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ACCT 311 Chapter 8 Study Notes, Study notes of Management Accounting

George Mason University (GMU)Management Accounting
Prof. David Stubing

These notes are derived from Chapter 8 "Flexible Budgets, Overhead Cost Variances, and Management Control" of the textbook "Horgen's Cost Accounting: A Managerial Emphasis" 17th edition.

Typology: Study notes

2021/2022

Uploaded on 06/13/2022

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โ— Planning Variable Overhead Costs
โ—‹ To effectively plan variable overhead costs, managers focus on activities that
create a superior product or service for their customers and eliminate activities
that do not add value.
โ— Planning Fixed Overhead Costs
โ—‹ Similar to planning variable overhead costs - only spend on essential activities
and be efficient
โ—‹ Choosing the appropriate level of capacity or investment that will benefit the
company in the long run.
โ—‹ Timing
โ–  At the start of a budget period, management will have made most of the
decisions determining the level of fixed overhead costs to be incurred.
โ–  But itโ€™s the day to day, ongoing operating decisions that mainly determine
the level of variable overhead costs in a period.
โ— Standard Costing
โ—‹ Costing system that:
โ–  Traces direct costs to output produced by multiplying the standard prices
or rates by the standard quantities of inputs allowed for actual outputs
produced.
โ–  Allocates overhead costs on the basis of the standard overhead cost
rates times standard quantities of the allocation bases allowed for the
actual outputs produced.
โ—‹ Simplifies recordkeeping because no record is needed of the actual overhead
costs or of the actual quantities of the cost-allocation bases used.
โ— Developing Budgeted Variable Overhead Rates
โ—‹ Choose the period to be used for the budget
โ—‹ Select the Cost-Allocation Bases to use in allocating the variable overhead costs
to the output produced
โ—‹ Identify the variable overhead costs associated with each cost-allocation base.
โ—‹ Compute the rate per unit of each cost allocations base used to allocate the
variable overhead costs to the output produced.
โ–  Divide Step 3 by Step 2
โ–  Divide total variable overhead costs by cost allocation base
โ–  Budgeted variable overhead cost rate per output unit = budgeted input
allowed per output unit * budgeted variable overhead cost rate per input
unit
โ— Hours per unit * rate per hour
โ— Developing Budgeted Fixed Overhead Rates
โ—‹ Fixed overhead costs are a lump sum of costs that remains unchanged for a
given period, despite wide changes in a firmโ€™s level of activity or output.
โ—‹ Fixed costs are included in flexible budgets, but they remain the same within the
relevant range of activity, regardless of the output level chosen to โ€œflexโ€ the
variable costs and revenues.
โ–  Donโ€™t assume that these costs can never be changed.
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โ— Planning Variable Overhead Costs โ—‹ To effectively plan variable overhead costs, managers focus on activities that create a superior product or service for their customers and eliminate activities that do not add value. โ— Planning Fixed Overhead Costs โ—‹ Similar to planning variable overhead costs - only spend on essential activities and be efficient โ—‹ Choosing the appropriate level of capacity or investment that will benefit the company in the long run. โ—‹ Timing โ–  At the start of a budget period, management will have made most of the decisions determining the level of fixed overhead costs to be incurred. โ–  But itโ€™s the day to day, ongoing operating decisions that mainly determine the level of variable overhead costs in a period. โ— Standard Costing โ—‹ Costing system that: โ–  Traces direct costs to output produced by multiplying the standard prices or rates by the standard quantities of inputs allowed for actual outputs produced. โ–  Allocates overhead costs on the basis of the standard overhead cost rates times standard quantities of the allocation bases allowed for the actual outputs produced. โ—‹ Simplifies recordkeeping because no record is needed of the actual overhead costs or of the actual quantities of the cost-allocation bases used. โ— Developing Budgeted Variable Overhead Rates โ—‹ Choose the period to be used for the budget โ—‹ Select the Cost-Allocation Bases to use in allocating the variable overhead costs to the output produced โ—‹ Identify the variable overhead costs associated with each cost-allocation base. โ—‹ Compute the rate per unit of each cost allocations base used to allocate the variable overhead costs to the output produced. โ–  Divide Step 3 by Step 2 โ–  Divide total variable overhead costs by cost allocation base โ–  Budgeted variable overhead cost rate per output unit = budgeted input allowed per output unit * budgeted variable overhead cost rate per input unit โ— Hours per unit * rate per hour โ— Developing Budgeted Fixed Overhead Rates โ—‹ Fixed overhead costs are a lump sum of costs that remains unchanged for a given period, despite wide changes in a firmโ€™s level of activity or output. โ—‹ Fixed costs are included in flexible budgets, but they remain the same within the relevant range of activity, regardless of the output level chosen to โ€œflexโ€ the variable costs and revenues. โ–  Donโ€™t assume that these costs can never be changed.

โ–  Managers can reduce them by selling equipment or laying off employees. โ–  Fixed in that they do not automatically increase or decrease with the level of activity within the relevant range. โ—‹ Choose the period to use for the budget. โ—‹ Select the cost-allocation bases to use in allocating the fixed overhead costs to the output produced. โ–  Number of machine hours is the denominator in the budgeted fixed overhead rate computation and is called the denominator level. โ—‹ Identify the fixed overhead costs associated with each cost allocation base. โ–  Group all fixed costs into a single cost pool. โ—‹ Compute the rate per unit of each cost allocation base used to allocate fixed overhead costs to the output produced. โ–  Budgeted fixed overhead cost per unit of cost allocation base = budgeted total costs in fixed overhead cost pool / budgeted total quantity of cost allocation base โ—‹ Budgeted fixed overhead cost per output unit = budgeted quantity of cost allocation base allowed per output unit * budgeted fixed overhead cost per unit of cost allocation base โ— Variance Overhead Cost Variances โ—‹ Flexible-Budget Analysis โ–  The variable overhead flexible-budget variance measures the difference between actual variable overhead costs incurred and flexible-budget variable over head costs. โ— Variable overhead flexible-budget variance = actual costs incurred

  • flexible budget amount โ—‹ Variable Overhead Efficiency Variance โ–  The difference between the actual quantity of the cost allocation base used and the budgeted quantity of the cost allocation base that should have been used to produce the actual output, multiplied by the budgeted variable overhead cost per unit of the cost allocation base. โ— Variable overhead efficiency variance = (actual quantity of variable overhead cost allocation base used for actual output - budgeted quantity of variable overhead cost allocation base allowed for actual output) * budgeted variable overhead cost per unit of cost allocation base. โ— Computed in the same way the efficiency variable for direct cost items is, however, the interpretation of the variance is different. โ—‹ Efficiency variances for direct cost items are based on the differences between the actual inputs used and the budgeted inputs allowed for the actual output produced. โ—‹ Efficiency variance for variable overhead is based on the efficiency with which the cost allocation base is useud โ—‹ Variable Overhead Spending Variance

โ—‹ Although fixed costs are unitized (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. โ–  Identifying the best ways to use capacity, or when making decisions, concentrate on total lump-sum costs instead of unitized costs โ—‹ Interpreting the Production-Volume Variance โ–  Lump-sum fixed costs represent the costs of acquiring capacity. โ— These costs do not decrease automatically if the capacity needed turns out to be less than the capacity acquired. โ—‹ Journal Entries for Fixed Overhead Costs and Variances โ–  To record actual fixed overhead costs incurred โ— Debit Fixed Overhead Control โ— Credit Salaries Payable, Accumulated Depreciation, and various other accounts. โ–  To record fixed overhead costs allocated โ— Debit Work-in-Process Control โ— Credit Fixed Overhead Allocated โ–  To record variances for the accounting period โ— Debit Fixed Overhead Allocated (if under allocated, credit if overallocated) โ— Debit Overhead Spending Variance (if unfavorable, credit if favorable) โ— Debit Fixed Overhead Production-Volume Variance (if unfavorable, credit if favorable) โ— Credit Fixed Overhead Control โ–  To write-off to Cost of Goods Sold โ— Debit Cost of Goods Sold โ— Credit Fixed Overhead Spending Variance (if unfavorable, debit if favorable) โ— Integrated Analysis of Overhead Cost Variances โ—‹ Variable overhead has no production-volume variance, Fixed overhead has no efficiency variance โ—‹ 4 Variance Analysis โ–  Provides the same level of information as the variance analysis for variable overhead and fixed overhead separately, but does so in a unified presentation that also indicates those variances that are never present. โ–  Overhead variances are not necessarily independent of each other โ—‹ Combined Variance Analysis โ–  Use less detailed analysis that combines the variable overhead and fixed overhead into a single total overhead cost โ— Still need to estimate variable overhead costs and fixed overhead costs to subdivide the total overhead variance into spending, efficiency, and production volume variances

โ— Variances are now the sums of the variable overhead and fixed overhead variances โ–  Accounting for 3-variance analysis is simpler than for 4-variance analysis, but some information is lost because the variable and fixed overhead spending variances are combined into a single total overhead spending variance. โ–  The overall total overhead variance is the sum of the preceding variances. โ— If the total overhead variance were favorable, it would equal the overallocated overhead costs. โ— Production-Volume Variance and Sales-Volume Variance โ—‹ For the fixed overhead, we noted that the flexible-budget variance is the same as the spending variance โ—‹ Production-volume variance is a component of the sales-volume variance โ—‹ A crucial point to keep in mind is that under standard costing, fixed overhead costs are allocated to finished goods as each unit is produced and so appear as if they are a variable cost. โ—‹ Sales-volume variance has two components: โ–  A difference between the operating income reported in the standard costing system and the flexible-budget income for the actual units produced. โ— Difference arises because the costing system allocates fixed costs to each unit produced (as if they behave in a variable manner) rather than the budgeted fixed costs. โ—‹ Results in the production-volume variance โ–  A difference between the static-budget operating income for budgeted # of units and the budgeted operating income the actual # of units. โ— This is the operating-income volume variance. โ— Reflects the fact that more/less units were produced and sold than what was budgeted. โ–  Although useful from a managerial point of view, the sales-volume variance and the operating-income volume variance are not part of the standard costing system โ— Provides a summary that formally disaggregates the static-budget variance into its components โ— Overhead Variances in Nonmanufacturing Settings โ—‹ Managers can also use variance analysis to examine the overhead costs of the nonmanufacturing areas of the company โ–  Product distribution costs. โ—‹ Most costs in service sector companies are fixed overhead costs. โ–  Using capacity effectively is the key to profitability, and fixed overhead variances can help managers in this task โ—‹ Financial and Nonfinacial Performance Measures โ–  Nonfinancial measures such as those related to capacity utilization and physical measures of input usage also provide useful information.