Chapter 11, Problem 50P

Montreal Scholastic Supply Company uses a standard-costing system. The firm estimates that it will operate its manufacturing facilities at 800,000 machine hours for the year. The estimate for total budgeted overhead is $2,000,000. The standard variable-overhead rate is estimated to be $2 per machine hour or $6 per unit. The actual data for the year are presented below.

Required:

1. 1. Compute the following variances. Indicate whether each is favorable or unfavorable, where appropriate.
   1. a.      Variable-overhead spending variance.
   2. b.      Variable-overhead efficiency variance.
   3. c.       Fixed-overhead budget variance.
   4. d.      Fixed-overhead volume variance.
2. 2. Prepare journal entries to
   • Record the incurrence of actual variable overhead and actual fixed overhead.
   • Add variable and fixed overhead to Work-in-Process Inventory.
   • Close underapplied or overapplied overhead into Cost of Goods Sold.

To determine

Calculate the given variances and indicate whether it is favorable or unfavorable of Company M.

Explanation of Solution

Flexible Budget: A flexible budget is a budget that is prepared for different levels of the output. In other words, it is a budget that adjusts according to the changes in the volume of the activity. The main purpose of preparing flexible budget is to determine the differences among standard and actual result.

Variance: Variance refers to the difference level in the actual cost incurred and standard cost. The total cost variance is subdivided into separate cost variances; this cost variance indicates that the amount of variance that is attributable to specific casual factors.

Calculate the given variances and indicate whether it is favorable or unfavorable of Company M as follows:

a. Variable overhead spending variance:

$\begin{array}{c}\begin{array}{l}\text{Variable overhead}\\ \text{ spending variance }\end{array}\}\text{= }\left[\begin{array}{l}\left(\text{Actual variable overhad}\right)-\\ \left(\text{Actual quantity}\times \text{Standard variable rate}\right)\end{array}\right]\\ \text{=\$1,701,000}-\left(764,000\text{ hours}\times \text{\$2 per hour}\right)\\ \text{=\$173,000 Unfavorable}\end{array}$

b. Variable overhead efficiency variance:

$\begin{array}{c}\begin{array}{l}\text{Variable overhead }\\ \text{efficiency variance}\end{array}\}\text{ =}\left[\left(\begin{array}{l}\text{Actual quantity}\times \\ \text{Standard variable rate}\end{array}\right)-\left(\begin{array}{l}\text{Standard quantity}-\\ \text{Standard varaible rate}\end{array}\right)\right]\\ =\left[\begin{array}{l}\left(\text{764,000 hours}\times \text{\$2 per hour}\right)-\\ \left(750,000\text{ hours (2)}\times \text{\$2 per hour}\right)\end{array}\right]\\ =\$28,000\text{ Unfavorable}\end{array}$

c. Fixed overhead budget variance:

$\begin{array}{c}\begin{array}{l}\text{Fixed overhead}\\ \text{budget variance}\end{array}\}\text{ = }\left(\begin{array}{l}\text{Actual fixed overhead}-\\ \text{Budgeted fixed overhead}\end{array}\right)\\ =\$392,000-\$400,000(3)\\ =\$8,000\text{ Favorable}\end{array}$

d. Fixed overhead volume variance:

$\begin{array}{c}\begin{array}{l}\text{Fixed overhead }\\ \text{volume variance}\end{array}\}\text{ = }\left(\begin{array}{l}\text{Budgeted fixed overhead}-\\ \text{Applied fixed overhead}\end{array}\right)\\ =\$400,000-\left(750,000\text{ hours (2)}\times \text{\$0}\text{.50 per hour (4)}\right)\\ =\$25,000\text{ Unfavorable}\end{array}$

Working note (1):

Calculate the standard hour per unit.

$\begin{array}{c}\text{Standard hour per unit = }\frac{\text{Standard rate per unit}}{\text{Standard rate per hour}}\\ =\frac{\$6\text{ per unit}}{\$2\text{ per unit}}\\ =3\text{ hours per unit}\end{array}$

Working note (2):

Calculate the standard hours for variable variance.

$\begin{array}{c}\text{Standard hours = Standard units}\times \text{Standard hours per unit}\\ =250,000\text{ units}\times \text{3 hours per unit (1)}\\ =\$750,000\text{ hours}\end{array}$

Working note (3):

Calculate the budgeted fixed overhead.

$\begin{array}{c}\text{Budgeted fixed overhead = }\left(\begin{array}{l}\text{Budgeted overhead}-\\ \text{Bugeted variable overehad}\end{array}\right)\\ =\left[\$2,000,000-\left(\begin{array}{l}800,000\text{ machine hours}\times \\ \text{\$2 per hour}\end{array}\right)\right]\\ =\$400,000\end{array}$

Working note (4):

Calculate the standard allowed hours.

$\begin{array}{c}\begin{array}{l}\text{Predetermined fixed }\\ \text{overhead rate }\end{array}\}\text{= }\frac{\text{Budgeted fixed overhead}}{\text{Budgeted machine hours}}\\ \text{=}\frac{\$300,000\text{ (3)}}{800,000\text{ hours}}\\ \text{= \$0}\text{.50 per hour}\end{array}$

To determine

Prepare journal entries of company M for the given transaction.

Explanation of Solution

Prepare journal entry to record the actual variable and fixed overhead costs:

Date	Accounts and Explanation	Debit ($)	Credit ($)
	Production overhead (5)	2,093,000
	Various Accounts		2,093,000
	(To record the actual overhead costs)

Table (1)

• Production overhead is an asset account and it increases the value of assets. Hence, debit the production overhead account with $2,093,000.
• A various account is an asset account, and it decreases the value of assets. Hence, credit the various account with $2,093,000.

Working note (5):

Calculate the production overheads.

$\begin{array}{c}\text{Production overhead}=\left[\begin{array}{l}\text{Actual variable overhead +}\\ \text{Actual fixed overheads}\end{array}\right]\\ =\$1,701,000+\$392,000\\ =\$2,093,000\end{array}$

Prepare journal entry to record the work-in-process inventory:

Date	Accounts and Explanation	Debit ($)	Credit ($)
	Work-in-Process Inventory (6)	1,875,000
	Production overhead		1,875,000
	(To record the applied production overhead)

Table (2)

• Work-in-process inventory is an asset account, and it increases the value of asset. Hence, debit the work-in-process inventory account with $1,875,000.
• Production overhead is an assets account and it decreases the value of assets. Hence, credit the production overhead account with $1,875,000.

Working note (6):

Calculate the work-in process inventory.

$\begin{array}{c}\begin{array}{l}\text{Work-in-Process}\\ \text{Inventory}\end{array}\}=\left[\text{Standard hours}\times \left(\begin{array}{l}\text{Standard variable rate per hour+}\\ \text{Predetermined fixed rate}\end{array}\right)\right]\\ =\left[\text{750,000 hours}\times \left(\begin{array}{l}\text{\$2 per hour +}\\ \text{\$0}\text{.50 per hour (4)}\end{array}\right)\right]\\ =\$1,875,000\end{array}$

Prepare journal entry to record the cost of goods sold:

Date	Accounts and Explanation	Debit ($)	Credit ($)
	Cost of goods sold (6)	218,000
	Production Overhead		218,000
	(To close the under-applied overhead cost into cost of goods sold)

Table (3)

• Cost of goods sold is an expense account and it decreases the value of stockholder’s equity. Hence, debit the cost of goods sold account with $218,000.
• Production overhead is an assets account and it decreases the value of assets. Hence, credit the production overhead account with $218,000.

Working note (7):

Calculate the under applied overhead cost.

$\begin{array}{c}\begin{array}{l}\text{Underapplied }\\ \text{overhead cost}\end{array}\}\text{ = }\left(\begin{array}{l}\text{Production overhead}-\\ \text{Cost transfer to work in process inventory}\end{array}\right)\\ =\$2,093,000-\$1,875,000\\ =\$218,000\end{array}$