ACCA F2 Management Accounting - 2010 - Study text

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Chapter 12: Standard costing and variance analysis

Variable production overhead cost variances: summary

Variable production overhead expenditure variance 990 (A)

Variable production overhead efficiency variance 440 (F)

Total variable production overhead cost variance 550 (A)

5.3 Variable production overhead: possible causes of variances

Source of the possible causes of variable production overhead variances including

the following.

 Incorrect budgets being set at the beginning of the year may give rise to

expenditure variances.

 Variable production overhead efficiency variances arise for the same reasons as

labour efficiency variances, for example: substituting one grade of labour for

another; introducing incentive schemes; and the learning curve effect.

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Fixed production overhead cost variances: absorption costing

 Total fixed production overhead cost variance

 Fixed production overhead expenditure variance

 Fixed production overhead volume variance

 Fixed production overhead efficiency and capacity variances

 Fixed production overheads: possible causes of variances

6 Fixed production overhead cost variances: absorption

costing

Variances for fixed production overheads are different from variances for variable

costs. The variances reported differ according to whether standard absorption

costing or standard marginal costing is used.

With standard absorption costing, the standard cost per unit is a full production

cost, including an amount for absorbed fixed production overhead. Every unit

produced is valued at standard cost.

This means that production overheads are absorbed into production costs at a

standard cost per unit produced. This standard fixed cost per unit is derived from a

standard number of direct labour hours per unit and a fixed overhead rate per hour.

 The total fixed overhead cost variance is the total amount of under-absorbed or

over-absorbed overheads, where overheads are absorbed at the standard fixed

overhead cost per unit.

 It was explained in an earlier chapter that the total under- or over-absorption of

fixed overheads can be analysed into an expenditure variance and a volume

variance. This applies to standard costing as well as to ordinary absorption

costing.

 The total volume variance can be analysed even further in standard absorption

costing, into a fixed overhead capacity variance and a fixed overhead efficiency

variance.

Chapter 12: Standard costing and variance analysis

Fixed overhead variances are as follows:

6.1 Total fixed production overhead cost variance

The total fixed overhead cost variance is rarely calculated, because it is more usual

to calculate the expenditure and volume variances.

However, the total fixed overhead cost variance is the amount of:

 under-absorbed fixed production overhead (= adverse variance) or

 over-absorbed fixed production overhead (= favourable variance).

Overheads are absorbed at a standard fixed cost per unit produced, not at standard

rate per hour.

In standard absorption costing, the total fixed production overhead cost variance

can be analysed into an expenditure variance and a volume variance. Together,

these variances explain the reasons for the under- or over-absorption.

6.2 Fixed production overhead expenditure variance

A fixed production overhead expenditure variance is the difference between:

 budgeted fixed production overhead expenditure, and

 actual fixed production overhead expenditure.

Actual fixed overheads are expected to be the budgeted fixed expenditure. If actual

fixed cost expenditure differs from the budget, there is an expenditure variance.

 An adverse expenditure variance occurs when actual fixed overhead

expenditure exceeds the budgeted fixed overhead expenditure.

 A favourable expenditure variance occurs when actual fixed overhead

expenditure is less than budget.

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Budgeted fixed production overhead expenditure X

Actual fixed production overhead expenditure Y

Fixed production overhead expenditure variance X – Y (F) or (A)

Fixed overhead expenditure variances can be calculated, for control reporting, for

other overheads as well as production overheads. For example:

 an administration fixed overheads expenditure variance is the difference

between budgeted and actual fixed administration overhead costs

 a sales and distribution fixed overheads expenditure variance is the difference

between budgeted and actual fixed sales and distribution overhead costs.

6.3 Fixed production overhead volume variance

In a system of standard absorption costing, the total cost variance for fixed overheads

can be analysed as the sum of the fixed overhead expenditure variance and a fixed

overhead volume variance.

The fixed production overhead volume variance measures the amount of fixed

overheads under- or over-absorbed because of the fact that actual production

volume differs from the budgeted production volume.

The volume variance is measured first of all in either:

 units of output or

 standard hours of the output units.

These are the same amount.

The volume variance in units (or standard hours of those units) is converted into a

money value, as appropriate, at the standard fixed overhead cost per unit (or the

standard fixed overhead rate per standard hour produced).

Fixed overhead volume variance

Units

produced **

Actual number of units produced ** X

Budgeted production (units) Y

Volume variance in units ** X – Y (F) or (A)

× Standard fixed overhead cost per unit × $P

Fixed production volume variance in $ (X – Y) x $P (F) or (A)

** Instead of units, these measurements could be in standard hours produced.

Standard hours produced = Actual units produced × Standard hours per unit.

Chapter 12: Standard costing and variance analysis

Example

A company budgeted to make 5,000 units of a single standard product in Year 1.

Budgeted direct labour hours are 10,000 hours. Budgeted fixed production overhead

is $40,000. Actual production in Year 1 was 5,200 units, and fixed production

overhead was $40,500.

Required

Calculate for Year 1:

 the total fixed production overhead cost variance

 the fixed overhead expenditure variance

 the fixed overhead volume variance

Answer

Standard fixed overhead cost per unit = $8 ($40,000/$5,000 units)

Fixed production overhead total cost variance

5,200 units: standard fixed cost (× $8)

= fixed overhead absorbed

41,600

Actual fixed overhead cost expenditure 40,500

Fixed production overhead total cost variance 1,100

(F)

The variance is favourable, because fixed overhead costs have been over absorbed.

Fixed overhead expenditure variance

Budgeted fixed production overhead expenditure 40,000

Actual fixed production overhead expenditure 40,500

Fixed overhead expenditure variance 500

(A)

This variance is adverse because actual expenditure exceeds the budgeted

expenditure.

Fixed overhead volume variance

units of production

Budgeted production volume in units 5,000

Actual production volume in units 5,200

Fixed overhead volume variance in units 200

(F)

Standard fixed production overhead cost per unit $8

Fixed overhead volume variance in $ $1,600

(F)

This variance is favourable because actual production volume exceeded the

budgeted volume.

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Summary

Fixed overhead expenditure variance 500

(A)

Fixed overhead volume variance 1,600

(F)

Fixed overhead total cost variance 1,100

(F)

Exercise 4

A company has budgeted to make 6,000 units of Product P345 in Year 2. Total

budgeted fixed production costs are $72,000. Each unit of Product P345 has a

standard direct labour time of 0.5 hours.

Actual output in Year 2 was 5,600 units of Product P345 and actual fixed production

overhead expenditure was $71,200.

Required

Calculate for Year 2:

 the fixed production overhead expenditure variance

 the fixed production overhead volume variance.

6.4 Fixed production overhead efficiency and capacity variances

A fixed production overhead volume variance can be analysed, if required, into a

fixed overhead efficiency variance and a fixed overhead capacity variance.

There are two reasons why actual production volume might differ from the

budgeted production volume:

 Production operations were either more or less efficient than budgeted, so that

more units or less units than expected were produced in the available time. This

causes an efficiency variance.

 Actual hours worked were either more or less than budgeted, which means that

either more units or less units than budgeted should be expected. This causes a

capacity variance. (It might help you to think of the capacity variance as an

‘hours worked’ variance.)

Fixed production overhead efficiency variance

This is exactly the same, in hours, as the direct labour efficiency variance and the

variable production overhead efficiency variance.

It is converted into a money value at the standard fixed overhead rate per hour.

Fixed production overhead capacity variance

This is the difference between the budgeted and actual hours worked (excluding

any idle time hours). It is converted into a money value at the standard fixed

overhead rate per hour.

Chapter 12: Standard costing and variance analysis

Fixed overhead capacity variance

hours

Actual number of hours worked AH

Budgeted hours BH

Capacity variance in hours AH – BH (F) or (A)

× Standard fixed overhead rate per hour × $P

Fixed production capacity variance in $

(AH – BH) × $P

(F) or (A)

Example

A company budgeted to make 5,000 units of a single standard product in Year 1.

Budgeted direct labour hours are 10,000 hours. Budgeted fixed production overhead

is $40,000. Actual production in Year 1 was 5,200 units in 10,250 hours of work, and

fixed production overhead was $40,500.

This same example was used earlier to calculate the fixed overhead volume

variance, which is $1,600 (F).

Required

Calculate for Year 1:

 the fixed overhead efficiency variance

 the fixed overhead capacity variance.

Answer

The standard direct labour hours per unit = 10,000 hours/5,000 units = 2 hours per

unit.

The standard fixed overhead rate per hour = $40,000/10,000 hours = $4 per hour.

The standard fixed overhead cost per unit is 2 hours × $4 per hour = $8 (or

$40,000/5,000 units).

Fixed overhead efficiency variance

hours

5,200 units should take (× 2 hours) 10,400

They did take 10,250

Efficiency variance in hours 150

(F)

Standard fixed overhead rate per hour $4

Fixed overhead efficiency variance in $ $600

(F)

Paper F2: Management Accounting

Fixed overhead capacity variance

hours

Budgeted hours of work 10,000

Actual hours of work 10,250

Capacity variance in hours 250

(F)

Standard fixed overhead rate per hour $4

Fixed overhead capacity variance in $ $1,000

(F)

The capacity variance is favourable because actual hours worked exceeded the

budgeted hours (therefore more units should have been produced).

Summary

Fixed overhead efficiency variance 600

(F)

Fixed overhead capacity variance 1,000

(F)

Fixed overhead volume variance 1,600

(F)

Exercise 5

A company manufactures widgets. These are expected to take 0.25 hours each to

make.

Budgeted production volume in Year 3 was 16,000 units and budgeted fixed

production costs were $96,000.

Actual production volume in Year 3 was 15,700 units in 4,200 hours of work. Actual

fixed overhead expenditure was $98,500.

Required

(a) For Year 3, calculate:

 the fixed overhead expenditure variance

 the fixed overhead volume variance.

(b) Analyse the volume variance into an efficiency and a capacity variance.

6.5 Fixed production overheads: possible causes of variances

Some of the possible causes of fixed production overhead variances include the

following.

Fixed overhead expenditure variance

 Poor control over overhead spending (adverse variance) or good control over

spending (favourable variance).

 Poor budgeting for overhead spending. If the budget for overhead expenditure

is unrealistic, there will be an expenditure variance due to poor planning rather

than poor expenditure control.

Chapter 12: Standard costing and variance analysis

 Unplanned increases or decreases in items of expenditure for fixed production

overheads, for example, an unexpected increase in factory rent.

Fixed overhead volume variance

A fixed overhead volume variance can be explained by anything that made actual

output volume different from the budgeted volume. The reasons could be:

 Efficient working by direct labour: a favourable labour efficiency variance

results in a favourable fixed overhead efficiency variance.

 Working more hours or less hours than budgeted (capacity variance).

 An unexpected increase or decrease in demand for a product, with the result

that longer hours were worked.

 Strike action by the workforce, resulting in a fall in output below budget.

 Extensive breakdowns in machinery, resulting in lost production.

Paper F2: Management Accounting

Sales variances: sales price and sales volume variances

 Sales price variance

 Sales volume variance

 Sales: possible causes of variances

7 Sales variances: sales price and sales volume

variances

Sales variances, unlike cost variances, are not recorded in a standard costing system

of cost accounts (in the cost ledger). However, sales variances are included in

variance reports to management.

 They help to reconcile actual profit with budgeted profit.

 They help management to assess the sales performance.

There are two sales variances:

 a sales price variance, and

 a sales volume variance.

7.1 Sales price variance

A sales price variance shows the difference between:

 the actual sales prices achieved for items that were sold, and

 their standard sales price.

To calculate this variance, you should take the actual items sold, and compare the

actual sales revenue with the standard selling prices for the items.

Actual units sold should sell for

(units sold × standard sales price/unit)

They did sell for (actual sales revenue) B

Sales price variance A – B (F) or (A)

There is a favourable sales price variance if units were sold for more than their

standard sales price, and an adverse variance if sales prices were below the

standard price.

7.2 Sales volume variance

A sales volume variance shows the effect on profit of the difference between the

actual sales volume and the budgeted sales volume. The sales volume variance is

calculated differently in standard absorption costing compared with standard

marginal costing.

ACCA F2 Management Accounting - 2010 - Study text - Emile Woolf Publishing

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