities (e.g., number of production runs).
Under ABC, as seen in this example, factory overhead costs are modeled as a
function of several activity measures (cost drivers). As such, the resulting overhead
flexible (control) budget can provide a more accurate benchmark of manufacturing
support costs. For example, some support costs can be modeled as variable with
respect to number of production runs or number of purchase orders.
Note that when a conventional system uses a volume-based cost driver (e.g.,
machine hours), then unit-level manufacturing support costs and facilities-level
support costs under ABC will be treated as variable and fixed costs under a
conventional cost system. As such, differences in cost estimates between ABC and
conventional systems are likely attributable to the different ways that each system
treats batch-level and product-sustaining support costs. In this example, the
traditional system would treat production set-up costs, incoming inspection costs,
and engineering support costs as fixed with respect to volume of output.
From a cost-control standpoint, these differences are important because they affect
the nature (favorable or unfavorable) and dollar amount of the flexible -budget
variances calculated under each system. For further information, the interested
reader can consult any of the following:
Kaplan, R. S. (1994). Flexible-budgeting in an activity-based costing framework.
Accounting Horizons (June), pp. 104109.
Mak, Y. T. and Roush, M. L. (1994). Flexible-budgeting and variance analysis in an
activity-based costing environment. Accounting Horizons (June), pp. 93103.
Ruhl, J. M. (1994). Activity-based variance analysis. Journal of Cost Management
(July/August), pp. 3847.
14-55 Payoff Tables for Variance Investigation (2030 minutes)

(1) Expected value of the decision to investigate the variance:
E(Investigate) = [(I x (1 p)] + [(I + C) x p]
= [($750 x (1 0.15)] + [($750 + $3,000) x 0.15]
= $637.50 + $562.50 = $1,200
(2) Payoff table:
Management
Action
Investigate
Dont Investigate
States of Nature (prob.)

Random (85%) Systematic (15%)
Expected
Value
$750
$3,750
$1,200
-0-
$25,000
$3,750
(3) Let p = the indifference probability, that is, the probability of for a nonrandom
variance such that management is indifferent between the two courses of action,
investigate or do not investigate.
p = I /(L C)
= $750/($25,000 $3,000)
= $750/$22,000 = 3.41%
where I = the expected cost to conduct an investigation, L = expected loss
associated with leaving an out-of-control process out of control (i.e., the present
value of losses the organization will experience until the next decision point), and
C = the expected cost to correct the process if the variance is found to have a
nonrandom cause.
That is, if the probability for a nonrandom cause (or causes) is 3.41%,
management would be indifferent, in expected value terms, between investigating
and not investigating the variance. The expected cost of each course of action to
the organization would be the same. If, as in the present case, p > 3.41%, the
indicated course of action is not to investigate.
14-55 (Continued)
Note: An Excel spreadsheet solution for this exercise is embedded below. You can
you to this document
PROBLEMS
Variable factory overhead
Actual
$352,000
Flexible-budget (FB) based

on Inputs (i.e., hrs. worked)
(AQ x SP)
440,000 x SP
Spending Variance
FB Based on Output
(i.e., allowed hours)
(SQ x SP)
SQ x SP
Efficiency Variance
Fixed factory overhead

Budget
Applied
(Lump-Sum)
(SQ x SP)
200,000 units x $3/unit
= $600,000
396,000 x SP
Actual
$575,000
Spending Variance
Production
Volume
Variance
1.
a. Total units manufactured
Standard hours allowed per unit manufactured
Total standard hours for the units manufactured
198,000
x
2
396,000
b. Standard variable factory overhead rate per hour

Total budgeted factory overhead
Denominator activity (capacity level)
Fixed factory overhead rate per unit
Total budgeted fixed factory overhead
Total budgeted variable factory overhead
Total direct labor hours @ capacity (200,000 x 2)
Standard variable factory overhead rate per hour
$900,000
200,000
x $ 3.00
$600,000
$300,000
400,000
$0.75

= (440,000 396,000) DLHs x $0.75/DLH =
$33,000U
14-56 (Continued-1)
c. Variable factory overhead incurred (given)
FB based on Inputs = 440,000 DLHs x $0.75/DLH
$352,000
330,000

d. Fixed factory overhead incurred (given)
Budgeted fixed factory overhead
$ 22,000U
=
$575,000
600,000

e. Total standard hours allowed for units manufactured
Standard fixed overhead rate/DLH = $3.00 2
$ 25,000F
=
396,000
$1.50
Total fixed factory overhead applied to production
$594,000
Alternative computation:
Units manufactured (given)
198,000
Standard fixed factory overhead rate/unit (given)
x $3.00
Total fixed overhead applied
$594,000
f. Total budgeted fixed factory overhead
$600,000
Total applied fixed factory overhead
$594,000
Fixed factory overhead production volume variance
$ 6,000U
(2) Journal entries:

Dr. Variable Overhead
$352,000
Cr. Accounts payable, etc.
To record actual variable overhead costs for the period.
$352,000
Dr. WIP Inventory ($0.75 x 396,000)

$297,000
Cr. Variable Overhead
$297,000
To apply standard variable overhead costs to production for the period.
$22,000
$33,000
Cr. Variable Overhead
To record variable overhead variances for the period.
$55,000
14-56 (Continued-2)
Dr. Fixed Factory Overhead
$575,000
Cr. Accumulated depreciation, etc.
To record actual fixed overhead costs for the period.
$575,000
Dr. WIP Inventory (396,000 x $1.50)

$594,000
Cr. Fixed Factory Overhead
$594,000
To apply standard fixed overhead costs to production for the period.
Dr. Production Volume Variance$6,000
Dr. Fixed Factory Overhead
To record fixed overhead variances for the period.
$19,000
$25,000
(3) One view of the production volume variance is an artifact of the product-costing
purpose of standard costing. To unitize budgeted fixed overhead for productcosting purposes, a denominator activity level must be chosen over which the
budgeted fixed overhead costs can be spread. If the actual level of activity differs
from the level chosen to establish the fixed overhead application rate, a production
volume variance will occur. From a cost-control standpoint, the production volume
variance, particularly when the denominator activity level is defined as practical
capacity, can be thought of as representing the cost of unused capacity. As such,
this variance information can be monitored over time to help better manage the
supply of capacity-level resources.
The fixed overhead spending variance represents the difference between planned
(budgeted) fixed overhead costs and actual fixed overhead costs for the period. If
management desires, this total variance can be broken down on a line-item basis.
The variable overhead spending variance is partly attributable to the fact that the
measure(s) chosen to budget variable overhead costs are imperfect. In the present
case, a single activity measure, DLHs, is used to construct the flexible (control)
budget for variable overhead cost. We know that such a simplification introduces
error into the variance-determination process. This variance is also attributable to
spending on overhead items being different from expectations. These variances
(e.g., spending on electricity) can theoretically be decomposed into price and
quantity components, much the same as we did in chapter 13 for direct
manufacturing costs.
The variable overhead efficiency variance refers to the impact of manufacturing
overhead of efficiency or inefficiency in the use of the activity measure(s) used to
construct the flexible-budget for variable overhead. It is a misnomer, therefore, to
interpret this variance as measuring the effect of efficiencies/inefficiencies
associated with the consumption of individual variable overhead components.
Note, too, that this variance is affected by the strength of the relationship between
variable overhead cost and the activity measure(s) used to budget these costs for
control purposes. That is, a clean interpretation of this variance exists only if the
relationship between cost and activity is perfect.
14-57 All Manufacturing Variances (4550 minutes)

1. At the time of purchase. Recording the price variance for materials at time of
purchase recognizes the variance at the point it occurs. Further, if the organization
in question uses a standard cost system, then this practice results in the materials
inventory being carried at standard cost, which is consistent with the way WIP
Inventory and Finished Goods Inventory are carried. Finally, recognizing the price
variance at point of purchase provides management with timely information that,
presumably, can be used to correct any problems that arise.
2. Total actual direct labor cost =
(2,000 x $7) + (1,400 x $7.20) =
Total actual hours at the standard hourly rate =
3,400 x $7 =
Direct labor rate (price) variance
3. Total actual direct labor hours at standard wage rates =
0
AQ x SP = 3,400 x $7.00
Total standard direct labor cost for units manufactured
= 800 units x 4 hours/unit x $7.00/hour
Direct labor efficiency variance = SP x (AQ SQ)
4.
AQ
AP
Iron
5,000
$2
Copper
2,200
$3.10
Direct Materials purchase price variance
Price
SP
$2
$3
=
=
=
$23,800
22,400
$ 1,400U
AP-SP
-0$0.10
Price
Variance
-0$220
$220U
SP
$2.00
$3.00
Usage
Variance
$200F
600U
$400U
5.
AQ
SQ
(AQ SQ)
Iron
3,900
800 x 5 = 4,000
100F
Copper
2,600
800 x 3 = 2,400
200U
Direct Materials usage (quantity) variance
$24,080
23,800
$ 280U
6. Actual variable overhead (given)

FB for Variable Overhead based on Inputs (actual hours
worked) = 3,400 hours x $3.00/hours
=
=
=
Alternative formula for variable overhead spending variance:

Variance = AQ x (AP SP)
= 3,400 hours x ([$12,000/3,400 hours] $3.00)/hour
= 3,400 hours x ($3.5294117 $3.00)/hour
= 3,400 hours x $0.5294117/hour
= $1,800U
$12,000
10,200
$1,800U
14-57 (Continued)
7. FB for Variable Overhead based on Inputs (i.e., based on actual
hours workedsee 6 above)
=
Total standard variable overhead applied for units
manufactured = 800 units x 4 hours/unit x $3/hour =
=
$10,200
9,600
$ 600U
Alternative formula for variable overhead efficiency variance:

Variance = SP x (AQ SQ)
= $3.00/hour x (3,400 3,200) hours
= $3.00/hour x 200 hours = $600U
8. Actual fixed overhead (given)
Budgeted fixed overhead = 4,000 hours x $2.00/hour
Fixed overhead budget (spending) variance
9. Budgeted fixed overhead (see 8 above)
Fixed overhead applied to units manufactured
= 800 units x 4 hours/unit x $2.00/hour
$8,800
8,000
$ 800U
$8,000
=
=
Alternative formulae for fixed overhead production volume variance:

Variance = SP x (Denominator activity level SQ)
= $2.00/hour x (4,000 hours 3,200 hours)
= $2.00/hour x 800 hours = $1,600U
Variance = SP x (Denominator volume Actual Units Produced)
= $8.00/unit x (1,000 units 800 units) = $1,600U
6,400
$1,600U
14-58 Straightforward Four-Way Analysis of Total Overhead Variance (4045

minutes)
The following solution is based on the model presented in text Exhibit
14.18.
1. and 2.
Actual
Variable Overhead
= (AQ x AP) =
$108,500
Total Variable Overhead

Variance = $6,500 U
Spending Variance
= AQ x (AP SP)
= $5,300U
Flexible Budget
Based on Inputs
(Actual Machine
Hours) = (AQ x
SP) = $103,200
Efficiency
Variance =
SP x (AQ x SQ)
= $1,200U
Flexible Budget
Based on Output
(Standard Machine
Hours) = (SQ x SP)
$102,000
Applied Variable
Overhead
= (SQ x SP)
$102,000
$0--These two are

always equal
Legend: SQ = standard labor hours allowed for units produced = 8,500 units x 2 hours/unit =
17,000 hours
AQ = actual labor hours worked for units produced = 17,200
SP = standard variable overhead cost per labor hour = ($135,000 x 0.80)/(9,000 units x
2 hours/unit) = $108,000/18,000 hours = $6.00/hour
AP = actual variable overhead cost per labor hour = $6.3081 (rounded)
Total Variable Overhead Variance = Spending Variance + Efficiency Variance
14-58 (Continued)
3. and 4.
Actual Fixed
Overhead
$28,000
Spending Variance
= $1,000U
Total Fixed
Overhead
Variance = $5,050U
Budgeted Fixed
Overhead (Lump
Sum) $27,000
Applied Fixed
Overhead = (SQ x SP)
= $22,950
Production Volume
Variance = SP x
(Denominator Volume
SQ) = $4,050U
Legend: SQ = standard DLH allowed for units produced = 8,500 units x 2 hours/unit =
17,000 hours
SP = standard fixed overhead cost per DLH = ($135,000 x 0.20)/(10,000 units x 2
hours/unit) = $27,000/20,000 DLHs = $1.35/DLH
Denominator Volume = number of DLHs used to calculate the predetermined fixed
overhead application rate = 10,000 units x 2 hours/unit = 20,000 DLHs
Total Fixed Overhead Variance = Spending (Budget) Variance + Production Volume
Variance
5. If the denominator activity level is set at budgeted (planned) output, the fixed
overhead application rate = Budgeted overhead/standard labor hours for planned
output = ($135,000 x 0.20)/(9,000 units x 2 hours/unit) = $27,000/18,000 hours =
$1.50/hour.
Volume variance = SP x (Denominator activity level SQ)
= $1.50/hr. x (18,000 [8,500 units x 2 hours/unit])
= $1.50/hr. x 1,000 hours = $1,500U
When budgeted (planned) output is used to determine the fixed overhead
application rate, the cost of unused capacity is allocated to the units produced.
When practical capacity is used to allocate budgeted fixed overhead costs to
products, the resulting product costs will be lower since the cost of unused capacity
is reported separately (i.e., is not allocated to units produced). The separate
reporting of the cost of unused capacity is thought to inform managerial decisions
regarding spending on capacity-related resources.
14-59 Four-Way Analysis of Total Overhead Variance (45 minutes)

1. Budgeted fixed manufacturing overhead fixed overhead allocation rate/hr.
practical capacity (hours) = $12/hour x 300,000 hours = $3,600,000
a & b: Fixed Manufacturing Overhead Variances
Budget
(Lump-sum)
Actual
$3,750,000
$3,600,000
Production Volume
Variance
= $240,000U
Spending Variance
= $150,000U
c & d: Variable Manufacturing Overhead Variances
Actual
(AQ x AP)
$2,340,000
FB based
on Inputs
(AQ x AP)
275,000 hrs.
x $8/hr.
= $2,200,000
Spending Variance
= $140,000U
Applied
56,000 units x
5 hrs./unit x $12/hr.
= $3,360,000
FB Based on
Output
(SQ x SP)
56,000 units x
5 hrs./unit x $8/hr.
= $2,240,000
Efficiency Variance
= $40,000F
Alternative formulas:
Variable overhead spending variance = AQ x (AP SP)
= 275,000 hrs. x ([$2,340,000/275,000 hrs.] $8.00/hr.)
= 275,000 hrs. x ($8.5090909 $8.00)/hr. =
= 275,000 hrs. x $0.5090909/hr. = $140,000U
Variable overhead efficiency variance = SP x (AQ SQ)
= $8.00/hr. x (275,000 hrs. [56,000 units x 5 hrs./unit])
= $8.00/hr. x (275,000 280,000) hrs.
= $8.00/hr. x 5,000 hrs. = $40,000F
1.
14-59 (Continued)
2. The production manager is right in that the firm probably needs to use a more up-todate base (or set of measures) for applying factory overhead to products and for
constructing its flexible-budgets for control purposes. With an up-to-date system,
the factory overhead variances may disappear or be substantially altered.
The favorable variable overhead efficiency variance is a result of using fewer labor
hours than the number of hours specified in the standard cost system for the output
achieved. However, with an out-of-date standard costing system the firm may have
allowed more variable overhead costs than a more accurate standard cost system
would have. As such, the favorable variable overhead efficiency variance may
decrease or even be unfavorable with an up-to-date standard cost system that relies
on the use multiple cost drivers, including non-volume-based measures, to construct
flexible (control) budgets.
14-60 Find the Unknowns, Four-Variance Analysis (4550 minutes)

Case 1
Actual Operating Level and Costs Incurred
Actual machine-hours worked
Variable factory overhead incurred
Fixed factory overhead incurred
FB Based on Output (allowed machine hours)
Budgeted variable factory overhead
Budgeted fixed factory overhead
Total budgeted factory overhead
Standard cost data
Variable factory overhead rate per machine hour
Fixed factory overhead rate per machine hour
Denominator level (in machine hours)
Total standard machine hours for output achieved
Total standard variable factory overhead applied
Total standard variable overhead for the actual MH
Total standard fixed factory overhead applied
Factory Overhead Variances
Variable factory overhead spending variance
600 K
$7,500 L
$11,400 M
Case 2
Case 3
600 U
$3,960 W
$7,200
1,280
$6,850
$11,500
B $8,800 N $3,960 X
$10,000 O $8,000
C$18,800
$11,960 Y
$6,200
$16,500
$22,700
D $11.00
E $12.50 P
800 Q
F
800
$8,800 R
G $6,600 S
$10,000 T
$900U
H $2,200F
I $1,400U
J
Fixed factory overhead production volume variance
$0
$6.60
$5.00
$12.50 Z
$13.75
640
1,200
600 AA
1,240
$3,960 BB $6,200
$3,960 CC $6,400
$7,500 DD $17,050
$0
$0
$800F EE
$500U
$450U
$200U
$5,000F
$550F
Case 1: Overhead Variance Summary

$7,500
$8,800
$8,800
$900U
Fixed overhead
$11,400
$10,000
$10,000/800
= $12.50/MH;
SQ x $12.50/MH
= $10,000
14-60 (Continued-1)
(B) (Flexible) budget for variable factory overhead = Total standard variable
overhead applied =
$8,800
(C) Total (flexible) budget for factory overhead = $8,800 + $10,000 =
$18,800
(G) Total variable overhead at actual MH = $7,500 $900 =
$6,600
(E) Fixed overhead rate per MH = $10,000 800 =
$12.50
(H) Variable overhead efficiency variance = $6,600 $8,800 =
$2,200F
(F) Total standard MH for the units manufactured = $10,000 $12.50 =
800
(D) Standard variable overhead rate/MH = $8,800 800 =
$11.00
(A) Actual MH spent = $6,600 (G) $11 (D) =
600
(I) Fixed overhead spending variance = $11,400 $10,000 =
$1,400U
(J) Production volume variance = $10,000 (Budgeted) $10,000 (Applied) =
$0

Variable overhead
$6.60 x 600
= $3,960
$6.60 x ?
$0
$3,960
$0
Fixed overhead
600 x ? = ?
$800F
$500U
(K) Actual machine-hours spent (same as total standard hours)
600
(N) Flexible (control) budget variable overhead = $6.60 x 600
$3,960
(R) Total standard variable overhead applied = (N)
$3,960
(L) Actual variable overhead cost incurred (in this case, same
as total standard variable cost applied to production)
$3,960
(S) Total variable overhead for the actual MH worked (in this
case, same as total standard variable cost applied to production) =
$3,960
14-60 (Continued-2)
(O)Total budgeted fixed overhead = $11,960 $3,960 (N)
$8,000
(T) Total fixed overhead applied = $8,000 (O) $500
$7,500
(P) Standard fixed overhead rate = $7,500 (T) 600
$12.50
(Q) Denominator level = $8,000 (O) $12.50 (P)
640
(M) Fixed factory overhead incurred = $8,000 (O) $800
$7,200

Variable overhead
$5 x ?
$450 U
$5 x ?
$200 U
Fixed overhead
$11,500
$16,500
$550 F
(Z) Standard fixed overhead rate =
$16,500 1,200 = $13.75
(DD) Total fixed overhead applied =
$16,500 + $550 = $17,050
(AA) Total standard machine-hours allowed for

the output achieved =
(BB)Total standard VOH applied
(X) Flexible-budget for variable overhead = (BB)
$17,050 (DD) $13.75 (Z) = 1,240

=
$5 x 1,240 (AA) = $6,200

=
$6,200
(CC) Total variable overhead for the actual MH worked = $6,200 (X) + $200 = $6,400
(U) Actual machine-hours spent =
(W) Actual variable overhead incurred =
(Y)Total budgeted factory overhead =
$6,400 (CC) $5.00 = 1,280

$6,400 (CC) + $450 = $6,850
$6,200 (X) + $16,500 = $22,700
(EE) Fixed factory overhead spending variance = $11,500 $16,500 =
$5,000F
14-61 Comprehensive Variance Analysis (60 minutes)

1. Total manufacturing cost for units produced in February
Total standard cost for the units manufactured in February:
$4 per unit x 8,500 units =
Total manufacturing cost variance =
2. Actual fixed overhead (given)
Budgeted fixed overhead per month
= (30,000 hrs. 12) x $1.20/hr.
Fixed overhead budget (spending) variance
3. Total actual hours at standard hourly rate
= (2,300 + 400) hours x $9.00/hr.
Total standard direct labor cost =
= [8,500 units x 0.3 hrs./unit] x $9.00/hr.
$41,670
34,000
$7,670 U
=
=
=
$3,100
3,000
$100 U
$24,300
=
=
22,950
$ 1,350 U
Alternatively, direct labor efficiency variance

= SP x (AQ SQ)
= $9.00/hr. x (2,700 2,550) hrs.
= $9.00/hr. x 150 hrs. =
$1,350 U
4. Total direct labor cost incurred = $23,000 + $6,000

Total actual hours at standard hourly rate
=
=
$29,000*
24,300
$ 4,700 U
$4,700 U
Direct labor rate (price) variance

Alternatively, the direct labor rate (price) variance is
= AQ x (AP SP)
= 2,700 hrs. x ($29,000/2,700hrs. $9.00/hr.)
= 2,700 hrs. x ($10.74074 $9.00)/hr.
= 2,700 hrs. x $1.74074/hr.
* The company includes overtime premiums as part of direct labor cost. A

company that treats overtime premium as variable factory overhead would
have $27,000 as the total direct labor cost incurred and $2,700 as the
direct labor rate (price) variance.
5. Total variable manufacturing cost incurred =
$41,670 $3,100 = $38,570
Total standard variable cost for units manufactured in February:
Total standard cost for the units manufactured
= $4.00/unit x 8,500 =
$34,000
Total standard fixed overhead applied
= $1.20/hr. x (0.3 hr./unit x 8,500 units) = 3,060 30,940
Total variable cost variance
$ 7,630 U
14-61 (Continued-1)
6. Total variable overhead cost incurred (given)
FB for variable overhead based on actual labor hours worked
= 2,700 hrs. x $1.60/hr.
=
=
=
$5,200 *
4,320
$ 880 U
* If the firm considers overtime premiums as variable factory overhead, the

total variable factory overhead cost incurred would be $7,200 and the
variable factory overhead spending variance would be $2,880 U.
Alternatively, the variable overhead spending variance
= AQ x (AP SP)
= 2,700 hrs. x ([$5,200/2,700hrs.] $1.60/hr.)
= 2,700 hrs. x ($1.9259259 $1.60)/hr
= 2,700 hrs. x $0.3259259/hr. =
FB for variable overhead based on actual labor hrs. (above)
FB for variable overhead based on allowed labor hrs.
= (8,500 units x 0.3 hrs./unit) x $1.60/hr.
$ 880U
=
$ 4,320
Alternatively, the variable overhead efficiency variance

= SP x (AQ SQ)
= $1.60/hr. x (2,700 hrs. 2,550 hrs.)
= $1.60/hr. x 150 hrs.
4,080
$ 240U
$ 240U
Variable overhead flexible-budget variance = variable overhead

spending variance + variable overhead efficiency variance
= $ 880U + $240U =
$1,120U
7. Budgeted fixed overhead per month (from 2 above)

=
Total fixed overhead applied =
8,500 x $0.36 per unit =
Production volume variance
=
Alternatively, production volume variance
= SP x (Denominator activity level SQ)
= $1.20/hr. x ([30,000 hrs./12] 2,550 hrs.)
= $1.20/hr. x (2,500 2,550) hrs.
$3,000
3,060
$ 60F
$ 60F
8. Aluminum:
Price variance:
Actual price paid (given)
$ 864
Standard cost for the quantity purchased = 1,800 lbs. x $0.40/lb. =
720
Purchase price variance
=
$144 U
14-61 (Continued-2)
Usage variance:
Standard cost for the quantity used = 1,900 pounds x $0.40/lb. =
Total standard cost allowed for the units produced
= (8,500 units x 0.2 lb./unit) x $0.40/lb.
=
Usage variance ($0.40/lb. x [1,700 1,900] lbs.)
=
$ 760
680
$80 U
Plastic
Price variance (AQ x (AP SP)):
Regular =
3,000 lb. x ($0.50 $0.38)/lb.=
Low grade =
6,000 lb. x ($0.29 $0.38)/lb.=
Purchase price variance
=
Usage variance (SP x (AQ SQ)) = (9,500 8,500) x $0.38/lb. =
$360 U
540 F
$ 180 F
$380 U
The $380 unfavorable materials usage variance is probably the result of using
low-grade plastics. The cost overrun is mitigated by the lower purchase cost
of low-grade plastics that saved $315 (3,500 pounds at $0.09 per pound).
The high rejection rate due to the use of low-grade materials leads to the
need to manufacture more units that, in turn, may have contributed to the
unfavorable direct labor efficiency variance and the need for paying overtime
premium for excess hours worked.
14-62 Standard Manufacturing Cost per Unit (50-60 minutes)

1. Direct materials used:
G27
M14
Total
Number of units manufactured
Actual materials cost per unit manufactured
$270,000
83,400
$353,400
6,200
$57.00
2. Total standard materials cost at 31,000 machine hours

= $260,400 + $80,600 =
Number of machine hours
Standard materials cost per standard machine hour
=
$341,000
31,000
$11.00
Note: either of the other two flexible budgets in the problem could have been used
to generate the $11.00 answer. Since it takes, at standard, 5 MHs per unit, the
standard materials cost/unit = 5 x $11.00 = $55.00.
3. Budgeted direct labor cost for 6,000 units:
Assembler
Grinder
Total
Budgeted number of units
Budget direct labor cost per unit
$273,000
234,000
$507,000
6,000
$84.50
Note: either of the other two flexible budgets in the problem could have been used
to generate the $84.50 answer.
4. Total manufacturing OH at 32,000 machine hours
Total manufacturing OH at 31,000 machine hours
Difference in manufacturing overhead
Difference in machine hours
Variable manufacturing OH rate per machine hour
$647,200
637,100
$ 10,100
1,000
$10.10
Note: the same answer, $10.10 per machine hour, would be obtained by taking the
change in costs divided by the change in machine hours for any two of the three
output levels reflected in the flexible-budget presented in the problem.
14-62 (Continued-1)
5. Total manufacturing overhead in the profit plan (6,000
units of output, or 30,000 standard machine hours) =
Less: Total variable manufacturing OH in the profit plan
= $10.10/unit x 30,000 units =
Total fixed manufacturing OH in the profit plan
Number of machine hours in the profit plan
Budgeted fixed overhead rate per machine hour
Total standard machine hours for the units manufactured
= 6,200 units x 5 hours/unit =
Fixed manufacturing cost per machine hour
Total fixed manufacturing cost applied to production
Total budgeted fixed manufacturing cost for the period
Manufacturing OH production volume variance
$627,000
303,000
$324,000
30,000
$10.80
=
=
31,000
x $ 10.80
$334,800
324,000
$10,800F
Comment: The Cain Company uses a single activity measure as the basis for
product-costing (standard overhead cost per unit produced) and for cost-control
purposes (flexible-budget). If there is a strong relationship between the chosen
activity measure and the incurrence of overhead costs, then this simple approach
has merit. However, more modern approaches to product costing (e.g., ABC)
provide multiple allocation bases for allocating manufacturing support (i.e.,
overhead) costs to products. Such improved cost-allocation procedures provide cost
variances that are both more readily interpretable and economically meaningful,
albeit at an increased cost.
Also, the Cain Company currently uses planned (budgeted) output as the basis for
setting the standard fixed overhead cost per unit. A more appealing approach would
be to use practical capacity volume (defined as a percentage of theoretical
capacity) for setting the fixed overhead allocation rate. Under this approach, the
cost of unused capacity is not assigned to the output of the period. Rather, it is
treated more as a period cost, assigned for control purposes to departments or
managers who are responsible for the capacity-related decisions. Also, the use of
practical capacity as the denominator activity level results in more stable unit costs
over time (as compared to the use of budgeted or planned output, which can
change from period to period). Finally, when practical capacity is used as the basis
for determining fixed overhead allocation rates (under either traditional or ABC
systems) there is a logical consistency between the numerator and denominator in
the calculation(s): the numerator represents spending on capacity-related resources
(i.e., the cost of resources supplied) while the denominator represents the amount of
capacity obtained.
14-62 (Continued-2)
6. Total actual manufacturing overhead (given)
=
$633,000
FB for overhead based on 32,000 machine hours worked:
Variable manufacturing overhead
= 32,000 MH x $10.10/MH =
$323,200
Fixed manufacturing overhead (5, above) =
324,000 =
647,200
Total manufacturing overhead spending variance
= $14,200F
7. Total direct materials cost in the profit plan
Number of units
Budget direct materials cost per unit produced
= $ 330,000
6,000
=
$55.00
Flexible-budget for 6,050 Units of Output:

Direct materials
$55.00/unit x 6,050 units = $332,750
Direct labor
84.50/unit x 6,050 units = 511,225
Manufacturing overhead:
Variable
$10.10/hr. x 5 hrs./unit x 6,050 units = 305,525
Fixed
324,000
TOTAL
$1,473,500
8. Day-to-day control of overhead costs:
a) Fixed Overhead Costs: these costs are essentially capacity-related costs and as
such are typically managed prior to the start of the year (e.g., through capital
budgeting procedures, through the use of zero-based budgeting, etc.). Capacityrelated decisions are of strategic importance: having too much capacity results
in wasted resources; having too little capacity involves opportunity costs (lost
sales and associated profit).
Many overhead costs that traditional accounting systems treat as short-term
fixed costs are variable, in a longer-term perspective, in terms of non-volumerelated activities (such as number of batch-level inspections performed). For
costs associated with these activities, the focus of modern systems (such as
ABC) is to identify non-value added activities (so these activities can be
eliminated) and to develop ways to perform value-added activities more
efficiently (e.g., through process reengineering).
b) Variable Overhead Costs: the key to controlling these support costs is through
an activity-cost analysis (revealed, for example, through ABC). That is, it is
necessary for managers to understand key manufacturing support activities and
then to try to eliminate non-value-added activities and to develop ways to
perform value-added activities more efficiently. Some of these costs are volumebased (i.e., unit-level) support costs (e.g., electricity). These costs can be
controlled using the procedures discussed in chapter 13 where the goal was to
isolate price and usage effects of spending on variable costs. Other
manufacturing support costs that
14-62 (Continued)
traditional accounting systems may treat as variable costs are variable only in
terms of non-volume-related activity measures. These costs, as with capacityrelated costs, can be controlled by reducing consumption of underlying activities
(i.e., operating more efficiently) OR by eliminating non-value-added activities, as
noted above.
Notice the subtle, but critical, message in the preceding answer: generally
speaking, typical accounting systems cannot provide the type of detail that is
needed to appropriately control manufacturing support costs in todays operating
environment.
14-63 Capacity Levels and Fixed Overhead Rates (50 minutes)

1. As the name suggests, maximum (theoretical) capacity is the maximum output
level for the plant, one that assumes operating at maximum efficiency. This
level of productivity suggests no down time for machine maintenance, no
internal disruptions to the manufacturing process, and no slack in external
sales demand. As such, maximum capacity levels are unattainable in the real
world. From a behavioral standpoint, the use of such tight expectations can
be dysfunctional. From a product-costing standpoint, the use of maximum
capacity may result in unrealistically low indicated product costs.
As indicated in the text, at least three other options exist for determining the
denominator activity level when setting the fixed overhead allocation rate:
budgeted (forecasted) activity; practical capacity (i.e., theoretical capacity
reduced by external demand considerations and normal internal losses due to
machine downtime, employee personal time, etc.); and, normal capacity
(expected sales demand over an upcoming three- to five-year period).
2. A revised variance report for Yuba Machine Company using expected
(budgeted) activity as the basis for applying fixed factory overhead is
presented below.
Yuba Machine Company
Revised Variance Report
for Six Months ended May 31, 2008
Total variable factory overhead

Fixed factory overhead:
Salaries
Depreciation and amortization
Other expenses
Total fixed factory overhead
Actual
Costs
Applied
Overhead
Costs
$120,220
$120,000
$ (220)
$ 39,000
25,000
15,300
$ 79,300
$ 40,000
25,000
15,000
$ 80,000
$ 1,000
(300)
$ 700
Variance
Revised Fixed Overhead Application Rate = Budgeted Fixed Overhead/Practical

Capacity (DLHs) = $160,000/80,000 DLHs = $2.00/DLH
Applied Fixed Overhead, First Six Months
Salaries: 40,000 DLHs x $1.00/DLH =
Depreciation and amortization:
40,000 DLHs x $0.625/DLH =
Other expenses: 40,000 DLHs x $0.375/DLH =
Total Applied Fixed Overhead (@$2/DLH) =
$40,000
$25,000
`$15,000
$80,000
14-63 (Continued-1)
3. If the fixed factory overhead rate was based on practical capacity rather than
theoretical (maximum) capacity, Yuba Machine Company's reported operating
income at May 31, 2008 would be $78,000, not $90,000 as reported, a reduction
of $12,000, calculated as follows.
Cost of goods sold (CGS), revised amount:
CGS, as originally reported
Less: fixed OVH included by Sid Thorpe
CGS prior to allocation of fixed overhead
Plus revised fixed OVH ([1.0 0.25] x $80,000 applied)
CGS, revised
$380,000
48,000
$332,000
60,000
$392,000
Yuba Machine Company

Interim Income Statement, Revised
For Six Months Ended May 31, 2008
Sales
CGS ($380,000 + $12,000)
Gross profit
Less:
Selling expense
Depreciation expense
Administrative expense
Operating income
$625,000
392,000
$233,000
$ 44,000
58,000
53,000
155,000
$ 78,000
Principal point: choice of the denominator volume affects product costs. If

resulting overhead variances for a period are closed to CGS (rather than
allocated), then these differences will affect the bottom line.
(4) As noted in part (1), the use of theoretical capacity is generally not recommended,
although perhaps some might argue that in an increasingly competitive environment
this alternative has some merit (since it will result in the smallest, that is, tightest,
standard costs). As discussed in the text, the ultimate choice of the denominator
activity level is affected by subjective considerations, which derive largely from the
fact that the resulting product-cost data can be used for multiple purposes
(performance evaluation, federal income-tax purposes, financial reporting purposes,
etc.). Overall, however, we feel that companies should use practical capacity as the
denominator level in setting fixed overhead allocation rates in conventional
accounting systems and in ABC systems as well.
From a managerial standpoint, the use of practical capacity has a number of key
advantages. For one thing, it reveals the cost of unused capacity (rather than
hiding this cost as part of the cost of good units produced). For another thing, it
helps managers avoid what has been referred to as the death spiral, which can
occur if
14-63 (Continued-2)
management sets selling prices on the basis of full-cost information (in this case, to
include the cost of unused capacity). The use of practical capacity also is consistent
with the way the numerator in the application rate is defined. That is, the numerator
represents planned spending on capacity-related resources and the denominator
represents, in practical terms, the supply of resources made available. Thus, the
resulting cost figure represents the cost of capacity as the cost of capacity supplied,
not cost based on the amount of capacity demanded. The time-series reporting of
the cost of unused capacity (i.e., production volume variances) under practical
capacity enables managers to better manage spending on capacity-related
resources. The use of practical capacity, at least compared to the use of budgeted
activity, results in more stable unit-cost data, which some managers find appealing.
Finally, we note that for U.S. federal income tax purposes, companies are required
to base their overhead rates on practical capacity. So, for all of the above reasons,
we recommend the use of practical capacity as the denominator activity level used
to calculate predetermined fixed overhead allocation rates.

Standard factory overhead rates:
Variable:
$0.25 + $0.34 =
Fixed:
$0.18 + $0.15 + $0.28 =
Total standard factory overhead rate per DLH
=
Total actual factory overhead:
Variable:
$75,000 + $111,000 =
Fixed:
$51,000 + $54,000 + $84,000 =
Total actual factory overhead incurred
$0.59
$0.61
$1.20
$186,000
189,000
$375,000
Standard DLHs per unit:

3,600,000 hours 720,000 units = 5 hours per unit
Total standard direct labor hours for the units manufactured in May:
66,000 units x 5 hours per unit =
330,000 hours
1. Applied overhead costs =
330,000 hrs. x $1.20/hr. =
$396,000
2. Variable-overhead spending variance:

Actual variable overhead incurred (see above)
=
FB for variable overhead based on Inputs (actual hours worked)
= 315,000 hr. x $0.59/hr. =
$186,000
185,850
$ 150 U
Alternatively, variable overhead spending variance

= AQ x (AP SP)
= 315,000 hrs. x [($186,000/315,000hrs.) $0.59/hr.]
= 315,000 hrs. x ($0.5904761 $0.59/hr.)
= 315,000 hrs. x $0.0004761/hr. = $150.00U
3. Variable-overhead efficiency variance:
FB for variable overhead based on Inputs (actual hours worked)
(see 2 above)
= $185,850
FB for variable overhead based on output (allowed hours for
units manufactured in May) = 330,000 hrs. x $0.59/hr. =
194,700
$ 8,850 F
Alternatively, variable overhead efficiency variance
= SP x (AQ SQ) = $0.59/hr. x (315,000 330,000) hrs.
= $0.59/hr. x 15,000 hrs. = $8,850F
14-64 (Continued)
4. Fixed-overhead spending variance:
Total actual fixed factory overhead
Total budgeted fixed factory overhead for May
189,000
183,000
$ 6,000 U
5. Production volume variance:

Total budgeted fixed factory overhead for May
Total standard fixed overhead applied to the
Units manufactured in May: 330,000 units x $0.61 =
$183,000
201,300
$18,300 F
Alternatively, production volume variance

= SP x (Denominator Volume Actual Volume)
= $3.05/unit x (60,000 66,000) units
= $3.05/unit x 6,000 units = $18,300 F
Note: An Excel spreadsheet solution for this problem is embedded below. You can open
this object by doing the following:
14-65 Proration of Variances (40 minutes)

Proration of Direct Materials Variances
Proration of DM
Standard
Price Variance, PV
DM Cost
%
Amount
DM, EI
$ 65,000
13.40
$ 1,340
DM, UV
15,000
3.09
309
FG, EI
87,000
17.94
1,794
CGS
348,000
71.75
7,175
Total
$485,000
100.00
$10,000
Total after
Prorating PV
$ 66,340
15,309
88,794
355,175
$495,000
Proration of DM
Usage Variance
%
Amount
20
80
100
$ 3,062
12,247
$15,309
Net Change
After
Proration
$ 1,340
Total $DM
After
Proration
$ 66,340
1,268
5,072
$5,000
85,732
342,928
$495,000
1. The amount of direct materials price variance, PV, prorated to finished goods ending inventory: $1,794
2. The total amount of direct materials in finished goods ending inventory after proration of all materials variances:
$85,732
Proration of Direct Labor & Manufacturing OH Variances
Direct labor rate variance
Total direct labor variance
Actual manufacturing overhead incurred
Manufacturing overhead applied to:
Finished goods inventory
Cost of goods sold
Manufacturing overhead overapplied
$20,000U
5,000F
$15,000U
$690,000
$104,400
591,600
$
696,000
6,000
14-65 (Continued)
FG
CGS
Total
Total Cost
Before
Proration
321,900
1,679,100
2,001,000
DL Cost before
Proration
Dollar
%
130,500
15
739,500
85
870,000 100
Proration of
DL
OH
Variance
Variance
2,250U
900F
12,750U
5,100F
15,000U
6,000F
Prorated
DM Cost after
Variance
1,268F
5,072F
6,340F
Total
Proration
321,982
1,681,678
2,003,660
3.
The total amount of direct labor in finished goods inventory at December 31, after all variances have been prorated:
$130,500 + $2,250 = $132,750
4.
The total cost of goods sold for the year ended December 31 after all variances have been prorated: $1,681,678
14-66 Working Backwards: 2-Variance Analysis of Total Overhead Variance (20

minutes)
Flexible-budget
Based on Output
Standard
Actual
(standard allowed hours)
Applied
VOH:
18,000 x $4/hr. = $ 72,000
FOH:
Total
+
?
50,000
$122,000
Budget Variance
= $1,000U
= $7,600F
Total flexible budget for factory overhead based on output (i.e., based on standard
allowed hours for the actual units manufacturedsee above):
(18,000 hours x $4/DLH) + $50,000 = $122,000
1. Actual total factory overhead incurred = $122,000 + $1,000 =
$123,000
2. Total factory overhead applied in October = $122,000 + $7,600 =
$129,600
3. Total factory overhead application rate per DLH = $129,600 18,000 =

Variable overhead application rate per DLH =
Fixed factory overhead application rate per DLH
$7.20
4.00
Budgeted total DLHs = Budgeted Fixed Overhead Fixed Overhead

Allocation Rate/DLH =
$50,000 $3.20/DLH
=
$3.20
15,625 DLH
14-67 Four-Variance Analysis of Total Overhead Variance and Summary Journal

Entries (45 minutes)
1.
Standard Factory Overhead Rates
$3,600,000 600,000 DLHs = $ 6.00per DLH
$3,000,000 600,000 DLHs = $ 5.00per DLH
$11.00 per DLH
Variable factory OH
Fixed factory OH
Total
a. & b. Variable manufacturing overhead variances
Actual Cost
$315,000
FB for Variable Overhead

based on Inputs
(i.e., Actual Hours
Worked) = (SP x AQ)
FB for Variable Overhead

based on Output (i.e., on
allowed hours for Units
produced) = (SP x SQ)
53,500 DLHs x
$6.00/DLH
= $321,000
26,000 units x 2 DLH/unit

= 52,000 DLHs x $6/DLH
= $312,000
Spending Variance
Efficiency Variance
= $6,000 F (a)
= $9,000 U (b)
c. & d. Fixed manufacturing overhead variances

Budgeted fixed manufacturing overhead per month:
$3,000,000 12 months = $250,000
Actual
Budget
$260,000
$250,000
Applied
26,000 x 2 x $5 = $260,000
Spending Variance
= $10,000 U (c)
= $10,000 F (d)
e. Under- or overapplied manufacturing overhead

($315,000 + $260,000) ($312,000 + $260,000) = $3,000 underapplied
or, $6,000F $9,000U $10,000U + $10,000F = $3,000 underapplied
14-67 (Continued)
2. Summary Journal Entries (this solution assumes that the company uses an actual
and an applied account for variable overhead and an actual and an applied account
for fixed overhead costs):
Dr. Variable Factory OverheadActual
$315,000
Cr. Utilities Payable, wages payable, etc.
To record actual variable overhead costs for the period.
$315,000
Dr. WIP Inventory

$312,000
Cr. Variable Factory OverheadApplied
To apply standard variable overhead costs to production.
$312,000
Dr. Variable Factory OverheadApplied

$312,000
$9,000
Cr. Variable Factory OverheadActual
To record variable overhead variances for the period.
$6,000
$315,000
Dr. Fixed Factory OverheadActual

$260,000
Cr. Salaries payable, accumulated depreciation, etc.
To record actual fixed overhead costs for the period.
$260,000
Dr. WIP Inventory

$260,000
Cr. Fixed Factory OverheadApplied
To apply standard fixed overhead costs to production.
$260,000
Dr. Fixed Factory OverheadApplied

Dr. Fixed Factory Overhead Spending Variance
Cr. Fixed Factory OverheadActual
To record fixed overhead variances for the period.
$260,000
$10,000
$10,000
$260,000
3. Closing Journal Entry:

Dr. Cost of Goods Sold (CGS)
$6,000
$10,000
$3,000
$9,000
$10,000
14-68 All Variable Manufacturing Cost Variances (5060 minutes)

1. The $44,000 unfavorable variance between budgeted and actual contribution
margin for the chocolate nut supreme cookie product line during April 2007 is
explained by the following variances.
a. Selling price variance = AQ x (AP SP)
Actual:
$3,555,000 450,000 units =
Budgeted:
$3,200,000 400,000 units =
Selling price variance per unit (AP SP):
Number of units (AQ)
Total selling price variance
b. Material price variance = AQ x (AP SP):
Cookie mix:
4,650,000 x ($0.02 $0.02) =
Milk Chocolate:
2,660,000 x ($0.20 $0.15) =
Almonds:
480,000 x ($0.50 $0.50) =
Total
$7.90 per unit

8.00 per unit
$0.10 U
x 450,000
$45,000 U
$
0
133,000 U
0
$133,000 U
c. Material usage variance = SP x (AQ SQ):

Cookie mix:
$0.02 x [4,650,000 (10 x 450,000 units)] = $3,000 U
Milk Chocolate:
$0.15 x [2,660,000 (5 x 450,000 units)] = 61,500 U
Almonds:
$0.50 x [480,000 (1 x 450,000 units)] = 15,000 U
Total
$79,500 U
d. Labor efficiency variance = SP x (AQ SQ):
Mixing: ($14.40 per hour 60 minutes) x
(450,000 minutes [1 min. x 450,000]) =
Baking: ($18.00 per hour 60 minutes) x
(800,000 minutes [2 min. x 450,000 units]) =
Total
30,000 F
$ 30,000 F
e. Variable overhead efficiency variance = SP x (AQ SQ)

Standard variable overhead rate per minute, SP:
$32.40/DLH 60 minutes/DLH =
$0.54
Standard hours (in minutes), SQ:
3 minutes x 450,000 units =
1,350,000
Actual hours (in minutes), AQ:
Mixing:
450,000
Baking
+ 800,000 1,250,000
Difference in minutes = (AQ SQ)
x 100,000
$54,000 F
14-68 (continued-1)
f. Variable overhead spending variance = actual variable overhead
(actual minutes x standard overhead rate)
Actual minutes:
1,250,000
Standard variable OH rate per minute:
x $0.54
$675,000
Actual total variable overhead
750,000
$75,000 U
g. Sales volume variance, in terms of contribution margin =
Budgeted cm/unit x (AQ Budgeted Quantity)
Budgeted contribution/unit:
Total budgeted CM
$1,636,000
Budgeted total units (lbs.)
400,000
Difference in units:
Actual total units (lbs.)
450,000
Budgeted total units (lbs.)
400,000
Sales volume variance
Contribution Margin Variance AnalysisSummary:
a. Sales price variance
b. Material price variance
c. Material quantity variance
d. Labor efficiency variance
e. Variable overhead efficiency variance
f. Variable overhead spending variance
g. Sales volume variance
Total
$4.09
x
50,000
$204,500 F
$ 45,000 U
133,000 U
79,500 U
30,000 F
54,000 F
75,000 U
204,500 F
$ 44,000 U
2. a. DLHs may not be the most appropriate base for Aunt Molly's Old Fashioned
Cookies because it may not be the activity that drives variable overhead costs. A
good indication of this disconnection is shown in the variance analysis. The
labor efficiency variance is favorable, while the variable overhead spending
variance is unfavorable. Another problem is that baking requires considerably
more power than mixing. As such, indicated product costs might be distorted if
DLHs rather than a more meaningful activity measure were used to assign
factory overhead costs (i.e., manufacturing support costs) to products.
b. Activity-based costing (ABC) may solve the problems described in Requirement
2a above and, therefore, is an alternative that Aunt Molly's should consider.
Since DLH does not seem to have a direct cause-and-effect relationship with
variable overhead costs, the company should try to identify the activity or
activities that drive these costs. If the same proportion of these activities is used
in all of Aunt Molly's products, then ABC may not be worthwhile, in a cost-benefit
sense; however, if the products require a different mix of these activities, then
ABC might be worthwhile because it yields more accurate product-cost data ( for
decision-making) and more accurate flexible-budgets (for cost-control purposes).
14-68 (Continued-2)
Note: An Excel spreadsheet solution for part (1) of this problem is embedded below.
You can open this object by doing the following:
1. Right click anywhere in the worksheet area.
14-69 Comparing Actual with Budgeted Overhead Costs (45 minutes)

1. The four cost variances covered below in items (a) (d) provide the basis for a
reconciliation of the $41,900 variance between budgeted and actual factory
overhead costs for November 2007.
a. Sales volume variance, measured in terms of variable overhead cost
= (Actual units Budgeted units) x Standard variable overhead rate
= (82,000 80,000) x $1/unit =
$2,000 U
b. Variable overhead efficiency variance = (Actual hours Standard hours allowed
for output achieved) x Standard variable overhead rate/hour = SP x (AQ SQ)
$246,000 $12/DLH =
20,500 DLHs
Standard hours allowed, SQ = 82,000 units x 0.25DLH/Unit =
20,500 DLHs
Actual hours worked, AQ =
Difference in hours, AQ SQ =
-0-
Variable overhead efficiency variance =
$0
c. Variable overhead spending variance = Actual variable overhead FB based on

Output = Actual variable OVH (Actual units x Standard variable overhead rate)
= $98,400 (82,000 x $1/unit) = $98,400 $82,000 =
$16,400 U
Alternatively, VOH spending variance = AQ x (AP SP)

= 20,500 DLHs x ([$98,400/20,500DLHs] $4.00)/DLH =
= 20,500 DLHs x ($4.80 $4.00)/DLH =
$16,400 U
d. Fixed overhead spending variance

= Actual fixed overhead cost Budgeted fixed overhead cost
= Actual fixed OVH cost [Total budgeted OVH budgeted variable OVH]
= $143,500 [$200,000 (80,000 x $1)]
= $143,500 $120,000 =
$23,500 U
Reconciliation of factory overhead master budget variance
Sales volume variance, in terms of VOH costs
$ 2,000 U
-0-
16,400 U
Fixed overhead spending variance
23,500 U
Total overhead master budget variance
$41,900 U
14-69 (Continued)
2. Bob Ricker is likely to be pleased with some of the information provided by the
analysis and should be motivated to seek new productivity improvements.
Nevertheless, some of the information may be confusing and cause him to be
concerned about some areas of the budget:
The variable overhead sales volume variance shows that $2,000 of the total
variance was due to the increase in production from 80,000 to 82,000 units; if
Ricker was authorized to produce 82,000 units, this variance is strictly a
budgeting problem.
Of the factory overhead variances the one that is most likely to reflect his
performance is the factory overhead efficiency variance. The report shows the
operation meets the efficiency standard. The variable overhead efficiency
variance, which is zero, shows that direct labor has been productive. The other
variances are likely to contain the effects of factors beyond Bobs control.
The variable overhead spending variance, from the information provided, shows
that most of the variance is due to overspending on indirect labor and power
usage. Ricker may be responsible for indirect labor and should be concerned
about looking for the causes of the overspending and implementing corrective
action.
The fixed overhead spending variance reflects items in fixed overhead that
would not generally be under Ricker's control. However, there is a significant
increase in quality inspection expenses. As the quality of the work that Ricker is
responsible for may affect expenditures in this area, he may wish to investigate
this area more thoroughly.
14-70 (Appendix): Variance Investigation under Uncertainty (2025 minutes)

1. Payoff Table
States of Nature
Courses of Action
Investigate
Dont Investigate
In-Control
Out-of-Control
(1 p) = 0.80
p = 0.20
$20,000
$0
$20,000 + $50,000
$250,000
2. Expected cost of conducting:

An investigation:
($20,000 x 0.8) + ($70,000 x 0.2) =
No investigation:
$250,000 x 0.2 = $50,000
$30,000
Based on the expected value of each course of action (decision alternative), the
manager should not conduct an investigation: the expected cost of making an
investigation > expected cost of not conducting an investigation.
3. Expected Value of Perfect Information (EVPI) = maximum value the manager would
pay to have knowledge (i.e., certainty) of whether the process is in control or out of
control. In this decision context, the EVPI can be thought of as the difference
between the expected cost with perfect information and the expected cost without
perfect information. (To calculate the former, we need to choose for each possible
state of nature the better course of action [decision] and then multiply the
associated cost by the probability of that state of nature occurring. We then sum
these resulting expected costs to get the expected cost with perfect information.)
EVPI = expected (average) cost with perfect information expected cost without
perfect information
= [($20,000 x 0.80) + ($250,000 x 0.2)] $30,000 = $36,000
= ($16,000 + $50,000) $30,000 = $66,000 $30,000 = $36,000
14-71 (Appendix): Investigation of Variance under Uncertainty (25 min)

2.
Payoff Table
State of the Market
Possible
Courses of
Action
Expected Value
of Each Action
Strong
Weak
Prob. = 0.6
Prob. = 0.4
Advertising
$10,000,000
$4,000,000
$7,600,000
No Advertising
$8,000,000
$5,000,000
$6,800,000
Yes, the firm has a higher expected profit with advertising ($7,600,000) than
without advertising ($6,800,000). Note that this conclusion is valid for decisionmakers who are risk-neutral.
2. Let p be the probability that the market is strong; thus, the probability that the
market is weak is 1p.
At the indifference point:
E(Advertising) = E(No Advertising)
$10,000,000 p + $4,000,000 (1p) = $8,000,000 p + $5,000,000 (1p)
p = 1/3 and (1 p) = 2/3
The manager is indifferent when the chance of a strong market is 33%.
3. EVPI = Expected (i.e., long-run average) profit with perfect information expected
(i.e., long-run average) profit without perfect information
= [($10,000,000 x 0.6) + ($5,000,000 x 0.4)] $7,600,000
EVPI = $8,000,000 $7,600,000 = $400,000
The maximum amount, on an expected-value basis, that a rationale decisionmaker would pay for perfect information is $400,000. On average, perfect
information would return $8,000,000 per year, which is $400,000 more than the
expected payoff under uncertainly, $7,600,000 (see payoff table above).
14-72 (Appendix): Variance Investigation Under Uncertainty (20 minutes)

Let p be the probability of the departmental labor process being out-of-control, I
= the cost of conducting an investigation ($6,000), the anticipated cost, C, to
correct an out-of-control process = $18,000, and the accumulated costs, to the
next decision point, of an out-of-control process = $33,000. Then,
Payoff Table
States of Nature
Courses of Action
Investigate
In-Control
Out-of-Control
1p
$6,000
Do Not Investigate
$0
$6,000 + $18,000
$33,000
From the above payoff table, we can represent the problem as follows: we are
looking for the probability, p, such that the expected cost of each decision
alternative (course of action) is the same. That is,
E(Investigate) = E(Do Not Investigate)
$6,000 x (1p) + $24,000p = $33,000p
$15,000p = $6,000
p = 0.40
Thus, if the probability of the process being out-of-control, p, is 40%, the
decision-maker would be indifferent between conducting and not conducting an
investigation of the reported variance: the expected cost associated with each
decision alternative would be the same.
We can also use the formula in the text to calculate the indifference probability,
p:
p = I / (L C) = $6,000/($33,000 $18,000) = 0.40
14-73 Two-Variance Analysis: Service Company Example (30 minutes)

14-73 Two-Variance Analysis: Service Company Example (30 minutes)
1. Budgeted number of letters of credit approved: $1,000,000 $2,000 = 500
Overhead application rates:
Variable: $2,000/letter of credit (given) + 1% of the amount of credit issued
Fixed:
($500,000 + $50,000 + $10,000) 500 = $1,120/letter of credit issued
3. Actual overhead costs incurred:
Variable:
Fixed:
Total
$2,000 x 600 x 0.75 x 110% =$990,000

Insurance premium
270,000
$560,000 x 95% =
$1,260,000
532,000
$1,792,000
Flexible Budget:
Variable:
$2,000 x 600 x 0.75

Insurance premium
$270,000 0.9 =
=
$900,000
=
300,000 $1,200,000
Fixed
560,000
Total
$1,760,000
Overhead controllable (flexible-budget) variance
$ 32,000 U
Flexible-budget:
$1,760,000
Overhead applied
$3,120 x 600 x 0.75 = $1,404,000

$2,700,000/(1 - 0.10) =
300,000
Overhead volume variance
1,704,000
$
56,000 U
Total overhead variance for the period = actual overhead costs applied overhead
costs
= $1,792,000 $1,704,000 = $88,000 underapplied
14-74 Ethical Considerations (40 minutes)

1.
Operating income as currently reported

Production volume variance:
($9,600,000)
$9,000,000 x 0.2 =
Operating income before adjusting for volume variance
1,800,000 U
($7,800,000)
Current fixed overhead application rate per machine hour:

$9,000,000 50,000 machine hours =
$180.00
Revised fixed overhead application rate per machine hour:

$9,000,000 2,500,000 machine hours =
3.60
Decrease in fixed overhead application rate per machine hour

Total standard hours for the units manufactured in 2007
Decrease in fixed overhead applied (= increase in reported
operating income if the volume variance is capitalized)
Revised operating income (under given assumptions)
$176.40
x
40,000
$7,056,000
($744,000)
Changes in operating income

Operating income as currently reported
Revised operating income
($9,600,000)
( 744,000)
Change (improvement) in operating income
$8,856,000
Elimination of unfavorable production volume variance
$1,800,000
or,
Decrease in fixed overhead applied to production
Change (improvement) in operating income
2.
7,056,000
$8,856,000
As indicated by the discussion in the text, there is a great deal of judgment

involved in determining the denominator activity level used to set the
predetermined fixed overhead application rate. That is, there is not necessarily a
clear-cut answer to this issue. Possible denominator levels include: budgeted
(forecasted) output, normal capacity, practical capacity, or theoretical capacity.
The numbers assumed in this problem might be viewed as extreme or contrived,
but this was done to drive home the point to students that choices made regarding
the treatment of fixed overhead for product-costing purposes, including how
variances are disposed of for reporting purposes, can affect the amount of
operating profit that an organization reports. That is, these choices can be used by
managers to smooth reported earnings (i.e., can be used to increase or to
decrease reported accounting income).
14-74 (Continued)
Our position is that a certain amount of latitude should be afforded managers in
regard to setting fixed overhead rates (specifically, choice of denominator activity
level) and the manner in which standard cost variances are treated at the end of
the year. Thus, one approach to this question is to focus on intent. Here the IMAs
Statement of Ethical Professional Practice (www.imanet.org) may be helpful. This
statement refers to four ethical standards of behavior for management
accountants: Competence; Confidentiality; Integrity; and, Credibility. The present
case raises issues regarding the fourth of these standards, Credibility. Each
member (of the profession) has a responsibility to: communicate information fairly
and objectively; and, to disclose all relevant information that could reasonably be
expected to influence an intended users understanding of reports, analyses, or
recommendation.
Under this standard, therefore, one might argue that it would be unethical for the
VP of Finance to change the denominator activity level solely to improve reported
operating results, particularly when these results would then be communicated to
financial analysts (i.e., to the market). At a minimum, full disclosure would dictate
that this corporate executive would accompany any such operating results with
details regarding the treatment of fixed overhead costs for product-costing and
income-determination purposes.
Finally, students might note that the standard of competence applies to the given
scenario. Part of this Standard states that members are expected to perform
professional duties in accordance with relevant...technical standards. At issue is
whether a production volume variance should be capitalized (carried forward on
the balance sheet). In order to do this, one would have to maintain that this item
meets the test of being an assetthat is, something that would benefit one or
more future periods. The underlying costs associated with a production volume
variance are capacity-related costs which, by definition, expire with the passing of
time. Thus, by capitalizing the volume variance the VP of Finance may, in fact, be
violating a basic accounting standard.
14-75 ABC versus Traditional Approaches to Control of Overhead Costs (50

minutes)
Additional information needed to solve this problem (highlighted in bold):
Units produced and sold

Batch size (units)
No. of batches
Set-up hours per batch
Total Set-up hours
Variable OVH cost per set-up hour
Total set-up-related variable overhead costs
Fixed set-up-related costs per year
Fixed set-up-related costs/set-up hour:
$20,000/160 hours
$21,000/191.25 hours
Budgeted
Results
10,000
250
40
4
160
$20.00
$3,200
$20,000
Actual
Results
9,000
200
45
4.25
191.25
$19.00
$3,633.75
$21,000
$125.00
$109.804
Note that the control (flexible) budget for set-up-related variable overhead costs should
be based in this case on set-up hours (the controllable factor). Thus, given an output
last year of 9,000 units, the company should have used 36 batches (9,000 units/250
units per batch). At a standard of 4.0 set-up hours per batch, the 9,000 units produced
equates to 144 set-up hours.
(1) (a) Fixed overhead spending variance = Actual fixed setup-related costs budgeted
fixed setup-related costs = $21,000 $20,000 = $1,000U
(b) Production volume variance = budgeted fixed setup-related costs applied fixed
setup-related overhead costs= $20,000 (36 batches x 4 setup-hours/batch x
$125.00/setup hour) = $20,000 $18,000 = $2,000U
Total fixed overhead variance = fixed overhead spending variance + production
volume variance = $1,000U + $2,000U = $3,000U
As the name implies, the fixed overhead spending variance means that last
spending on setup-related fixed overhead costs was $1,000 more than what was
envisioned when the master budget was prepared. The production volume
variance in this context means that capacity, measured in terms of budgeted
setup hours, was not fully utilized during the period. Specifically, the standard
allowed setup hours (for this years production), 144, was 16 less than capacity
available (160 hours). Thus, $2,000 = 16 hours x $125/hour.
14-75 (Continued-1)
(2) (a) variable setup-related overhead spending variance = actual variable setuprelated overhead costs budgeted variable setup-related overhead costs based
on inputs (i.e., based on actual setup hours worked during the year)
= (actual batches x actual setup hours/batch x actual variable setup-related
overhead costs/setup hour) (actual batches x actual setup hours/batch x
budgeted variable setup-related overhead costs/setup hour)
= (45 batches x 4.25 setup-hours/batch x $19.00/setup hour) (45 batches x
4.25 setup-hours/batch x $20.00/setup hour)
= $3,633.75 $3,825.00 = $191.25F
(b) variable setup-related overhead efficiency variance = FB for variable setuprelated overhead costs based on Inputs FB for variable setup-related
overhead costs based on Outputs
= $3,825 (36 batches x 4 setup-hours/batch x $20.00/setup hour)
= $3,825 $2,880 = $945U
The favorable spending variance is attributable to spending on variable setuprelated overhead costs being $1.00 per hour less than budgeted. This amount
could be broken down further if we had additional data regarding the
components of this cost (i.e., materials and electricity costs). The unfavorable
efficiency variance for variable setup-related overhead costs is due to a
combination of the following two factors: (1) the actual output of the period
(9,000 units) took 9 more batches than standard (actual # of batches = 45;
standard allowed batches = 36, as shown above); and (2) each setup took
slightly more time than standard (4.25 hours/setup vs. 4.00 hours/setup). The net
unfavorable variable setup-related overhead variance indicates that the
favorable spending variance was not enough to offset the unfavorable efficiency
variance.
(3) Fixed setup-related overhead costs are controlled primarily prior to the point of
operations. That is, they are controlled primarily through the planning process (for
example, the capital budgeting process or the use of zero-based budgeting). These
costs basically relate to the capacity/ability to produce.
On the other hand, variable setup-related costs, by definition, vary in response to
one or more underlying causal factors (cost drivers). Therefore, these costs are
controlled by attempting to identify and eliminate non-value-added activities and to
perform value-added activities more efficiently. ABC systems, because of their
focus on costing of activities, should provide greater control of variable setuprelated overhead costs, compared to the use of traditional systems. For example, in
this problem we assumed that prior to the current year the company in question
allocated all setup-related overhead costs by a single, volume-based activity
measure: number of machine hours. This approach (a) fails to recognize that some
of these overhead costs are capacity-
14-75 (Continued-2)
related and therefore controlled differently, and (b) fails to identify meaningful
strategies for cost control. When machine hours are used as the basis for cost
allocation and some costs (as in this case) are not related to machine hours, then
the variable overhead spending variance based on machine hours will include the
effect of spending on these other activitiesin other words, the reported variance
does not yield actionable information. Further, the use of ABC allows the
accountant to isolate spending and efficiency variances at different levels in the
cost hierarchy. As in the present case, the analysis of batch-level support costs
would reveal financial tradeoffs of using larger lot sizes compared to the lot size
assumed for flexible-budgeting purposes.
(4) Most companies find that a comprehensive control system consists of both financial
and nonfinancial performance indicators. Thus, one would expect that operating
units in the Bangor Manufacturing Company would have timely access to
nonfinancial performance indicators such as process yields (e.g., ratio of good
outputs to inputs), manufacturing processing time, reject rates, percent first-pass
yield, defect rates (e.g., parts-per-million, ppm), etc. Such information has the
advantage of being expressed in a manner that is readily interpretable by operating
personnel. As well, these data direct worker attention to actionable steps when a
process is perceived to be out of control. The financial performance indicators are
also helpful. For one thing, they provide a common measure (dollars) that
managers can use to evaluate tradeoffs (e.g., larger lot sizes). For another thing,
dollar-based variance information provides decision-makers with information that
can be used to determine which variances should be investigated. Finally, the
periodic financial performance indicators remind operating personnel of the
financial impact of their actions and decisions.
14-76 Income-Statement Effects of Alternative Denominator Activity Levels (4550

minutes)
(1) Production Volume Variance:
Alternative
Theoretical
Practical
Normal
Budgeted
Budgeted
Fixed
Overhead
$350,000
$350,000
$350,000
$350,000
Standard
Fixed OVH
Rate/Hour
$11.6667
$12.9630
$14.0000
$14.5833
Standard
Allowed
Hours
24,500
24,500
24,500
24,500
Fixed OVH
Applied to
Production
$285,833
$317,593
$343,000
$357,292
Production
Volume
Variance
$64,167U
$32,407U
$7,000U
$7,292F
(2) Ending Inventory of Finished Goods:

Beg. Inventory
Plus: Units Produced
Less: Units Sold
Units in End. Inventory
Mfg. Cost/Unit:
Variable
Fixed
Total
End. Inv. @ Std.
Cost
Theoretical
0
12,250
11,500
750
Practical
0
12,250
11,500
750
Normal
0
12,250
11,500
750
Budgeted
0
12,250
11,500
750
$60.25
$23.33
$83.58
$60.25
$25.93
$86.18
$60.25
$28.00
$88.25
$60.25
$29.17
$89.42
$62,688
$64,632
$66,188
$67,063
(3) Profit Reports:

Theoretical
Revenues
$1,150,000
CGS (@ Standard Cost)
$916,021
Plus/Minus Vol. Variance
$64,167
CGS, Adjusted
$980,188
Gross Profit
$169,813
Less: Operating Expenses:
Variable
$56,925
Fixed
$65,000
Total
$121,925
Operating Profit
$47,888
Gross Profit %
Operating Profit %
14-76 (Continued-1)
14.77%
4.16%
Practical
$1,150,000
$945,836
$32,407
$978,243
$171,757
Normal
Budgeted
$1,150,000 $1,150,000
$969,688
$983,104
$7,000
($7,292)
$976,688
$975,813
$173,313
$174,188
$56,925
$65,000
$121,925
$49,832
$56,925
$65,000
$121,925
$51,388
$56,925
$65,000
$121,925
$52,263
14.94%
4.22%
15.07%
4.47%
15.15%
4.54%
Calculation of Cost of Goods Sold @ Standard Manufacturing Cost:

Theoretical
Beginning Inventory
$0
Plus: Cost of Goods Manufactured:
Variable Mfg. Costs1
$692,875
Applied Fixed OVH2
$285,833
Goods Available for Sale
$978,708
Less: Ending Inventory
$62,688
CGS @ Standard Cost
$916,021
Practical
$0
$692,875
$317,593
$1,010,468
$64,632
$945,836
Normal
$0
Budgeted
$0
$692,875
$692,875
$343,000
$357,292
$1,035,875 $1,050,167
$66,188
$67,063
$969,688
$983,104
Notes:
1
$60.25/unit (given)
2
See part (1)
(4) The primary point of the preceding analysis is that once it is maintained that
products should be costed at full (absorption) cost, there is a need to unitize
budgeted fixed overhead (manufacturing support) costs. To do this, the accountant
must assume a level of activity over which the budgeted fixed costs can be spread.
Differences in assumed activity level, as the example above shows, lead to
differences in per-unit manufacturing costs and, in turn, in the amount of the
production volume variance (over- or under-applied budgeted fixed overhead). The
situation is further clouded by two factors: (a) costs are allocated to products for
different purposes (e.g., planning and control, motivation, to meet financial reporting
requirements) and depending on the purpose, different denominator activity levels
might be appropriate; and (b) there are different end-of-year treatments for the
disposal of the production volume variance that occurred during the year. Choice of
the denominator activity level and some latitude in terms of how resulting volume
variances are disposed of imply that short-term profit reporting can, at least to some
extent, be managed, just as shown in the example above.
As a general rule, as stated in the text, we favor the use of practical capacity as
the denominator volume used to set the standard fixed overhead allocation rate.
Finally, we note that if either the allocation method or what is called rate-adjustment
method (where the cost of all jobs and units produced during the period is
readjusted based on the actual manufacturing support cost per unit of activity) the
ability to manage earnings is somewhat decreased since the inventory and CGS
accounts after rate-readjustment approximate, if not equal, actual costs.
14-76 (Continued-2)
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CHAPTER 14: FLEXIBLE-BUDGETSFACTORY OVERHEAD

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies

The McGraw-Hill Companies 2008

The McGraw-Hill Companies 2008

factory overhead to production, a variable factory overhead efficiency variance

Unexpected stoppage or slowdown of operations because of unscheduled

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

logical consistency between the numerator and denominator in the

Absence of output inventory

The McGraw-Hill Companies 2008

on-time delivery of quality materials or components at an agreed-upon price

The McGraw-Hill Companies 2008

Magnitude of the variance

Blocher, Stout, Cokins, Chen, Cost Management, 4/e 14-7

The McGraw-Hill Companies 2008

Thus, the flexible-budget variance for the production supervisory salaries in

$144,000 per year

Total actual indirect labor cost incurred in April

14-22 Fixed overhead variances for the year:

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

(a) Spending variance = Actual variable overhead - Flexible-budget based on

(b) Efficiency variance = Flexible-budget based on Inputs Flexible-budget

14-24 Summary journal entries for the year:

Overhead Costs Applied to Production

14-25 To Record Factory Overhead Variances

Blocher, Stout, Cokins, Chen, Cost Management, 4/e 14-9

The McGraw-Hill Companies 2008

14-26 To Allocate the Net Factory Overhead Variance at Year-End

14-27 Factory Overhead Variance: Two-Variance Decomposition

= Variable overhead flexible-budget variance + fixed

(c) Production Volume variance = budgeted fixed overhead - applied fixed

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

14-28 Summary Journal Entries

Overhead Costs Applied to Production

(b) To Record Overhead Variances Using a Two-Variance Approach

14-29 End-of-Year Journal Entry to Close Out Variance Accounts

(b) Net Variance Allocated to Ending Inventories and CGS:

Blocher, Stout, Cokins, Chen, Cost Management, 4/e 14-11

The McGraw-Hill Companies 2008

Variable Factory Overhead Variances (2025 minutes)

1. Standard Variable factory overhead rate per direct labor hour:

= $15,000/2,500 hours = $6.00 per direct-labor hour

= 2,500 hours/5,000 units = 0.50 hours/unit

or, = AQ x (AP SP)

= 2,700 x ($5.7777 - $6.00)

= (2,700 2,400) x $6.00/hr.

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

To Record Unfavorable Variable Overhead Efficiency Variance:

Blocher, Stout, Cokins, Chen, Cost Management, 4/e 14-13

The McGraw-Hill Companies 2008

14-31 Fixed Factory Overhead Variances (2025 minutes)

Total DirectLabor Hours, PracticalCapacity

= $90,000/2,500 hours = $36.00 per DLH

Practical Capacity Units

= 2,500 hours/5,000 units = 0.5 DLHs per unit

Production Volume variance

2. Fixed factory overhead (FOH) flexible-budget variance

Blocher, Stout, Cokins, Chen, Cost Management, 4/e