10SE - Horngren'S Financial And Managerial Accounting

Question

Computing overhead variances

Refer to the Morgan, Inc. data in Short Exercise S23­9. Last month, Morgan reported the following actual results: actual variable overhead, \(10,800; actual fixed overhead, \)2,770; actual production of 7,000 units at 0.20 direct labor hours per unit. The standard direct labor time is 0.25 direct labor hours per unit (1,300 static direct labor hours / 5,200 static units).

Requirements 

1. Compute the overhead variances for the month: variable overhead cost variance, variable overhead efficiency variance, fixed overhead cost variance, and fixed overhead volume variance. 

2. Explain why the variances are favorable or unfavorable.

Step-by-Step Solution

Answer

Particular	(1) Amount	(2) Favorable/Unfavorable
Variable overhead cost variance	$11,970	Unfavorable
Variable overhead efficiency variance	$2,100	Favorable
Fixed overhead cost variance	$1,130	Favorable
Fixed overhead volume variance	$1,350	Favorable

Step 1: Meaning of Direct Labor Cost

Direct labor is the cost directly attached to producing goods and services and depends upon the direct labor hours.

Step 2: Calculation of overhead variance

1. Calculation of variable overhead cost variance:

$\begin{array}{rcl}\mathbf{Variable}\mathbf{ }\mathbf{overhead}\mathbf{ }\mathbf{cost}\mathbf{ }\mathbf{variance}& \mathbf{=}& \left(\mathrm{Actual} \mathrm{cost}-\mathrm{Standard} \mathrm{cost}\right)\mathbf{\times }\mathbf{Actual}\mathbf{ }\mathbf{quantity}\\ & \mathbf{=}& \left(\frac{\$10,800}{7,000\times 0.20}-\$6\right)\mathbf{\times }\mathbf{7}\mathbf{,}\mathbf{000}\\ & \mathbf{=}& \left(\$7.71-\$6\right)\mathbf{\times }\mathbf{7}\mathbf{,}\mathbf{000}\\ & \mathbf{=}& \mathbf{\$}\mathbf{11}\mathbf{,}\mathbf{970}\mathbf{ }\left(U\right)\end{array}$ 

Working note:

 $\begin{array}{rcl}\mathbf{Standard}\mathbf{ }\mathbf{variable}\mathbf{ }\mathbf{overhead}\mathbf{ }\mathbf{allocation}\mathbf{ }\mathbf{rate}& \mathbf{=}& \frac{\mathbf{Static}\mathbf{ }\mathbf{budget}\mathbf{ }\mathbf{variable}\mathbf{ }\mathbf{overhead}\mathbf{ }}{\mathbf{Static}\mathbf{ }\mathbf{budget}\mathbf{ }\mathbf{direct}\mathbf{ }\mathbf{labor}\mathbf{ }\mathbf{hour}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{7}\mathbf{,}\mathbf{800}}{\mathbf{1300}\mathbf{ }\mathbf{hours}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{6}\mathbf{ }\mathbf{per}\mathbf{ }\mathbf{direct}\mathbf{ }\mathbf{labor}\mathbf{ }\mathbf{hour}\end{array}$

1. Calculation of variable overhead efficiency variance:

 $\begin{array}{rcl}\mathbf{Variable}\mathbf{ }\mathbf{overhead}\mathbf{ }\mathbf{efficiency}\mathbf{ }\mathbf{variance}& \mathbf{=}& \left(\mathrm{Actual} \mathrm{quantity} -\mathrm{Standard} \mathrm{quantity}\right)\mathbf{\times }\mathbf{Standard}\mathbf{ }\mathbf{cost}\\ & \mathbf{=}& \left(\left(7,000\times 0.02\right)-\left(\frac{1,300\times 7,000}{1,500}\right)\right)\mathbf{\times }\mathbf{\$}\mathbf{6}\\ & \mathbf{=}& \left(1400-1750\right)\mathbf{\times }\mathbf{\$}\mathbf{6}\\ & \mathbf{=}& \mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{100}\mathbf{ }\left(F\right)\end{array}$

Fixed overhead cost variance:

Particular	Amount $
Actual fixed overhead	$2,770
Less: Budgeted fixed overhead	(3,900)
Fixed overhead cost variance (F)	$1,130

 

Fixed overhead volume variance:

Particular	Amount $
Budgeted fixed overhead	$3,900
Less: Allocated fixed overhead  $\left(\frac{\$3,900}{5,200}\times 7,000\right)$	(5,250)
Fixed overhead volume variance (F)	$1,350

Step 3: Explanation for variance

1. Variable overhead cost variance: This variance is unfavorable and adverse because the actual variable overhead rate is higher than the standard variable overhead rate.
2. Variable overhead efficiency variance: It is favorable because actual direct labor hours used in the production process are less than the standard direct labor hours.
3. Fixed overhead cost variance: fixed overhead cost variance is favorable because the actual fixed cost of the business entity is lower than the established standards.
4. Fixed overhead volume variance: It is favorable because the number of units produced is higher than the established standard.