This results because of the intrinsic nature of a

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Unformatted text preview: iation from budget. This results because of the intrinsic nature of a fixed cost. For instance, rent is usually subject to a lease agreement that is relatively certain. Depreciation on factory equipment can be calculated in advance. The costs of insurance policies are negotiated and tied to a contract. Even though budget and actual numbers may differ little in the aggregate, the underlying fixed overhead variances are nevertheless worthy of close inspection. Download free ebooks at 37 Variance Analysis Tools for Enterprise Performance Evaluation 4.16 An Illustration of Fixed Overhead Variances Let’s take one final look at Blue Rail. Assume that the company budgeted total fixed overhead at $72,000; only $70,000 was actually spent (seemingly a good outcome). Here our accounting objective will be to allocate the $70,000 actually spent between work in process and variance accounts. The temptation would be to book $72,000 into work in process and reflect a $2,000 offsetting favorable variance -- but that would be the wrong approach! Instead, the Work in Process account should reflect the standard fixed overhead cost for the output actually produced. We get to this calculated value by reconsidering the company’s original assumptions about production. Assume that Blue Rail had planned on producing 4,000 rail systems during the month; remember that only 3,400 systems were actually produced -- output was disappointing, perhaps due to the inexperienced labor pool. This means that the planned fixed overhead was $18 per rail ($72,000/4,000 = $18). Because three labor hours are needed per rail, the fixed overhead allocation rate is $6 per direct labor hour ($18/3). Use this new information to consider the following illustration for fixed factory overhead (remember from the earlier discussion that the standard labor hours for the actual output were 10,200): By reviewing this familiar looking illustration, you can see that $61,200 should be allocated to work in process. This reflects the standard cost allocation of fixed overhead that would be attributable to the production of 3,400 units (i.e., 10,200 hours should be used to produce 3,400 units). Notice that this differs from the budgeted amount of fixed overhead by $10,800, representing an unfavorable Fixed Overhead Volume Variance. In other words, since production did not rise to the anticipated level of 4,000 units, much of the fixed cost (that was in place to support 4,000 units of output) was “wasted” or “under-utilized.” Thus, the measured volume variance is highly unfavorable. If more units had been produced than originally anticipated, the fixed overhead volume variance would be favorable (this would reflect total budgeted fixed overhead being spread over more units than originally anticipated). For Blue Rail, the volume variance is offset by the more easily understood favorable Fixed Overhead Spending Variance of $2,000; $70,000 was spent versus the budgeted $72,000. Together, the two variances combine to reveal a net $8,800 unfavorabl...
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