Learning Objective 4 Compute the fixed overhead flexible-budget variance, the fixed overhead spending variance, and the fixed overhead production-volume variance
difference between actual fixed overhead costs and flexible-budget fixed overhead amounts
same as the preceding explanation
difference between budgeted fixed overhead and fixed overhead allocated on the basis of actual output produced
The flexible-budget amount for a fixed-cost item is also the amount included in the static budget prepared at the start of the period. No adjustment is required for differences between actual output and budgeted output for fixed costs because fixed costs are unaffected by changes in the output level within the relevant range. At the start of 2020, Webb budgeted its fixed overhead costs to be $276,000 per month. The actual amount for April 2020 turned out to be $285,000. The fixed overhead flexible-budget variance is the difference between actual fixed overhead costs and fixed overhead costs in the flexible budget:
The variance is unfavorable because the $285,000 actual fixed overhead costs exceed the $276,000 budgeted for April 2020, which decreases that month’s operating income by $9,000.
The variable overhead flexible-budget variance described earlier in this chapter was subdivided into a spending variance and an efficiency variance. There is no efficiency variance for fixed overhead costs. That’s because a given lump sum of fixed overhead costs will be unaffected by how efficiently machine-hours are used to produce output in a given budget period. As Exhibit 8-2 shows, because there is no efficiency variance, the fixed overhead spending variance is the same amount as the fixed overhead flexible-budget variance:
Exhibit 8-2
Columnar Presentation of Fixed Overhead Variance Analysis: Webb Company for April 2020a
The details of the table are as follows:
Actual Costs Incurred: dollar 285,000
Flexible Budget (Same budgeted lump sum as in static budget regardless of output level): dollar 276,000
Allocated (Budgeted input quantity allowed for actual output times budgeted rate): dollar 230,000 which is 0.40 hour per unit times 10,000 units times dollar 57.50 per hour, which equals 4,000 hours times dollar 57.50 per hour.
Level 3:
Spending variance: dollar 9,000 that has unfavorable effect on operating income is the difference of the above section 1 and 2.
Production-volume variance: dollar 46,000 that has unfavorable effect on operating income is the difference between the above section 2 and 3.
Level 2:
Flexible-budget variance: dollar 9,000 that has unfavorable effect on operating income the difference between the above section 1 and 2.
Reasons for the unfavorable spending variance could be higher equipment-leasing costs, higher depreciation on plant and equipment, or higher administrative costs, such as a higher-than-budgeted salary paid to the plant manager. If equipment-leasing costs were higher, for example, managers might look to lease equipment from other suppliers.
Production-Volume Variance
The production-volume variance arises only for fixed costs. It is the difference between the budgeted fixed overhead and the fixed overhead allocated on the basis of actual output produced. Recall that at the start of the year, Webb calculated a budgeted fixed overhead rate of $57.50 per machine-hour based on monthly budgeted fixed overhead costs of $276,000. Under standard costing, Webb’s fixed overhead costs are allocated to the actual output produced during each period at the rate of $57.50 per standard machine-hour, which is equivalent to a rate of $23 per jacket If Webb produces 1,000 jackets, out of April’s budgeted fixed overhead costs of $276,000 will be allocated to the jackets. If Webb produces 10,000 jackets, will be allocated. Only if Webb produces 12,000 jackets (that is, operates, as budgeted, at capacity) will all of the budgeted fixed overhead costs be allocated to the jacket output. The key point here is that even though Webb budgeted its fixed overhead costs to be $276,000, it does not necessarily allocate all these costs to output. The reason is that Webb budgets $276,000 of fixed costs to support its planned production of 12,000 jackets. If Webb produces fewer than 12,000 jackets, it only allocates the budgeted cost of capacity actually needed and used to produce the jackets.
The production-volume variance, also referred to as the denominator-level variance, is the difference between the budgeted and allocated fixed overhead amounts. Note that the allocated overhead can be expressed in terms of the budgeted fixed cost per unit of the allocation base (machine-hours for Webb) or in terms of the budgeted fixed cost per unit:
As shown in Exhibit 8-2, the budgeted fixed overhead ($276,000) will be the lump sum shown in the static budget and also in any flexible budget within the relevant range. The fixed overhead allocated ($230,000) is calculated by multiplying the number of output units produced during the budget period (10,000 units) by the budgeted cost per output unit ($23). The $46,000 U production-volume variance can also be thought of as that were not produced.
Exhibit 8-3 shows Webb’s production-volume variance. For planning and control purposes, Webb’s fixed (manufacturing) overhead costs do not change in the 0- to 12,000-unit relevant range. Contrast this behavior of fixed costs with how costs are depicted for the purpose of inventory costing in Exhibit 8-3. Under Generally Accepted Accounting Principles, fixed (manufacturing) overhead costs are allocated as an inventoriable cost to the output units produced. Every output unit that Webb manufactures will increase fixed overhead allocated to products by $23. That is, for purposes of allocating fixed overhead costs to jackets, these costs are viewed as if they had a variable-cost behavior pattern. As the graph in Exhibit 8-3 shows, the difference between the $276,000 in fixed overhead costs budgeted and the $230,000 of costs allocated is the $46,000 U production-volume variance.
Exhibit 8-3
Behavior of Fixed Manufacturing Overhead Costs: Budgeted for Planning and Control Purposes and Allocated for Inventory Costing Purposes for Webb Company for April 2020
The details of the graph are as follows:
The Y-axis shows the budgeted and allocated fixed manufacturing overhead costs, ranging from 0 to 400,000 with increments of 100,000 and X-axis shows output units ranging from 0 to 20,000 with increments of 5,000. The graph shows the following data:
Graph for planning and control purposes: The costs remain constant at dollar 276,000 from 0 units to 13,000 units.
Graph for inventory costing purpose (dollar 23 per output unit): The cost and output units are directly proportional to that of output unit from origin. The line reaches dollar 230,000 when the output units are 10,000.
Production-volume variance of dollar 46,000 U: It is depicted by the line, extended from the ending of the graph for inventory costing purpose and reaches dollar 276,000 when the output units are approximately 13,000 units.
Note: It is evident from the graph, the perpendicular distance between the first and second graph gives the value of production-volume variance.
Be careful to distinguish the true behavior of fixed costs from the manner in which fixed costs are assigned to products. In particular, although fixed costs are unitized (i.e., converted into per-unit amounts) and allocated for inventory-costing purposes, be wary of using the same per-unit fixed overhead costs for planning and control purposes. When forecasting or controlling fixed costs, identifying the best ways to use capacity, or when making decisions, concentrate on total lump-sum costs instead of unitized costs.
