Question

You have been assigned for reviewing the actual and budgeted figures of the variable manufacturing overhead of straight umbrellas at Ombrelloni Felici (OF). The management at OF argues there are no evident issues with the variable manufacturing overhead budget as the static-budget variance is often favourable, which proves the budgeting process works quite well. The management at OF also argues the employees at the production line of straight umbrellas are always highly efficient because of the consistently favourable efficiency variances. Your analysis is for a specific month of the year, comparing the budgeted and actual figures. The variable manufacturing overhead cost is allocated to each straight umbrella based on budgeted direct manufacturing labour-hours per straight umbrella. For the specific month of the year, each straight umbrella is budgeted to take 5 labour-hours. Budgeted variable manufacturing overhead cost per labour-hour is $20. The budgeted number of straight umbrellas to be manufactured in this given month is 100. Actual variable manufacturing overhead costs in the given month were $12,000 for 95 straight umbrellas started and completed. There was no opening or closing stock of straight umbrellas. Actual direct manufacturing labour-hours for this given month were 490. Required a) Calculate the static-budget variance, the flexible-budget variance, the sales-volume variance and the spending and efficiency variances for the given month for the variable manufacturing overhead. (e.g., Exercise 16.11, Chapter 16, 10 marks) b) Explain whether the management at OF is correct or not regarding having a good budgeting process due to often having a favourable static-budget variance and a consistently favourable efficiency variance. Use your calculations for supporting your argument. (Chapter 16, 10 marks)

Answer 1

a)

Static budget variance

Fixed budgeted Variable manufacturing overhead                  = 100 units x 5 hours x $20 = $10000

Actual Variable manufacturing overhead                                  =                                                  $12000

Variance        = 10000 – 12000 = -2000 Adverse                                                  

Flexible budget variance

Flexed budgeted Variable manufacturing overhead               = 95 units x 5 hours x $20 = $9500

Actual Variable manufacturing overhead                                  =                                                $12000

Variance        = 9500 – 12000 = -2500 Adverse           

Sales Volume variance

                                             = (Budgeted Units of sales – Actual Units of sales) x Budgeted price per unit

                                             = (100 – 95 )     x Budgeted price (?Not given in the question)            

Variable overhead spending variance        

                                                = Actual hours x (Standard Rate – Actual Rate)

Actual hours = 490 hours

Actual Rate    = $12000/490 hours = $24.49           

Standard Rate =   $20                           

Spending Variance = 490 (20 – 24.49) = -2200 Adverse          

Variable overhead efficiency variance      

                                              = Standard overhead rate x (Standard hours – Actual hours)

Standard hours for actual production = 95 x 5 = 475 hours

                                Efficiency variance             = $20 x (475 hours – 490 hours) = $300 Adv

b) Static budget variance calculation is always will not give correct variance as we are not able to compare like with like. It calculates only the differences between budgeted figure and actual figures. The actual activity level may vary and the actual amount of overhead expenditure will not be the same as budget. Static budget variance is the difference between what a company it would spend in its budget versus what it actually it did.   In this case it showed an adverse variance of 2000 but actually there is a difference of 2500 when the budget is flexed. For producing 95 units they should take 475 hours and $20 per hour means the variable should have been $9500. Instead of it actual amount of overhead was $12000. Resulting into an adverse variance of 2500.

Efficiency variance is the difference between actual and budgeted hours worked measured in standard hours. Actually worked 490 hours against the budget of 475 hours (95 x5). Extra 15 hours worked than the standard. So there is an adverse variance of (15 x $20) $300.

So the management is not always correct with their static budget variances. Better to consider flexible budget variances for correct decisions.