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Lecture 6

AYB225 - Lecture 6 Notes

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LECTURE 6 – STANDING COSTING AND OVERHEADS; DISPOSITION OF VARIANCES STANDARD COSTING – OVERHEADS Standard Costing – Overhead Compared with DM, DL  Price variances which were calculated for direct materials and direct labour will be calculated for both fixed and variable overhead. They have the same meaning as they had last week  Efficiency variances calculated last week for direct materials and direct labour will be calculated for variable overhead only. It also has the same meaning as the efficiency variance from last week o We will not calculate a fixed overhead efficiency variance.  Fixed overhead: An additional variance (which was not calculated for direct materials and direct labour) will be calculated. o This variance is the fixed overhead volume variance.  A fixed overhead volume variance occurs whenever actual production ≠ budgeted production.  If actual is greater than budget the variance is favourable.  If actual is less than budget, the variance is unfavourable. Definitions  An overhead price (spending) variance occurs when a firm spends more or less on either fixed or variable overhead for units produced than it planned (budgeted) to spend.  A variable overhead efficiency variance occurs when a firm uses more or fewer units of the cost driver (in ITB’s case, machine hours) than it should have used for the units produced.  Fixed OH volume variance (also called denominator and production volume variance (PVV)): o This variance occurs only because actual production volume (number of units produced) differs from budgeted (static/denominator) production level:  Volume variance (F) = produced more units than budgeted  Volume variance (U) = produced fewer units than budgeted  Volume variance 0 = actual units produced equals budgeted production. This variance is not a measure of the firm’s efficiency. Common Conventions  If given a budgeted fixed amount for a year, divide it by 12 to convert to a monthly figure.  Where possible, variances are calculated separately for fixed and variable overhead.  Some firms have a separate ledger account for fixed and variable overhead. Other firms include both fixed and variable in the one account, which is what we do.  In the variance table, these notes show the fixed calculations on the first line, then variable costs. This setting out is chosen simply because it lines up with the way the flexible budget formula is always expressed. Overhead – Normal and Standard Costing Compared Items which remain the same under Standard Costing  Actual OH incurred is recorded on an OH cost sheet (which is the subsidiary ledger for overhead), and entered on the debit side of the OH account in the ledger, or if using two OH accounts, on the debit side of the OH Control account. This will occur in all costing systems.  The budgeted OH rate is always: budgeted OH (at static budget level) budgeted (denominator/normal capacity/static budget) activity level.  OH applied: The entry for OH applied to production in any costing system will Debit WIP and Credit OH, or if using two OH accounts, credit the OH Applied account.  Variances: Firms will calculate under/over-applied overhead as they did under normal costing. Under/over applied is always the difference between actual overhead and overhead applied.  Disposition of variances: Firms using standard costing will dispose of the under/over applied overhead either to COGS, or across inventories and COGS. Differences under Standard Costing  OH applied: While the accounts in the journal entry for OH will be the same, the amounts will be different. The underlining in the table below highlights the difference: Costing Amount for OH applied system Normal actual activity (which may be actual DL hours worked; actual machine hours; actual DL cost etc depending on the base chosen by the firm) multiplied by the budgeted OH rate. Standard standard activity (machine hours, DL hours, or DL cost etc) multiplied by the budgeted OH rate.  Variances: Because the amount of OH applied is different under standard costing, the amount of the overhead variance will also be different under standard costing. Another difference is that under/over applied OH in standard costing systems is split further into standard costing overhead variances. As a result of this split into four variance accounts, ledger accounts will be required for these variances.  Disposition of variances: Under standard costing you will have to dispose of all variances (not just under/over applied overhead) either to COGS, or across inventories and COGS. Overhead Variances Variance Report Reviewed The following table is an extract from last week’s lecture notes, showing the variance report. Focusing on OH this week, recall that this report shows:  Budgeted variable and fixed OH costs at original budget (static) budget level, i.e. 60,000 boxes.  Budgeted costs at 60,000 units “flexed” to 50,000 units (note: expected fixed OH costs remain the same).  Actual OH costs entered, and cost and volume variances calculated. Actual Variances FlexibleVariances Static costs due to budget due to budget (50,000) cost (50,000) volume (60,000) DM $124,800 $ 200 F $125,000 $25,000F $150,000 DL $305,250 $ 5,250U $300,000 $60,000F $360,000 V OH $ 59,500 $ 9,500 U $ 50,000 $10,000 F $ 60,000 F OH $ 37,400 $ 1,400U $ 36,000 No variance $ 36,000 Totalcosts $526,950 $15,950U $511,000 $95,000F $606,000 This week we consider OH variances only.  “Volume” column: As for DM and DL, the variances due to volume exist solely because output was not 60,000 units.  “Cost” column: As was the case with DM and DL, these overhead variances do not give the full picture. Management wanting to correct any out-of-control situations needs to be able to determine whether the cost variance is caused by: o a differenceinprice from budget,or o a differenceinquantityused from budget,or o a differenceinbothpriceand quantity.  What
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