Question

Chilczuk SA of Gdansk, Poland, is a major producer of classic Polish sausage. The company uses a standard cost system to help in the control of costs. Overhead is applied to production based on labor-hours. According to the company's flexible budget, the following manufacturing overhead costs should be incurred at an activity level of 35,000 labor-hours (the denominator activity level): Variable overhead costs Fixed Overhead costs Total Overhead costs £ 87,500 £ 210,000 £ 297,500 Last year the following operating results were recorded: 30,000 hours 32,000 hours Activity Actual labor-hours worked Standard labor-hours allowed for output Cost Actual Variable overhead cost incurred Actual fixed overhead cost incurred £ 78,000 £ 209,400 At the end of the year, the company's manufacturing overhead account contained the following data: Actual Manufacturing Overhead Applied Manufacturing Overhead Difference £ 287,500 £ 272,000 £ 15,500 (unfav.) Management would like to determine the cause of the £15,500 unfavorable overhead. Required 1. Compute the predetermined overhead rate. Break the rate down into variable and fixed cost elements. 2. Show how the £272,000 applied manufacturing overhead account was computed. 3. Decompose the £ 15,500 unfavorable overhead figure to find how much is coming from variances in a. Spending b. Efficiency C. Budget d. Volumen. 4. Explain the meaning of each variance that you computed in Requirement 3 above.

Answer 1

1. Computation of predetermined overhead rates:

  Fixed overhead rates= Total Fixed overhead cost year / Budgeted standard direct labour hours

= 210000/ 35000

= 6.00 per machine hour

Variable overhead rate = Total fixed overhead cost year/ Budgeted standard direct labour hours

= 87500/35000

= 2.50 per direct labour hour

2) Computation of manufacturing overheads

Variable overhead applied = predetermined overhead rate × standard labour - hours allowed for the output

= 2.50× 32000

= 80000

Fixed overhead applied = predetermined overhead rate × standard labour - hours allowed for the output

= 6 × 32000

= 192,000

Total overhead applied = Variable overhead + Fixed overhead

= 80,000 + 192000

= 272000

3) Analysis of under applied overhead variances :

Particular	Amount
Actual variable overhead	78,000
Actual labor hours	30000
Actual variable overhead rate	2.60

Variable overhead rate variance = Actual hours × ( Actual rate - Standard rate)

= 30000 ×(2.60- 2.50)

= 3000( Unfavourable)

Variable overhead efficiency variance = Standard rate (Actual hours - standard hours)

= 2.50- (30000 - 32000)

= 5000(favourable)

Total variable overhead variance = 3000 (U) + 5000(F)

= 2000 ( favourable)

Fixed overhead budget variance = Actual fixed overhead - budgeted fixed overhead

= 209,400- 210000

= 600(favourable)

Fixed overhead volume variance = Budgeted fixed overhead - Fixed overhead applied to work in process

= 210,000 -(32000 × 6)

= 18000 (unfavourable)

Total fixed overhead variance = 600(F) + 18000(U)

= 17400 (Unfavourable)

Total overhead variance = Fixed overhead variance + Variable overhead variance

= 17400(U) + 2000(F)

= 15400(U)

4)

Overhead variance computed in (3) above indicate that the variable overhead variance is favourable. Although rate variance is little unfavourable,however efficiency variance is favourable and therefore total variable overhead variance is favourable.

Fixed overhead variance is unfavourable Although budget variance is favourble.however volume variance is unfavourable.The volume variance does not measure the overspending and under spending,it is the error that occurs when the level of activity is incorrectly estimated at the begning of the period.