Chapter 15, Problem 45P

1.

To determine

Calculate each of the following for the month of November:

1. a. The variable overhead spending variance
2. b. The variable overhead efficiency variance
3. c. The fixed overhead spending (budget) variance
4. d. The fixed overhead production volume variance
5. e. The total amount of under-or over applied manufacturing overhead.

Explanation of Solution

Operational control is the power to carry out those functions of orders over subordinate forces concerning the organization and use of instructions and compels the assignment of tasks, the assignment of goals and the giving of the instructive path requisite for the task.

A cost variance is the difference between the cost actually incurred and the amount of costs money earmarked or scheduled that should have been imposed. These variances establish a mandatory part of many reporting tools for the management.

Overhead costs, sometimes referred to as overhead or operating expenses, are those costs that are associated with running a business that cannot be connected to constructing or manufacturing a product or a service. They are the expenses the business incurs in staying in business, irrespective of its level of achievement.

Calculate Standard variable factory overhead rate per direct labor hour (DLH):

$\begin{array}{c}\text{Std}\text{.variable factory overhead rate}=\text{Bgtd}\text{. total variable factory Overhead}÷\text{Bgt}\text{. total DLH}\\ =\$3,600,000÷\$600,000\\ =\$6.00\text{/DLH}\end{array}$

Calculate Standard fixed factory overhead rate per direct-labor hours (DLH):

$\begin{array}{c}\text{Std}\text{. fixed factory overhead DLH}=\text{Bgtd}\text{. Total fixed factory overhead}÷\text{Practical capacity LH}\\ =\$3,000,000÷\$600,000\\ =\$5.00\text{/direct labor hr}\end{array}$

The standard factory overhead rate per direct labor hour (DLH) is ($6.00 + $5.00).= $11.00 /DLH

1. a. The variable overhead spending variance

Variable Overhead Spending Variance is the difference between what the overheads of the variable production actually cost and what they should cost, given the activity level over a period. Usually the standard overhead variable rate is expressed in terms of machine hours or work hours.

The formula to calculate the variable overhead spending (budget) variance is as follows:

$\text{Variable overhead spending variance}=\text{Actual variable cost overhead}-\text{Flexible budget based on inputs}$

Calculate the variable overhead spending (budget) variance:

$\begin{array}{c}\text{Variable overhead spending variance}=\$315,000-(53,500\text{ DLHs}\times \$6.00\text{/DLH)}\\ =\$315,000-\$321,000\\ =\$6,000\text{ F}\end{array}$

Hence, the variable overhead spending (budget) variance is $6,000 F.

1. b. The variable overhead efficiency variance

The formula to calculate variable overhead efficiency variance is as follows:

$\text{Efficiency variance}=\text{Flexible budgets based on inputs}-\text{Flexible budget based on output}$

Calculate the variable overhead efficiency variance:

$\begin{array}{c}\text{Variable overhead Efficiency variance}=(53,500\text{DLHs}\times \$6.00\text{/DLH)}-\left(26,000\text{ units}\times \text{2DLH/unit}\times \$\text{6/DLH}\right)\\ =\$321,000-\$312,000\\ =\$9,000\text{ U}\end{array}$ Hence, the variable overhead efficiency variance is $9,000 U.

1. c. The fixed overhead spending (budget) variance

Calculate budgeted fixed manufacturing overhead per month:

$\begin{array}{c}\text{Budgeted fixed manufacturing overhead/month}=\$3,000,000÷12\text{ months}\\ =\$250,000\end{array}$

The formula to calculate fixed overhead spending (budget) variance is as follows:

$\text{Fixed overhead spending (budget) variance}=\text{Actual fixed overhead}-\text{Budgeted fixed overhead}$

Calculate fixed overhead spending (budget) variance:

$\begin{array}{c}\text{Fixed overhead spending }\left(\text{budget}\right)\text{variance}=\$\text{260},000–\$\text{250},000\\ =\$\text{10},000\text{ U}\end{array}$

Hence, the fixed overhead spending (budget) variance for March is $10,000 U

1. d. The fixed overhead production volume variance

Fixed variance in the overhead production volume is the difference between the budgeted fixed overhead over the period and the standard fixed overhead applicable to production.

The formula to calculate the fixed overhead production volume variance is as follows:

$\text{Fixed overhead production volume variance}=\text{Budgeted fixed overhead}-\text{Applied fixed Overhead}$

Calculate the fixed overhead production volume variance:

$\begin{array}{c}\text{Fixed overhead production volume variance}=\$\text{25}0,000-\left(26,000\text{ units}\times \text{2}\times \$\text{5}\right)\\ =\$250,000-\$260,000\\ =\$10,000\text{ F}\end{array}$ Hence, the fixed overhead production volume variance is $10,000 F.

1. e. The total amount of under-or over applied manufacturing overhead

Overhead manufacturing (also referred to as overhead factory, factory burden, and cost of support for manufacturing) refers to indirect factory-related costs incurred when a product is made.

Calculate the total amount of under-or over applied manufacturing overhead:

$\begin{array}{c}\text{Total amount of under-over applied manufacturing overhead}=(\$315,000+\$260,000)-(\$312,000+\$260,000)\\ =\$3,000\text{ underapplied}\end{array}$

2.

To determine

Provide appropriate journal entries to record actual overhead costs and standard overhead cost applied to production and all four overhead variances.

Explanation of Solution

Overhead costs, sometimes referred to as overhead or operating expenses, are those costs that are associated with running a business that cannot be connected to constructing or manufacturing a product or a service. They are the expenses the business incurs in staying in business, irrespective of its level of achievement.

The required journal entries are as follows:

Date	Accounting Explanation	Amount ($)	Amount ($)
	Variable Factory Overhead - Applied	$\$315,000$
	Utilities Payable, wages payable, etc		$\$315,000$
	(To record actual variable overhead costs for the period)
	WIP Inventory	$\$312,000$
	Variable Factory Overhead—Applied		$\$312,000$
	(To apply standard variable overhead costs to production)
	Variable Factory Overhead—Applied	$\$312,000$
	Variable Overhead Efficiency Variance	$\$9,000$
	Variable Overhead Spending Variance		$\$6,000$
	Variable Factory Overhead—Actual		$\$315,000$
	(To record variable overhead variances for the period)
	Fixed Factory Overhead—Actual	$\$260,000$
	Salaries payable, accumulated depreciation, etc		$\$260,000$
	(To record actual fixed overhead costs for the period)
	WIP Inventory	$\$260,000$
	Fixed Factory Overhead—Applied		$\$260,000$
	(To apply standard fixed overhead costs to production)
	Fixed Factory Overhead—Applied	$\$260,000$
	Fixed Factory Overhead Spending Variance	$\$10,000$
	Production Volume Variance		$\$10,000$
	Fixed Factory Overhead—Actual		$\$260,000$
	(To record fixed overhead variances for the period)

3.

To determine

Provide the required journal entry to close all overhead variances to the Cost of Goods Sold (CGS) account.

Explanation of Solution

Operational control is the power to carry out those functions of orders over subordinate forces concerning the organization and use of instructions and compels the assignment of tasks, the assignment of goals and the giving of the instructive path requisite for the task.

A cost variance is the difference between the cost actually incurred and the amount of costs money earmarked or scheduled that should have been imposed. These variances establish a mandatory part of many reporting tools for the management.

Fixed variance in the overhead production volume is the difference between the budgeted fixed overhead over the period and the standard fixed overhead applicable to production.

The required journal entry is as follows:

Date	Accounting Explanation	Amount ($)	Amount ($)
	Variable Overhead Spending Variance	$\$6,000$
	Production volume variance	$\$10,000$
	Cost of Goods Sold (CGS)	$\$3,000$
	Variable Overhead Efficiency Variance		$\$9,000$
	Fixed Overhead Spending Variance		$\$10,000$
	(To record overhead variances and close the overhead account)

4.

To determine

Mention how the GAAP provisions on inventory costing reflect the variance-disposition at the end of the period.

Explanation of Solution

Operational control is the power to carry out those functions of orders over subordinate forces concerning the organization and use of instructions and compels the assignment of tasks, the assignment of goals and the giving of the instructive path requisite for the task.

A cost variance is the difference between the cost actually incurred and the amount of costs money earmarked or scheduled that should have been imposed. These variances establish a mandatory part of many reporting tools for the management.

Inventory is the concept used for the goods available for sale and the raw materials used to manufacture goods for sale. Inventory costs include the costs of ordering and holding inventory, as well as administering the paperwork associated with it. Such costs are related to the space needed for inventory holding, the cost of the capital needed for inventory acquisition, and the risk of failure through inventory obsolescence.

GAAP designates that "normal capacity" should be used to set fixed overhead allocation rates, and that any unallocated overhead should be recognized as a period expense. Although not making clear this, it appears that GAAP signifies that any amount of unallocated overhead will be regarded as "abnormal" when normal capacity is used to assign fixed overhead costs to the product, and thus handled as a period cost.

5.

To determine

Illustrate how the reported earnings under absorption costs will be handled using the disposal method of overhead cost variances (fixed) at the end of this period.

Explanation of Solution

Operational control is the power to carry out those functions of orders over subordinate forces concerning the organization and use of instructions and compels the assignment of tasks, the assignment of goals and the giving of the instructive path requisite for the task.

A cost variance is the difference between the cost actually incurred and the amount of costs money earmarked or scheduled that should have been imposed. These variances establish a mandatory part of many reporting tools for the management.

Overhead costs, sometimes referred to as overhead or operating expenses, are those costs that are associated with running a business that cannot be connected to constructing or manufacturing a product or a service. They are the expenses the business incurs in staying in business, irrespective of its level of achievement.

Absorption costing, also often referred to as full absorption costing, is a managerial accounting method for capturing all costs associated with making a specific product. This method accounts for the direct and indirect costs, such as direct materials , direct labor, rent, and insurance. Under absorption costs, the reported operating income may be affected by the method of disposing of any variance in production volume associated with fixed overhead. In other words, the method of variance-disposition can be used to "manage profits" under the cost of absorption.

The amount of fixed overhead costs absorbed in or released from the inventory (i.e., the balance sheet) is affected by the denominator level selected to evaluate the predetermined overhead application rate. Choosing the level of the denominator volume simultaneously affects the amount of variance in the volume of production for the period. Therefore, the impact of changes in physical inventory can be strengthened or lowered predicated on how the variance in the volume of production at the end of the period is disposed of.

In particular, this ability to affect reported income is confined to the situation where the variance in production volume is written off entirely to the cost of sold goods (CGS), as follows:

• Choosing a lower denominator-volume level will strengthen the increase in absorption costing income due to the deferral of fixed overhead in the inventory if inventory increases.
• If inventory decreases, the choice of a higher denominator level will moderate the decrease in absorption-costing revenue as a result of the release of fixed overhead into CGS.

Consequently, it is through the interaction of how the fixed overhead rate is set and how the resulting variance in production volume is accounted for that provides management with an opportunity to manage earnings under the cost of absorption. Hence, the managers can increase short-run operating income by choosing greater denominator levels if the inventory is expected to decline or selecting smaller denominator levels if they expect an increase in inventory. If the variance in production volume is prorated based on the units that create the variance, then the choice of denominator level has no effect on the absorption-costing income. This is because it effectively changes the budgeted overhead application rate to the actual overhead application rate by prorating this variance.