Standard Costing at Webb Company

Learning Objective 2 Develop budgeted variable overhead cost rates and budgeted fixed overhead cost rates

• budgeted variable costs divided by quantity of cost-allocation base
• budgeted fixed costs divided by quantity of cost-allocation base

Webb uses standard costing. Chapter 7 explained how the standards for Webb’s direct manufacturing costs are developed. This chapter explains how the standards for Webb’s manufacturing overhead costs are developed. Standard costing is a costing system that (1) traces direct costs to output produced by multiplying the standard prices or rates by the standard quantities of inputs allowed for actual outputs produced, and (2) allocates overhead costs on the basis of the standard overhead cost rates times the standard quantities of the allocation bases allowed for the actual outputs produced.

The standard cost of Webb’s jackets can be computed at the start of the budget period. This feature of standard costing simplifies recordkeeping because no record is needed of the actual overhead costs or of the actual quantities of the cost-allocation bases used for making the jackets. What managers do need are the standard overhead cost rates for Webb’s variable and fixed overhead based on the planned amounts of variable and fixed overhead and the standard quantities of the allocation bases. We describe these computations next. Once managers set these standards, the costs of using standard costing are low relative to the costs of using actual costing or normal costing.

Developing Budgeted Variable Overhead Rates

Budgeted variable overhead cost-allocation rates can be developed in four steps. Throughout the chapter, we use the broader term budgeted rate rather than standard rate to be consistent with the term used to describe normal costing in earlier chapters. When standard costing is used, as is the case with Webb, the budgeted rates are standard rates.

1. Step 1: CHOOSE THE PERIOD TO BE USED FOR THE BUDGET. Webb uses a 12-month budget period. Chapter 4 provided two reasons for using annual overhead rates rather than, say, monthly rates. The first relates to the numerator, such as reducing the influence of seasonality on the firm’s cost structure. The second relates to the denominator, such as reducing the effect of varying output and number of days in a month. In addition, setting overhead rates once a year rather than 12 times a year saves managers’ time.
2. Step 2: SELECT THE COST-ALLOCATION BASES TO USE IN ALLOCATING THE VARIABLE OVERHEAD COSTS TO THE OUTPUT PRODUCED. Webb’s operating managers select machine-hours as the cost-allocation base because they believe that the number of machine-hours is the sole cost driver of variable overhead. Based on an engineering study, Webb estimates it will take 0.40 of a machine-hour per actual output unit. For its budgeted output of 144,000 jackets in 2020, Webb budgets $\text{57,600}\mathrm{\hspace{0.17em}}(\mathrm{0.40}\times \text{144,000})$ machine-hours.
3. Step 3: IDENTIFY THE VARIABLE OVERHEAD COSTS ASSOCIATED WITH EACH COST-ALLOCATION BASE. Webb groups all of its variable overhead costs, including the costs of energy, machine maintenance, engineering support, indirect materials, and indirect manufacturing labor, in a single cost pool. Webb’s total budgeted variable overhead costs for 2020 are $1,728,000.
4. Step 4: COMPUTE THE RATE PER UNIT OF EACH COST-ALLOCATION BASE USED TO ALLOCATE THE VARIABLE OVERHEAD COSTS TO THE OUTPUT PRODUCED. Dividing the amount in Step 3 ($1,728,000) by the amount in Step 2 (57,600 machine-hours), Webb estimates a rate of $30 per standard machine-hour for allocating its variable overhead costs.

When standard costing is used, the variable overhead rate per unit of the cost-allocation base ($30 per machine-hour for Webb) is generally expressed as a standard rate per output unit. Webb calculates the budgeted variable overhead cost rate per output unit as follows:

The $12-per-jacket rate is the budgeted variable overhead cost rate in Webb’s static budget for 2020 as well as in the monthly performance reports the firm prepares during 2020. If Webb had multiple cost-allocation bases (for example machine hours and direct manufacturing labor-hours) and corresponding variable overhead cost pools, Webb would repeat Steps 1 to 4 for each cost pool.

The $12-per-jacket rate represents the amount by which managers expect Webb’s variable overhead costs to change when the output changes. As the number of jackets manufactured increases, the variable overhead costs allocated to output (for inventory costing) increase at the rate of $12 per jacket. The $12 per jacket constitutes the firm’s total variable overhead costs per unit of output, including the costs of energy, repairs, indirect labor, and so on. Managers control variable overhead costs by setting a budget for each of these line items and then investigating the possible causes of any significant variances.