Chapter 11, Problem 51P

College Memories, Inc. publishes college yearbooks. A monthly flexible overhead budget for the firm follows.

The planned monthly production is 6,400 yearbooks. The standard direct-labor allowance is .25 hour per book and overhead is budgeted and applied on the basis of direct-labor hours. During February, College Memories, Inc. produced 8.000 yearbooks and actually used 2,100 direct-labor hours. The actual overhead costs for the month were as follows:

Required:

1. 1. Determine the formula-style flexible overhead budget for College Memories. Inc.
2. 2. Prepare a display similar to Exhibit 11–6, which shows College Memories’ variable-overhead variances for February. Indicate whether each variance is favorable or unfavorable.
3. 3. Draw a graph similar to Exhibit 11–7, which shows College Memories’ variable-overhead variances for February.
4. 4. Interpret each of the variances computed in requirement (2).
5. 5. Prepare a display similar to Exhibit 11–8, which shows College Memories’ fixed-overhead variances for February.
6. 6. Draw a graph similar to Exhibit 11–9, which depicts the company’s applied and budgeted fixed overhead for February. Show the firm’s February volume variance on the graph.
7. 7. Interpret each of the variances computed in requirement (5).
8. 8. Prepare journal entries to record each of the following:
   • Incurrence of February’s actual overhead cost.
   • Application of February’s overhead cost to Work-in-Process Inventory.
   • Close underapplied or overapplied overhead into Cost of Goods Sold.
9. 9. Draw T-accounts for all of the accounts used in the journal entries of requirement (8). Then post the journal entries to the T-accounts.

To determine

Compute the formula-style flexible overhead budget for incorporation C.

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.

The formula-style flexible overhead budget for incorporation C is as follows:

$\begin{array}{c}\text{Total monthly overhead}=\left[\begin{array}{l}\text{Total fixed cost}+\text{standard }\\ \text{variable-overhead rate (1)}\end{array}\right]\\ =\text{\$20,000}+\text{\$9X}\end{array}$

Working note (1):

Compute the standard variable-overhead rate:

$\begin{array}{c}\begin{array}{l}\text{standard }\\ \text{variable-overhead rate}\end{array}\}=\frac{\text{Total variable cost}}{\text{Direct-labor hours}}\\ =\frac{\text{\$13,500}}{1,500}\\ =\$9\end{array}$

Note: X denotes the activity measured in direct-labor hours.

To determine

Prepare a diagram showing variable-overhead variances for the month of February and indicate whether each variance is favorable or unfavorable.

Explanation of Solution

Prepare a diagram showing variable-overhead variances for the month of February and indicate whether each variance is favorable or unfavorable as follows:

Figure (1)

Working note (2):

Compute the actual variable overhead rate:

$\begin{array}{c}\begin{array}{l}\text{Actual variable}\\ \text{overhead rate}\end{array}\}=\frac{\text{Actual variable overhead cost}}{\text{Actual hours}}\\ =\frac{\text{\$19,530}}{2,100}\\ =\text{\$9}\text{.30 per hour}\end{array}$

Note:

Variable overhead applied to work-in-process is not used to compute the variances. However, it is included to point out that the flexible-budget amount for variable overhead of $18,000, is the amount that will be applied to Work-in-Process inventory for product.

To determine

Draw a graph showing variable-overhead variances for the month of February.

Explanation of Solution

Draw a graph showing variable-overhead variances for the month of February as follows:

Figure (2)

To determine

Interpret each variances calculated in requirement (2).

Explanation of Solution

• The variable-overhead spending is $630 and it is an unfavorable variance, which indicates that the company has spent more money on variable overhead in the month of February than it should have been spent, for 2,100 direct-labor hours that were used. This is the control variance for variable overhead.
• In this case, the actual direct-labor hours of February exceed the standard allowed direct-labor hours hence it results in a an unfavorable variable-overhead efficiency variance of $900. Thus, the variable-overhead efficiency variance will not disclose any information about the efficiency with which variable-overhead items such as electricity are used. Instead, it results from inefficiency or efficiency, in relation to the standards, in the usage of the cost driver (such as direct-labor hours).

To determine

Prepare a diagram showing fixed-overhead variances for the month of February and indicate whether each variance is favorable or unfavorable.

Explanation of Solution

Prepare a diagram showing fixed-overhead variances for the month of February and indicate whether each variance is favorable or unfavorable as follows:

Figure (3)

Working note (3):

Compute the standard fixed overhead rate:

$\begin{array}{c}\begin{array}{l}\text{Fixed budgeted}\\ \text{overhead}\end{array}\}=\frac{\text{Budgeted fixed overhead cost}}{\left(\begin{array}{l}\text{Budgeted output }\times \\ \text{Direct labor hours per unit}\end{array}\right)}\\ =\frac{\text{20,000 hours}}{\left(6,400\text{ units}\times 0.\text{25 hours per unit}\right)}\\ =\text{\$12}\text{.5 per hours}\end{array}$

Note: Some accountants would designate a positive volume variance as "unfavorable" and a negative volume variance as "favorable.

To determine

Draw a graph that portrays the company’s applied overhead and budgeted fixed overhead for the month of February, also show the firm’s February volume variance on the graph.

Explanation of Solution

Draw a graph that portrays the company’s applied overhead and budgeted fixed overhead for the month of February, also show the firm’s February volume variance on the graph:

Figure (4)

To determine

Interpret each variances ascertained in requirement (5).

Explanation of Solution

• In this case, the actual fixed overhead exceeded the budgeted fixed overhead by $17,600. Hence, there is an unfavorable fixed-overhead budget variance of $17,600.
• The volume variance is the difference between budgeted monthly fixed overhead ($20,000) and the applied fixed overhead ($25,000). The budgeted fixed overhead is used for planning and controlling purposes whereas, the applied fixed overhead graph is used for product costing purposes. In this case, the applied fixed overhead exceeds the budgeted fixed overhead hence there is a negative volume variance of $5,000.

To determine

Prepare journal entries to record the given transaction.

Explanation of Solution

• Prepare journal entry to record the actual overhead costs:

Date	Accounts and Explanation	Debit ($)	Credit ($)
	Production overhead (4)	57,130
	Various Accounts		57,130
	(To record the actual overhead costs)

Table (1)

• Production overhead is an asset account and it increases the value of an asset. Hence, debit production overhead account with $57,130.
• A various account is an asset account, and it decreases the value of an assets. Hence, credit the various account with $57,130.

Working note (4):

Calculate the raw materials inventory:

$\begin{array}{c}\text{Production overhead}=\left[\begin{array}{l}\text{Actual variable overhead}\\ +\text{Actual fixed overheads}\end{array}\right]\\ =\$19,530+\$37,600\\ =\$57,130\end{array}$

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

Date	Accounts and Explanation	Debit ($)	Credit ($)
	Work-in-Process Inventory (5)	43,000
	Production overhead		43,000
	(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 $43,000.
• Production overhead is an asset account and it decreases the value of an asset. Hence, credit production overhead account with $43,000.

Working note (5):

$\begin{array}{c}\begin{array}{l}\text{Work-in-Process}\\ \text{Inventory}\end{array}\}=\left[\begin{array}{l}\text{Standard variable overheads}\\ +\text{Applied fixed oveheads}\end{array}\right]\\ =\$18,000+\$25,000\\ =\$43,000\end{array}$

Prepare journal entry to record the cost of goods sold:

Date	Accounts and Explanation	Debit ($)	Credit ($)
	Cost of goods sold $\left(\$57,130-\$43,000\right)$	14,130
	Production Overhead		14,130
	(To record the under-applied overhead 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 $14,130.
• Production overhead is an asset account and it decreases the value of an asset. Hence, credit production overhead account with $14,130.

To determine

Draw T-accounts for the journal entries given in requirement (8).

Explanation of Solution

Draw T-accounts for the journal entries given in requirement (8) as follows:

Figure (5)