 Welcome to this session. This is Professor Farhad in this session. I'm going to cover variable and fixed overhead variances. In the prior session what I did is I looked at direct labor and direct material variances and those lectures can be found on my farhadlectures.com and these topics are either covered in a managerial accounting course, the cost accounting course, the CPA exam, the BEC section, as well as the CMA exam. But in this session I'm going to be focusing specifically on variable and fixed overhead variances. To start let's go ahead and review what we have. We talked about standard in the prior session and what is the standard? I compared it to a recipe. Basically standard that what we start with. It's what's the input into our product. What's the input? So we already looked at direct labor, direct material. For example we're producing frames. We said we need four pounds. The price per pound is 55 cent and it's going to cost us 220 in direct material and for direct labor per frame we're going to have to spend 0.05 of an hour. We're going to have to pay the someone 20 dollars which it costs us a dollar per frame. In this session we're going to be focusing on the variable overhead component and the variable overhead component it's based on the direct labor hour. So it's also going to take us 0.05 of an hour and we have it the rate is $12 an hour. Therefore the variable overhead just kind of so we know what we are dealing with here. The variable overhead is 60 pennies per frame. This is the input. This is the standard. This is the standard. Here's what we are told. Once again the standard cost is 50 pennies per frame at $12 per hour 60 cent per frame. So $12 is the variable production overhead rate. So we already determined the production overhead rate is $12. Number of frames produce 80,000 frames. Actual variable overhead cost was $53,680. In this session what we're going to have to do we're going to have to add one additional piece of information and we're going to assume that the overhead what's driving our overhead it's the direct labor hours. Simply put because the overhead is a little bit different. Overhead is driven by something. Something drives our overhead and we happen to choose direct labor hour. Therefore I brought the direct labor hour information from the prior session and what we actually spent is actual direct labor hour of $4,400. Why this is important? Because we need this. We need to know how many hours we actually spent how many direct labor hours because on the base on the direct labor hours we are going to set up our problem. And let's go back and review what number of you basically go back and use the same exact strategy that we used in the prior session. And what's the strategy? The three column strategy. Hopefully you remember this. Column one, column two and column three. And basically column one is the actual is the actual overhead. Let me just make this a little bigger. Column one is the actual and what goes under actual? We're going to have actual quantity times actual price and we're going to have I always jump to column three standard quantity times the standard price and in between and in between we are going to have actual quantity actual quantity times the standard price. So this this this still holds this still holds. Now what is the actual overhead? Actually we are giving the actual overhead of $53,680 but it's good to know how we how we came up with that. Well we used $4,400 hours. Okay this is this was the overhead then we multiplied by some rate gave us 53,680. Now what's that rate? Well which is the unknown. All what we have to do is just to show you how come up with the rate you will divide 53,680 divided by 4,400 and the rate is just kind of we know the rate the rate the actual rate was $12 and 20 cent. Although the budgeted the overhead it's 12 is the variable but we spent a little bit more 12,20. This is the actual column. So the actual column is 53,680. Let's go to the standard column. The standard column what did we do in this problem? In this problem we produced if you remember we produced 80,000 frames or the problem says we produced 80,000 frames and what's going to happen is each frame 80,000 frames and each frame as far as time wise it's going to it's going to consume 0.05 of an hour. Let's see what we have here. So 80,000 frames times 0.05 which we're supposed to spend 4,000 hours this is the standard. So if we're producing 80,000 frame if we produce 80,000 frame we should have have standard quantity of $4,000 and we need to know what is our standard rate and our standard rate is $12. So if we take 4,000 times 12 times 12 it's going to give us 48,000 so that's the third column the standard column and in between we're going to take the actual quantity which is 4,000 let me do this in a different color just so in the middle we're going to take the actual quantity 4,400 multiplied by the standard rate which is let's see 4,400 times 12 will give us 52,800. Now we are ready to do our analysis again using the same concept that we did for direct labor and direct material. The difference between column one and column two has to do with the price and let me tell you why. Look we have actual quantity so let me just abbreviate this we have in column one we have actual quantity times actual price and in column two we have actual quantity times standard price so notice the quantity is the same all what we changed so notice the quantity is the same all what we changed is the price once again let me show you this if I want to simplify this formula I can factor actual quantity out and the difference between the standard price and the actual price is my answer so let's look up the answer first 53,680 minus 52,800 we have 880 dollars unfavorable variance and how did I know it's unfavorable variance my standard rate is 12 I spent 12,20 so simply put I spent 20 cent more than what I should have and I spent 4,400 hours so if I take 4,400 if I take 4,400 hours and I spend 20 pennies more for each hour so I spent 880 dollars and that's unfavorable more so I'm done with the with my price variance for the overhead now I'm gonna do the efficiency variance and this is the difference between column two and column three so this is called the efficiency variance efficiency variance first let's compute the total let's compute the total before we analyze it 52,800 minus 48,000 the total is 4,800 and what does the what does the what does the efficiency variance deals with it deals with the level of production okay deals with the level of production so let me show you again in the formula so column two formula is aq times sp column three formula is a standard standard quantity times standard price notice sp is the same in both so I can factor the standard price out and I can multiply it by the difference between actual quantity minus standard quantity the difference between actual quantity and standard quantity quantity which happens to be labor in this example is 400 hours of labor okay how did I know it's 400 hours because notice in the formula all what I change is the is the is the quantity which is the hours and I spent 400 hours more and the standard price supposed to be 12 if I take okay 12 times 400 that's gonna give me 4,800 and the question this is this very favorable or unfavorable variance well let's think about it I'm supposed to only spend 4,000 hours to produce those 80,000 frames I spent 4,400 well guess what that's unfavorable I spent too much time so simply put for this example I spent too much time too much time to produce them and I paid a little bit more than what I should have 20, simply put I paid 20 20 cent more per hour and I spent an additional 400 hours and as a result my total I can also compute my total which is my flexible budget together I have unfavorable of 5680 because they're both unfavorable you just net them that's that now let me just go back to the PowerPoint slides and this is basically what I just worked with you on the PowerPoint slides this is what I just worked with you on the PowerPoint slides this is the actual again this is I they call this the flexible I call this the standard okay the flexible production budget or the standard and in between is the is the actual actual times the standard okay so this is basically what I did and here here it comes now this is the the variable overhead variance the next thing we're gonna look at is the fixed fixed overhead variance and how does the fixed overhead variance let's go back and review when we were starting to do variances what we when we started to do variance as we said we're gonna have an actual column if you remember when we prepared the budget we started with preparing a budget when we looked at sales price variances we have a master budget master or planning whatever you want to call it remember that was the master or the planning budget then in between for things to make sense we have the flexible budget hopefully you remember this okay hopefully you remember this actually you don't have to remember this is what we worked with so let me let me just show it to you so when we started this we said we have this was this was the actual column this was the actual column basically we're going to be focusing on the fixed component here we're going to be focusing on a fixed component this was the actual and this is the master budget and this is the master budget and in between what we did for things to make sense for us we created a flexible budget why did we create a flexible budget because by creating flexible budget we we brought the activity down to 80 000 to the actual activity so those two things are comparable because we cannot compare the master budget to the actual budget because the production level was different but this is what we are using now bear in mind bear in mind what I need to show you is this before we proceed and I mentioned this notice when it comes to fixed manufacturing fixed manufacturing overhead cost and fixed selling and administrative cost let me just highlight this it's important that you see this here you see the big picture notice the difference between there is no difference between the flexible budget and the master budget you remember this we said there is no difference between the flexible budget and the master budget okay what does that mean it means there is no variances between those two the only variances we are going to study for now is the between the flexible budget and the actual budget so so we're going to look at the variances between the flexible budget the flexible and the actual which is the flexible and the actual and what we're going to be doing we're going to call this spending variance basically simply put did we spend more money on fixed manufacturing overhead or did we spend less money so the first the first the first um the first um variance for the fixed cost variance we're going to call it spending variance spending variance and that variance sometime it's called the budget variance sometime it doesn't matter just the different terminology depending which textbook you are using it's called spending or budget variance and how do we compute this we'll take the actual minus the budget okay let's take a look look at this fixed manufacturing overhead the actual we actually spent 195 500 dollar and we budgeted we budgeted 200 000 so notice the actual was less than the uh was less than the budgeted it's a favorable variance simply we spend less money on our fixed manufacturing overhead we need to know why maybe we missed something we maybe would have not include certain things so this we have to be careful about this the selling the budgeted was 140 and we only spent 132 that's also favorable but this is we separate them because we just wanted to show the fixed manufacturing overhead and there's a relevancy why we're gonna we we separate those two fixed costs but this is how you compute the spending variance basically the actual minus the budget and this is basically what we're talking about the the spending variance is the difference between the budgeted and the actual pretty straightforward and it has to do simply with spending was spending now you might be asking hold on a second we've been doing all these three columns what happened to the fixed fixed fixed cost don't we have three columns yes it is possible we could have three columns when it comes to when it comes to uh when it comes to fixed manufacturing overhead when do we have this is when the fixed manufacturing overhead is part of the product cost if this is part of the product cost when is this part of the product cost this is part of the product cost when we use absorption cost and hopefully you remember what absorption costing is absorption costing means all fixed cost gets absorbed in the product okay we don't separate variable so for example this is a variable cost method but if we are using absorption costing the fixed manufacturing overhead, it's part of the product cost. Under those circumstances, we do have another variance we have to compute. So basically, how does it work? Let me see, just get a get a new slide here. So what we're going to have to do, we're going to have to go back to our actual, actual, we're going to have the flexible, flexible budget, and we're going to have a third column now, so we have the actual, we have the flexible, and the third column, let me put it in a different color, and hopefully you remember this, it's called the applied, the applied, and hopefully you remember what applied overhead is. Applied overhead is used when we first compute an overhead, we compute an overhead rate before we start the year, before we start the year. Once again, let's put the numbers in the actual for our purposes, the actual manufacturing overhead was 195,500, as per the third income statement, the flexible was 200,000, and remember the difference between the flexible, this was the spending variance, we already talked about this. Now what we need to do, we need to compute the difference between the flexible and the applied, and what is the applied? Applied is how much we should have, we should have used, okay, based on the estimated, okay, based on our predetermined overhead rate. Now to do so, we're going to call this the volume variance, so this variance has to do with the volume, volume variance. Now to do so, we have to, we have to determine, we have to determine a predetermined overhead rate for this company. So for our purposes, we're going to assume the budgeted fixed cost, the budgeted, to be more specific, fixed manufacturing cost, fixed manufacturing cost was 2.4 million, 2.4 million, and we assume we are going to produce 1.2 million frames. What does that mean? It means our fixed cost is $2 per frame, or we could have expressed this in terms of direct labor hour, let's assume we're gonna have 2.4 million fixed manufacturing overhead cost, and that's, that's driven by direct labor hours, assuming we have 60 direct labor hours for the whole year. Let's see, that's going to give us $40 of direct labor hour. Okay, so the fixed cost is for every hour, we have $40 of fixed overhead cost. It doesn't matter which rate we use, but let's go ahead and look at what we have here. In this problem, just to make it simple, I'm gonna use the $2 for every frame we manufacture, we are going to apply $2 per rate. So in this example, let's go back to the, let's go back to our data. In this example, we produced, we happen to produce 80,000 frames, we happen to produce 80,000 frames. Well, so how much overhead we should have applied, let me go back, how much overhead we should have applied then? If we produced 80,000 frames, how much overhead we should have applied? Well, fixed overhead, we should have applied $2 per frame, which is 160. Now we have 160, which is the applied under the applied column. The difference is 40,000. Now the question becomes, is this 40,000 favorable or unfavorable? Well, we thought, we budget, or at least for 80,000, for 200,000 flexible, for $200,000, for $200,000. If you think about it, if our flexible budget is $200,000, what we should have consumed, it means we should have produced, if it's $200,000 divided by 2, we should have produced 100,000 frames. Why? Because the flexible budget says, if I remember the flexible budget is what we thought, because the flexible budget and the master budget are the same. I, my flexible budget is $200,000. Once again, remember the flexible budget, let me just show you this one more time, maybe I, it's right here. The flexible budget and the master budget is the same, remember this. So what I'm saying here is, I, for that month, for that month, I wanted, I budgeted, budgeted or the flexible budget was $200,000. For $200,000, a few budget at $200,000, it means you should have produced 100,000 frames, because if I produce 100,000 frames at $2 per frame, my budget should have been, my flexible budget, because it's $2 per frame. I only, my, but when I applied, I applied 160. Why did I apply 160? Because I only produced 80,000. 80,000 times 2 is 160. What does that mean? Well, it clearly mean I did not produce enough frame within the, with it for my fixed manufacturing overhead. That's all what it means. It means unfavorable. Okay, unfavorable, because I did not produce enough frames. If I budgeted $200,000, I'm supposed to come out at the end of the month with 100,000 frames. I came out, I came out with 80,000. It means I applied 160, because the way I applied overhead when I'm using, when I am applying overhead is based on the predetermined overhead rate, which is $2 an hour. And let's assume I'm using direct labor hours for direct labor hours. I ask myself, how many direct labor hours was, am I supposed to spend? Well, if I am producing 80,000 frame times 0.05 hour per frame, right? So let's do this. So 80,000 times 0.05, that's 4,000 hours, 4,000 hours, 4,000 hours times $40. If I'm applying my overhead based on the direct labor hour, that's going to give me 160,000, which is the same as here, the same as I have earlier. So it doesn't matter if I use this or this is my application of overhead. So the applied is 160. What does that mean? It means for 4,000, I should have only spent 4,000 hours, but what I actually spent is 4,400 hours, remember. Also, it means it's unfavorable. My applied overhead is unfavorable. Now, once again, you can net those spending versus the volume and find out the total, but this is how it works. So it's based on the production level, based on the volume level. Hopefully, now you understand how fixed and variable overhead work, if you have any questions, any comments by all means, email me or see me in class. And if you're studying for your CPA exam, by all means, study hard. It's worth it.