BUSN3003 Management Decision Making
Lecture 12
Overhead and Marketing Variances
Outline
Budgeted, Standard, and Actual Volume
Overhead Variances
Marketing Variances
Connection to Other Lectures
This lecture extends the price and quantity variances considered last lecture to include overhead and marketing variances.
Last lecture began the price and quantity variance analysis with direct labor and direct materials.
Lecture 9 described how absorption costing applies overhead to jobs.
Lecture 4 built the foundation on how internal accounting is used for decision control.
Overhead Volume Measures
BV: Budgeted volume (also known as denominator volume)
Estimated at the beginning of the year and used for calculating the overhead rate
SV: Standard volume (also known as earned or allowed volume)
(Output units completed) (Standard input hours per output unit)
Volume used to apply overhead to work-in-process inventory
AV: Actual volume
Actual hours or other input resource used during period
Budget Volume Estimates
Estimated budget volume influences overhead rate.
Increasing budgeted volume (denominator) while holding total budgeted dollars constant (numerator) decreases the overhead rate.
Expected volume to set budget
Adjust expectation based on number of units forecast for next year.
Rises and falls with business cycle
Normal volume to set budget
Forecast of long-run average annual production
Does not change during business cycle
Flexible Overhead Budget
Flexible overhead budget is the formula for budget forecast.
Flexible overhead budget = FOH + (VOH V)
= $1,350,000 + ($14 V)
Estimate budgeted overhead (BOH) dollars using a specific budgeted volume number (BV) and the flexible overhead budget formula.
BOH = FOH + (VOH BV)
= $ 1,350,000 + ($14 67,500 hours)
= $ 2,295,000
Overhead Rate
Overhead rate is the total budgeted overhead dollars for the year divided by the budgeted volume for the year.
OHR = (BOH BV) = (FOH BV) + VOH
The overhead rate consists of the estimated:
fixed overhead $ per input hour (FOH BV), and
variable overhead $ per input hour (VOH)
Overhead Absorbed
Overhead is absorbed (also known as applied) by the product when work is done in the factory. The accounting system transfers costs from the overhead account to the work-in-process account (Fig. 9-1 on p. 430).
For most firms, overhead is absorbed using the standard volume.
Overhead absorbed = Overhead rate Standard volume = OHR SV
Standard Volume = Units of output Standard input per output
See Table 13-5: SV = 67,400 machine hours for 96,000 blocks
Overhead absorbed = $34 67,400 machine hours
Total Overhead Variance
Overhead variances occur when the actual overhead incurred does not equal the overhead absorbed (see Figure 9-1 and the T-accounts).
Actual overhead Overhead absorbed
cost incurred (applied to product)
AOH (OHR SV)
|_________________________________________|
AOH - (OHR SV)
Total overhead variance
Underabsorbed, if actual > absorbed
Overabsorbed, if actual < absorbed
3-way Overhead Variances
Actual overhead Flex. budget at Flex. budget at Overhead absorbed
at actual volume actual volume standard volume (applied to product)
AOH [FOH + (VOH AV)] [FOH + (VOH SV)] (OHR SV)
|________________| |______________| |________________|
Overhead Overhead Overhead
Spending Efficiency Volume
Variance Variance Variance
|_______________________________________ __________|
Total overhead variance
Over/underabsorbed overhead
See Table 13-5 example and Self-Study Problem.
Overhead Efficiency Variance
Flexible budget at Flexible budget at
actual volume standard volume
[FOH + (VOH AV)] [FOH + (VOH SV)]
|______________________________________________|
Overhead Efficiency Variance
[FOH + (VOH AV)] - [(FOH + (VOH SV)]
= VOH AV - SV)
Unfavorable (U) when AV > SV
Favorable (F) when AV < SV
When overhead is allocated with the same base as direct labor, the overhead efficiency and labor efficiency variances will be in the same direction.
Overhead Volume Variance
Flexible budget at Overhead absorbed
actual volume (applied to product)
[FOH + (VOH SV)] (OHR SV)
|______________________________________________|
Overhead Volume Variance
[FOH + (VOH SV)] - (OHR SV)
= [FOH BV - SV)] BV
Unfavorable (U) when BV > SV
Favorable (F) when BV < SV
When output exceeds planned capacity, SV>BV, the volume variance is favorable. Rewarding favorable volume variances encourages inventory building.
Overhead Spending Variance
Actual overhead at Flexible budget at
actual volume actual volume
AOH [FOH + (VOH AV)]
|_____________________________________________|
Overhead Spending Variance
AOH - [FOH + (VOH AV)]
Unfavorable (U) when AOH > [FOH + (VOH AV)] Favorable (F) when AOH < [FOH + (VOH AV)]
Cause: unexpected changes in prices of variable and fixed overhead items, and changes in production technology
Inaccurate Flexible Budget
Usefulness of overhead variances in performance measurement depends on accuracy of flexible budget in predicting cost-volume relation.
Flexible budget assumes a linear formula over relevant range.
But as production volume increases to levels near or above plant capacity, congestion occurs and:
actual costs increase above flexible budget.
unfavorable spending variance is reported.
A more accurate flexible budget formula would forecast congestion costs, and allow variable costs to increase as volume increases.
Sales Price and Quantity Variances
Symbols: Q = Quantity; P = Price; a = actual; s = standard
Total Flexible budget Total
actual based on budgeted
sales actual quantity sold sales
(Qa Pa) (Qa Ps) (Qs Ps)
|_______________________| |____________________|
[Qa (Pa - Ps)] [(Qa - Qs) Ps]
Price variance Quantity variance
|______________________________________________|
[( Qa Pa) (Qs Ps)]
Total sales variance in sales dollars
Price variances measure sales manager’s pricing policy.
Quantity variances depend on salespersons’ efforts and customer orders.
Marketing Contribution Margin Variances
Q = Quantity; CM = Contribution margin per unit; a = actual; s = standard [Note: Cma is (actual price – budgeted variable costs).]
Total Flexible budget Total
actual based on budgeted
sales actual quantity sold sales
(Qa Cma) (Qa CMs) (Qs CMs)
|_______________________| |______________________|
[Qa (CMa - CMs)] [(Qa - Qs) CMs]
CM price variance CM quantity variance
|________________________________________________|
[(Qa CMa) (Qs CMs)]
Total sales variance in profit dollars
Price variances measure sales manager’s pricing and purchasing policy.
Quantity variances depend on salespersons’ efforts and customer orders.
Marketing Sales and Mix Variances
Actual Flex. budget at Flex. budget at Standard
revenue actual mix % standard mix % revenue
$23,241 10,600 % $ 10,600 60% $ 6,000 $
24,210 10,600 % $ 10,600 40% $ 4,000 $
$47,451 $47,480 $47,064 $44,400
|_________________| |_________________| |__________________|
Price variance Mix variance Sales variance
$ 29 U $ 416 F $ 2,664 F
|______________________________________|
Quantity variance
$ 3,080 F
|_________________________________________________________|
Total sales variance
$ 3,051 F
