Cost Accounting Variances: Overhead Planning & Analysis

Planning Variable and Fixed Overhead Costs

Planning fixed costs, both direct and indirect, involves identifying and focusing only on activities that add value, then efficiently performing these activities. The key difference for planning variable costs is that progressive decisions taken during the budget period significantly influence them. In contrast, fixed cost decisions are typically made long before the budget period begins.

Understanding the Standard Cost System

Why Companies Use Standard Costing

Companies utilize a standard cost system to track costs effectively. For a cost object, the system tracks direct costs by multiplying the established standard price or rate by the standard input for actual production. Indirect costs are allocated based on the standard overhead rate multiplied by the standard allocation bases for the actual output produced.

Variable Overhead Variances

Calculable Variances for Variable Overhead

When a flexible budget is developed for variable overhead, it's possible to calculate two key variances: a variable overhead efficiency variance and a variable overhead spending variance.

Variable Overhead Efficiency Variance vs. Direct Cost Efficiency Variance

These two efficiency variances are not similar. The variable overhead efficiency variance indicates whether more or less of the chosen allocation base (e.g., machine hours, labor hours) per unit of production was used than included in the flexible budget. Conversely, the efficiency variance for a direct cost item indicates whether a varying amount of input (e.g., direct materials, direct labor) per unit of production was used compared to what was included in the flexible budget.

Fixed Overhead Cost Analysis

Calculating the Budgeted Fixed Overhead Rate

The budgeted fixed overhead cost rate is computed by dividing the total budgeted fixed overhead costs by the chosen denominator level of the cost allocation base.

Interpreting Production Volume Variance

Managers should interpret the production volume variance cautiously. This variance primarily measures the economic cost of unused capacity. It does not, however, account for any potential decrease in the selling price of production that might be necessary to stimulate greater demand, which could otherwise utilize idle capacity.

Reconciling Actual Indirect Costs

Detailed Reconciliation of Indirect Costs

The most detailed way a company can reconcile actual indirect costs incurred with the amount applied over a period is through a comprehensive analysis. This involves examining:

• The spending and efficiency variances for variable overhead costs.
• The budget and production volume variances for fixed overhead costs.

Activity-Based Costing (ABC) and Overhead Analysis

Using ABC for Flexible Budget Variance Analysis

Yes, the activity-based costing (ABC) approach can be effectively used for flexible budget variance analysis to understand overhead. Flexible budgets within ABC systems help clarify why actual activity overhead differs from budgeted activity overhead.

Impact of Denominator Level on Fixed Overhead Variance

Denominator Level and Production Volume Variance

The chosen denominator level significantly impacts the production volume variance:

• When the chosen production level (denominator level) exceeds the actual production level, there will be an unfavorable production volume variance. This indicates unused capacity.
• Conversely, when the chosen capacity level is below the actual production level, there will be a favorable production volume variance. This suggests that more capacity was utilized than planned.