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Operational Performance Measurement: Indirect-Cost Variances and

Resource-Capacity Management

 Standard Overhead Costs: Planning versus Control

Standard costs can be used alone for control purposes, or they can be incorporated formally
into the accounting records for both product-costing and control purposes. We used a flexible
budget at the end of the period to calculate various revenue and cost variances. For cost-control
purposes, we calculated a total flexible-budget variance and then proceeded to explain this total
variance by calculating a selling price variance, fixed cost variances. For variable factory
overhead the underlying model for cost-control and product-costing purposes is the same.

 Variance Analysis for Manufacturing Overhead Costs

For product-costing purposes, the total overhead variance for the period (also called the
total under/overapplied overhead) is equal to the difference between actual overhead cost
incurred and the standard overhead cost applied to production.
Total overhead variance = Total actual overhead – Total applied overhead
= (Total variable overhead + Total fixed overhead) – (Total overhead application rate ×
Standard hours allowed for this period’s production)

 Variable Overhead Cost Analysis

The total variable overhead variance is the difference between actual variable overhead
cost incurred and the standard variable overhead cost applied to production; also called over-
or under applied variable overhead for the period.
Cost Control: Breakdown of the Total Variable Overhead Variance
Variable overhead = Actual variable overhead – Budgeted variable overhead
spending variance based on inputs
= (AQ × AP) – (AQ × SP)
= AQ × (AP – SP)

Variable overhead = Budgeted variable overhead – Standard variable overhead

efficiency variance based on inputs applied to production
= (AQ × SP) – (SQ × SP)
= SP × (AQ – SQ)

 Variable Overhead Spending Variance

This variance is attributable to actual spending for variable overhead items per unit of the
activity variable being different from standard. If the variable overhead spending variance is
considered “material” or “significant,” a follow-up analysis of individual variable overhead
items is indicated.

 Variable Overhead Efficiency Variance

Care needs to be exercised when interpreting this variance. Simply put, the variable
overhead efficiency variance reflects efficiency or inefficiency in the use of the activity
variable used to apply variable overhead costs to products.
The variable overhead efficiency variance is therefore related to efficiency or inefficiency
in the use of whatever activity variable is used to apply variable overhead for product-costing
purposes (and for constructing the flexible budget for cost-control purposes). This reinforces
the need to choose the proper activity variable for allocating variable overhead costs

 Fixed Overhead Cost Analysis

Total fixed overhead variance is the difference between the actual fixed overhead cost
incurred and the fixed overhead cost applied to production based on a standard fixed overhead
application rate; also called over- or underapplied fixed overhead for the period.

 The Production-Volume (Denominator) Variance

For federal income tax and GAAP purposes, companies must report inventories on a full
(absorption) cost basis. This means that each unit produced must absorb a share of fixed factory
overhead costs in addition to variable manufacturing costs. The following four-step process
can be used for this purpose.
Step 1: Determine budgeted total fixed factory overhead
Step 2: Choose an appropriate activity measure for applying fixed factory overhead
Step 3: Choose a denominator activity level, for alternatives:
1. Supply-Based Definitions of Capacity
2. Demand-Based Definitions of Capacity
Step 4: Calculate the predetermined fixed overhead application rate
In summary, for product-costing purposes a company must choose an activity level over
which it spreads budgeted fixed manufacturing costs for a given period. Fixed overhead
production volume variance is the difference between budgeted fixed overhead for the period
and the standard fixed overhead applied to production (using the fixed overhead allocation
Production-volume variance = Budgeted fixed factory overhead cost – Standard fixed
overhead cost assigned to production
= SP × (Denominator activity hours – SQ)