Overhead Cost and Variance Relationships
Fargo Corporation reported a $400 favorable price variance for variable overhead and a $4,000 favorable price variance for fixed overhead. The flexible budget had $256,800 variable overhead based on 21,400 direct labor hours; only 21,200 hours were worked. Total actual overhead was $434,800. The number of estimated hours for computing the fixed overhead application rate totaled 22,000 hours.
Required
a. Prepare a variable overhead analysis like the one in Exhibit 16.10.
b. Prepare a fixed overhead analysis like the one in Exhibit 16.13.
Exhibit 16.10 Variable Overhead Variances, August (80,000 Frames)—Bayou Division
At Bayou Division, the $880 unfavorable price variance for August (see Exhibit 16.10) was attributed to waste in using supplies and recent price increases for petroleum products used to maintain the machines.
Exhibit 16.13 Fixed Overhead Variances, August— Bayou Division
In this situation, a $40,000 unfavorable production volume variance exists. It is unfavorable because less overhead was applied than was budgeted; production was lower than the average monthly estimate. This variance is a result of the full absorption costing system; it does not occur in variable costing.
This $160,000 applied fixed overhead equals $2 per frame multiplied by 80,000 units actually produced (see Exhibit 16.14). If the $40 rate per direct labor hour had been used, the amount applied to the 80,000 units produced would still be $160,000 (= $40 x 0.05 x 80,000).
A variance occurs if the number of units actually produced differs from the number of units used to estimate the fixed cost per unit. Again, this variance is commonly referred to as a production volume variance (also called a capacity variance , an idle capacity variance , or a denominator variance ).
Our example has a production volume variance because the 80,000 frames actually produced during the month do not equal the 100,000 estimated for the month. Consequently, production is charged $160,000 (point A in Exhibit 16.14) instead of $200,000 (point B in Exhibit 16.14). The $40,000 difference is the production volume variance
Exhibit 16.14 Fixed Overhead Variances, Graphic Presentation—Bayou Division
because it is caused by a deviation in production volume level (number of frames produced) from that estimated to arrive at the standard cost.
If Bayou had estimated 80,000 frames per month instead of 100,000 frames, the standard cost would have been $2.50 per frame (= $200,000 ÷ 80,000 frames). Thus, $200,000 (= $2.50 x 80,000 frames) would have been applied to units produced, and there would have been no production volume variance.
The production volume variance applies only to fixed costs; it occurs because we are allocating a fixed period cost to units on a predetermined basis. It does not represent resources spent or saved. This is unique to full absorption costing. The benefits of calculating the variance for control purposes are questionable. Although the production volume variance signals a difference between expected and actual production levels, so does a simple production report of actual versus expected production quantities.
Compare with the Fixed Production Cost Price Variance The fixed production cost price variance is the difference between actual and budgeted fixed production costs. Unlike the production volume variance, the price variance commonly is used for control purposes because it is a measure of differences between actual and budgeted period costs.
Exhibits 16.13 and 16.14 summarize the computation of the fixed production price (spending) and production volume variances. Reviewing them will help you see the relationship between actual, budgeted, and applied fixed production costs.