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I'm Larry Walther.
This is principlesofaccounting.com chapter 22.
And in this module, we are continuing our consideration of variance analysis.
This time we're going to look at the overhead variances.
Now recall that overhead has both variable and fixed components.
As a result, variance analysis for overhead is split between variances
related to variable overhead and variances related to fixed overhead.
Remember when more is spent on actual variable factory overhead than is applied
based on a standard application rate result is called underapplied overhead and
it produces unfavorable variances.
When less is spent that is applied,
the balance represents overapplied overhead or favorable variances.
Differences are transferred to variance accounts as they were for
material and labor.
And we're going to look first at variable overhead.
This illustration shows how we're spending money for overhead on wages,
indirect material in other words, supplies and so forth.
As we credit those accounts, and you've seen this in a prior chapter,
we're debiting the factory overhead account to count
actual costs in overhead account then we apply that overhead to production.
We credit factory overhead and we debit work in process for
the standard amount of variable overhead.
We would debit the unfavorable variance account.
This is if it's an unfavorable variance,
that is we've spent more than we anticipated under standard.
Notice in the middle,
the factory overhead account should be zeroed out at the end of the period.
That is we should have charged overhead all of the amount in the factory
overhead account.
If we turn this around and look at a slide for favorable variances you can
see in the middle we've applied a standard more than we've accumulated at actual.
So the ZZ, the variance in this case,
we're going to need to close that out by crediting a favorable variance account.
That's the total picture for variable overhead but
it can be divided into spending components and it can be divided into
efficiency components just as we did for material and labor.
So a variable overhead spending variance would be a variance that reflects
the difference between actual variable overhead and
standard variable overhead associated with the actual units of the application base.
And the Overhead Efficiency Variance is a variance that reflects the level of
efficiency associated with the application of the variable overhead to production.
And so we're going to return to Blue Rail Manufacturing.
This again is the illustration used in the book.
And remember that it was estimated that variable factory overhead
should be equal to $10 per direct labor hour.
That's the model, that's the standard that we set, $10 per labor hour.
During August, $105,000 was actually spent on the variable overhead items.
And so our 3,400 units of output, we expected 3 hours per unit.
So our standard hours to achieve the output was 10,200 hours.
That's our application base for overhead at $10 an hour,
means our standard cost was $102,000 but we spent a $105,000 and
so we have $3,000 of unfavorable variance to deal with.
Let's look closer at these variances using a graphic.
In this graphic, we can see that we have 3,000 of unfavorable variance.
If we break this down, however, we get an entirely different picture.
We actually have a $20,000 variable
overhead spending variance that's favorable in nature.
And we have a $23,000 unfavorable variable overhead efficiency variance.
In the case of the overhead spending variance, we actually spent 105,000.
But if we look at the application base of hours,
we had 12,500 hours at a standard rate of $10.
For that number of hours, we would've spent 125,000 so
we get a variable overhead spending variance of 20,000 that's favorable.
But that compares poorly to the 102.000 that should have been spent
the standard cost as compare to that sign 125,000.
This is recorded in the journal entry,
here we\re going to debit in work in process for 102,000 standard cost.
We're going to credit 105,000 to close out the actual amount of factory overhead and
the differences get applied to our overhead efficiency and
spending variances.
Again, debit unfavorable and credit, favorable.
The variable overhead efficiency variance may reflect efficiencies or
inefficiencies experienced with the base used to apply overhead.
In our example, the number of hours was run up because of inexperienced labor.
Let's next turn our attention to the fixed overhead variances.
The actual fixed factory overhead often times shows little deviation from budget.
The reason being that fixed costs are truly fixed, they're set by contract or
some other agreement, but there can be variations.
And we can divide the analysis to those variations into a fixed overhead volume
variance which compares the budgeted fixed overhead to the fixed overhead that is
applied to production based on standard fixed overhead per unit.
And fixed overhead spending that compares actual fixed overhead
to the budgeted amount of fixed overhead.
And so let's reflect on Blue Rail one last time.
Blue Rail had budgeted total fixed overhead of 72,000 but
only 70,000 was spent.
So that's positive, but when we look at this closer Blue Rail had planned to
product 4,000 systems, therefore the planned fixed overhead was $18 per rail,
that is 72,000 that we thought we would spend divided by the 4,000 units.
The fixed overhead allocation rate therefore $6 per hour,
$18 per unit, divided by 3 labor hours per unit.
And so when we look at this graphically, we spent 70,000.
The standard cost however, that we would apply would be the 10,200 standard
hours for the production that we achieved times the $6 per
hour standard application rate for fixed overhead would be $61,200.
So that yields an $8,800 difference or
unfavorable variance that we need to divide further.
As it turns out, we had a $2,000 favorable spending variance,
that is we spent 70,000 when 72,000 was the budgeted amount, but
we really got shot out of the saddle here with the fixed overhead volume variance.
We didn't produce the 4,000 units we anticipated, we only produced 3,400 units.
And so when it came to applying the fixed overhead to production,
we produced a very unfavorable volume variance.
We didn't spend as much as we thought, but
then we certainly didn't produce nearly as much as we thought.
So by the time we get through with the total analysis,
we've got 8,800 of unfavorable overall fixed overhead variances.
And here's the entry for that.
We're going to charge Work in Process for
the standard amount associated with production we produced.
We'll credit Factory Overhead to clear out the 70, 000 net account, and
the differences are applied to our Volume Variance and
our Overhead Spending Variance.
And so all of this information is incorporated in the ledger,
the management has to assess it very carefully to determine its cause and
effects and what immediate actions were necessary.
And if you look at other books you see two variance method,
a three variance method, a four variance method.
There's many thoughts and
ideas about the best way to analyze variances related to overhead.
I've elected to use a four variance method, portions of these can be combined
to come up with the two various method for example.
In the end, what's important to see is that just like you analyze your
efficiency related to labor and materials,
you would do the same thing with respect to your overhead.
And with regard to the level of spending, you would do the same analysis.
You would apply the same sort of thought processes to overhead that you do to labor
and materials.
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