Chapter 21: Overhead Standards and Variances

Computing Overhead Controllable and Volume Variances In a standard cost system, overhead costs are assigned to products using a standard overhead rate, which is set based on expected levels of production and associated overhead costs. To help managers control these costs, overhead variances are analyzed into two main types: 1. Controllable Variance: Measures how well the production manager controlled variable and fixed overhead costs based on actual activity levels. 2. Volume Variance: Measures the impact of operating at a different production level than originally budgeted, generally beyond the production manager's control. 1. Flexible Overhead Budgets and Standard Overhead Rate Flexible Overhead Budgets adjust total budgeted overhead costs for different levels of production, distinguishing between: • • Variable overhead costs (which vary with production volume) and Fixed overhead costs (which remain constant within a certain range of activity). Example: G-Max Flexible Overhead Budget • • • Capacity: G-Max’s maximum capacity is 5,000 units, with an expected activity level at 80% of this, or 4,000 units. Overhead Rates: o Variable Overhead Rate: $2 per unit. o Fixed Overhead: $12,000 per month. Standard Overhead Rate Calculation: o For 4,000 units, the expected direct labor hours are 2,000 hours (4,000 units x 0.5 DLH per unit). o Total overhead at this activity level is $20,000, leading to a standard overhead rate of $10 per direct labor hour ($20,000 ÷ 2,000 DLH). 2. Overhead Variance Calculation Once actual production levels and overhead costs are known, overhead variances are calculated by comparing actual overhead costs to the flexible budgeted and standard applied costs. Key Formulas 1. Total Overhead Variance: Difference between actual overhead and standard overhead applied. Total Overhead Variance=Actual Overhead−Standard Overhead Applied 2. Controllable Variance: Difference between actual overhead and the flexible budget overhead based on the actual production level. Controllable Variance=Actual Overhead−Flexible Budget Overhead 3. Volume Variance: Difference between the flexible budgeted overhead at expected production and the standard overhead applied at actual production. Volume Variance=Flexible Budget Overhead−Standard Overhead Applied Example - G-Max Overhead Variances In May, G-Max produced 3,500 units (below the expected 4,000), which should have used 1,750 direct labor hours (3,500 units x 0.5 DLH per unit). The actual overhead cost was $18,150. 1. Standard Overhead Applied: o Applied based on actual production, 3,500 units, using the standard rate per direct labor hour. Standard Overhead Applied=1,750 DLH×$10=$17,500 2. Total Overhead Variance: Total Overhead Variance=$18,150−$17,500=$650 Unfavorable (U) 3. Controllable Variance: o Compares actual overhead to the flexible budget for 3,500 units. o The flexible budget at 3,500 units (70% capacity) includes:  Variable Overhead: 3,500 units×$2=$7,000  Fixed Overhead: $12,000  Total Flexible Budget Overhead: $19,000 Controllable Variance=$18,150−$19,000=−$850 (Favorable) 4. Volume Variance: o Compares flexible budget overhead at expected 4,000 units with standard overhead applied for the actual 3,500 units. Volume Variance=$19,000−$17,500=$1,500 Unfavorable (U) Interpretation of Overhead Variances • • Controllable Variance (Favorable): Actual overhead costs were $850 below the flexible budget at the 3,500-unit level. Lower indirect labor, materials, and maintenance contributed positively, even though some costs (like power) were slightly over budget. This variance reflects efficient cost management by the production manager. Volume Variance (Unfavorable): The $1,500 unfavorable variance results from producing 500 fewer units than the predicted 4,000 units. This shortfall reflects lower-than-anticipated capacity utilization, potentially due to factors outside the production manager's control, such as market demand. Summary: The overhead variance report assists managers by distinguishing controllable cost efficiencies from volume-based performance variations, guiding corrective actions and better forecasting.