Flexible Budget and Variance Analysis for Fixed Setup Overhead Costs

Exhibit 8-7 presents the variances for fixed setup overhead costs in columnar form.

Exhibit 8-7

Columnar Presentation of Fixed Setup Overhead Variance Analysis: Lyco Brass Works for 2020a

A table shows Lyco Brass Works’ columnar presentation of fixed setup overhead variance analysis for the year 2020.

Actual costs incurred: dollar 220,000

Flexible budget (same budgeted lump sum as in static budget regardless of output level): dollar 216,000

Allocated (budgeted input quantity allowed for actual output times budgeted rate): dollar 181,440 (which is 1,008 batches times 6 hours per batch times dollar 30 per hour).

Level 3: Spending variance: dollar 4,000 is the difference of 1 and 2 and has an Unfavorable effect on operating system; Production-volume variance: dollar 34,560 is the difference of 2 and 3 and has an Unfavorable effect on operating system.

Level 2: Flexible budget variance: dollar 4,000 is again the difference of above 1 and 2, and has an unfavorable effect on operating system.

Note: 1,008 batches equals 151,200 units divided by 150 units per batch.

Lyco’s fixed setup overhead flexible-budget variance is calculated as follows:

Fixed‐setupoverheadflexible‐budgetvariance=Actual costsincurred−Flexible‐budgetcosts=$220,000 − $216,000=$4,000 U  

Note that the flexible-budget amount for the fixed setup overhead costs equals the static-budget amount of $216,000. That’s because there is no “flexing” of fixed costs. Moreover, because the fixed overhead costs have no efficiency variance, the fixed setup overhead spending variance is the same as the fixed overhead flexible-budget variance. The spending variance could be unfavorable because of higher leasing costs of new setup equipment or higher salaries paid to engineers and supervisors.

To calculate the production-volume variance, Lyco first computes the budgeted cost-allocation rate for the fixed setup overhead costs using the same four-step approach described in section Developing Budgeted Fixed Overhead Rates.

  1. Step 1: CHOOSE THE PERIOD TO USE FOR THE BUDGET. Lyco uses 12 months (the year 2020).
  2. Step 2: SELECT THE COST-ALLOCATION BASE TO USE IN ALLOCATING THE FIXED OVERHEAD COSTS TO THE OUTPUT PRODUCED. Lyco uses the 7,200 budgeted setup-hours (equal to the setup capacity) as the cost-allocation base for fixed setup overhead costs.
  3. Step 3: IDENTIFY THE FIXED OVERHEAD COSTS ASSOCIATED WITH THE COST-ALLOCATION BASE. Lyco’s fixed setup overhead cost budget for 2020 is $216,000.
  4. Step 4: COMPUTE THE RATE PER UNIT OF THE COST-ALLOCATION BASE USED TO ALLOCATE THE FIXED OVERHEAD COSTS TO THE OUTPUT PRODUCED. Dividing the $216,000 from Step 3 by the 7,200 setup-hours from Step 2, Lyco estimates a fixed setup overhead cost rate of $30 per setup-hour.The production-volume variance for fixed setup overhead costs is calculated as:Production‐volumevariance forfixed setupoverhead costs=Budgetedfixed setupoverheadcosts−Fixed setup overheadallocated using budgetedinput allowed for actualoutput units produced=$216,000−(1,008 batches×6 hours/batch×$30/hour)=$216,000−(6,048 hours×$30/hour)=$216,000−$181,440=$34,560 U

During 2020, Lyco planned to produce 180,000 units of Elegance but actually produced 151,200 units. The unfavorable production-volume variance measures the amount of extra fixed setup costs Lyco incurred for setup capacity it did not use. One interpretation is that the $34,560 U production-volume variance represents an inefficient use of the company’s setup capacity. However, Lyco may have earned higher operating income by selling 151,200 units at a higher price than 180,000 units at a lower price. As a result, Lyco’s managers should interpret the production-volume variance cautiously because it does not consider the effect of output on selling prices and operating income.

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