 Hello and welcome to this session. This is Professor Farhad in which we would look at variable overhead variance and fixed overhead variance. The good news is this, just like when we looked at direct labor variance and direct material variance, we're going to practically using the same method. And we're going to be breaking down the variable overhead variance into a spending component and a usage or efficiency component. And the same thing with the fixed, we're going to look at it from a spending and we're going to look at it from a volume component. So the concept is the same. Therefore, we're going to be looking at a company and this company is producing this pen right here. And for the sake of illustration, we have our standard cost sheet here. I'm going to ignore the fixed cost for now. Don't worry, we'll cover the fixed cost later. And to produce this, to produce this pen, again, this is fictitious stuff, we're going to need 0.4 pound, not four pound, 0.4 pound of material. It costs us 55 cents per pound, material $2.22. It's going to cost us indirect labor, 0.05 hours, which is technically, if you, if you convert it into minutes, just basically if you're just, if it's easier for you, you're dealing with three minutes, it takes us three minutes to produce a pen and we pay someone per hour, $20 an hour. Therefore, if that's the case, we can, we can imply that it's costing us $1 per direct labor. So if we take 0.05 times 20, it's costing us 0.05 times $20, $1 per direct labor. Our variable overhead is driven by hours. So what we do is this, for every three minutes of hours that we spend, we charge $12 of variable overhead. So the variable overhead rate is $12 per hour. And again, per one unit, if we take 0.005 times $12, we charge 60 pennies as variable overhead cost. Again, we'll ignore the fixed overhead cost. What else do we need to know to illustrate the concept of variable and fixed? For the month of June, we produced 80,000 pens. Actual variable overhead cost was $53,680. This was the actual, again, the standard cost for direct material is $1 per direct, I'm sorry, per direct labor. The actual direct labor cost, we worked for the month of June, 4,400 hours. The total labor cost is $79,200. Therefore, the average cost per hour, $79,200 divided by $4,400, the average cost per hour was $18, $18. Now, why am I giving you all this information? The reason is, once I start to look at the variances, I'm going to be using the three column method that we saw in the prior session, where we look at the actual, we look at the standard, and we find the differences, the actual quantity times the standard price, then we do the price variance and the usage or efficiency variance. But if you don't have this data, please copy it down, we're going to look at it on the next slide. So going with the three column method, first, we're going to look at the actual data. The actual column, we are given, this number was given as $53,680. Now, I can compute the rate because to come up with $53,680, the rate was not given. Therefore, if I take the actual price times the actual rate, it gave me this number, $53,680. Now, what was the actual, how many hours did we spend? Well, we spent 4,400 hours. The rate, we don't know what the rate is. It gave us in total $53,680. Well, if we solve for rate, the rate, the overhead rate is $12.20. So hold on a second. I was told the variable overhead rate was $12. Now, the actual, this was the standard, the standard, the actual was $12.20. So I know the, now I know that the actual was more than the standard. So let's take a look at the standard. The standard is, the standard is $12. Now, how many hours should I, should have I spent? Well, I produced, let's see how many units I produced. Kind of, so you know, what are we dealing with here? Number of pens produced were 80,000 pens. Well, if I produce 80,000 pens, how long it took me to produce those pens? Well, 80,000 pens, it takes approximately three minutes to produce each pen or 0.05. So it took me 4,000 hours. Therefore, the standard quantity to produce, to produce the pens, to produce those 80,000 is $12, which is the, my variable overhead rate, my standard variable overhead rate times the standard quantity of 4,000. Therefore column two is 48,000. Now I'm not column three, I'm sorry, the flexible or the flexible or the standard, the same thing. Now I'm going to take my actual price, my actual price, and I'm sorry, I'm going to take my actual quantity, my actual quantity, which is 4,400 times the standard price, which is $12. And this is column two. So standard price times actual quantity, it's going to give us $52,800. We're going to be using the same strategy that we utilize for the direct labor and the direct material. We're going to take the difference between one and two, and that's going to be the price variance. So the price variance is unfavorable, and we already know it's unfavorable. Why? Because the actual variable overhead rate was $12.20. Now, let me show you the formula. If we take actual price times actual quantity, standard price times the actual quantity, we can factor out the actual quantity, we can turn this into actual quantity times actual price minus the standard price, which is again, the difference is 20 pennies. And we did work 4,400 hours. And as a result, we have an unfavorable variance of $880. Why it's unfavorable? Because we paid 20 pennies more. We paid 20 pennies more. Now we look at column two and column three. And here we are looking at the usage variance. Did we use more hours than they should have, or did we use less hours? Well, based on producing 80,000 pens, we should have utilized 4,000 hours. What we actually did is we utilized 4,400. So we know this is going to be unfavorable. Why? Because we spend an additional 400 hours. Now we're going to take the 400 hours difference times the standard price, which is $12. And it's going to give us an unfavorable variance of 4,800. Simply put, the price was higher, and we used more time. We are very inefficient. We need to know what's going on, and we are paying more. This is the problem here. Again, if you want to use the formula here, we have standard price times actual quantity, standard price times the standard quantity, we can factor out the standard price, which is $12, and find the difference in quantity. I told you it's 400. And this is using the formula, which is standard price, actual quantity minus standard quantity, which will give us 400. We times 12 times 400. Once again, they're both unfavorable. The total variance is 880 plus 4,800 is 5680. And it is unfavorable. So notice, if you know how to use direct material variance, direct labor variance, the variable overhead is not that much difference. Sometimes the information is given indirectly. You have to slow down and know what you are given. Practice, practice, practice. Now we're going to look at the fixed overhead variance. Before we look at this fixed overhead variance, most likely you are watching because you are a student or a CPA candidate. That's great. You have arrived. Go to farhatlectures.com where you will have additional resources such as additional lectures, multiple choices. You want to practice this as much as possible through false exercises that's going to help you do better, whether you are studying for your exam or taking some accounting course. Connect with me on LinkedIn. If you haven't done so, like this recording, share it with other. Connect with me on Instagram, Facebook, Twitter and Reddit. Let's now take a look at the fixed overhead variance. Well, and we're going to be looking at Adam's Lawn Service, which is we looked at this company in the prior session when we looked at activity variances and volume activity and revenue and spending variances. So for the fixed cost variances, we're going to be computing first the spending variance. How do we compute the spending variance? Well, the spending variance is the difference between the actual results. And here we're dealing with the only thing that we have as fixed cost are those four, the spending variance, it's going to be the difference between the actual results and the flexible budget. So the difference between those two will be the spending variance. And for the purpose of our example, so these are only the fixed cost, right? Oops, not the shop. Yeah, actually the shop as well. So these are the fixed cost. If you remember from the prior example, those are the four fixed costs. In total, it's unfavorable 150. This is the revenue and spending variance. So basically, we find the difference between the actual result and the flexible budget. Now, even if we compute the difference between the flexible budget and the planning budget, there should not be any difference. So there's no activity variance. And the reason is, well, it does not matter. Fixed cost by nature is fixed. So when we prepare the flexible budget, as long as we are within the relevant range, there is no really third column as long as we are separating our variable and fixed cost. Now, what happened if the fixed cost of the fixed cost, we're using the absorption costing and the fixed cost is part of the product cost. Under those circumstances, we don't have a planning budget. Now we have the applied. Now we have the third column will be the applied overhead. Now we have the difference between the flexible budget, flexible budget, which is simply put the budget and the applied overhead. The applied overhead. And what I mean by simply the flexible budget is the same thing as the planning or the static budget. And I'm referring only, and let me highlight what I just said, I don't want to confuse people, I'm referring only to the fixed cost. So it doesn't make a difference whether it's the flexible budget or the planning budget, those two are the same. But now I'm comparing the flexible to I'm going to be creating the applied. Now I'm going to apply the overhead. So let's take a look at an example to illustrate this concept because under absorption costing, we can compute what's called the volume, the volume variance. So fixed overhead is part of the product cost. Here's what we're going to do. We're going to assume that we have a company and the actual fixed overhead for the sake of the illustration, the actual, the first column is 195. That's the actual, that's the actual column two, the budgeted or the flexible, because again, they're going to be the same, the budgeted or the flexible column two, I'm going to call it the flexible is 200,000. Again, if we take the difference between the actual and the flexible, that's going to give us the 5000 and it is the actual was less, it's favorable, right? Because the actual was less than the flexible. Now the third column, under the third column, this is going to be the applied overhead, how much applied overhead to do the applied overhead, you have to find out the fixed overhead rate, fixed budgeted fixed overhead rate, which is for the purpose of this example, we're going to be assuming 2.4 million in overhead divided by where the driver will be the number of units, 1.2 million pens. So our fixed overhead is $2 per pen. Now, bear in mind, fixed overhead does not vary, but we turn it into a variable just to be able to compute the volume. So what we're saying is this, every time we produce a pen, we allocate to this pen $2 of fixed cost, $2 of fixed cost. So that's the rate. Now, so now we are ready to compute column three. So the difference between column two and column three, what we call the volume variance, the volume variance. So what did we do for the sake of this example? For the sake of this example, if you remember, we produced 80,000 pens. We multiply 80,000 pen by $2 of fixed cost per pen. The applied overhead was 160,000. This is the applied overhead. And this is the third column. If you are dealing with the three column situation, the difference between column two and column three is $40,000. Well, let's think about this for a moment. If we budgeted $200,000 for this month, because what I'm assuming is this, it's either this is $200,000, remember $2.4 million. If we take $2.4 million divided by $12,000, let's see what we'll get, $2.4 million, $2.4 million divided by $12,000. That's going to give us $200,000 per month in fixed cost. Or if you want to take it $1.2 million, $1.2 million divided by $12,000, $1.2 million divided by $12,000, that's going to give us $100,000 pens. So simply put, we plan to produce for that month $100,000 pens. If we did produce $100,000 pens, another way to look at it, if we did produce $100,000 pens times $2, our budgeted overhead fixed cost for that month should have been $200,000. Did we produce $100,000 pens? No, we only produced $80,000 pens. That's not good. In what sense, it's not good. Well, we did not really utilize our capacity to the max. What does that mean? It means we did not use, we did not really took advantage of our fixed cost because fixed cost is fixed. It does not change. However, we spend the fixed cost. It's going to be spent regardless. And our calculation says that if we spend $200,000 and fixed cost, we should produce $100,000 pens because our fixed cost, fixed cost per pen is $2. Well, guess what? We only produce $80,000 pens. So the $40,000 is unfavorable and it's called A volume, volume variance. It's an unfavorable volume variance. When does this happen? This happened with companies when there's an economic downturn, when there's an economic downturn, the company will stop producing. They will produce less. Well, yes, why? Because we don't have a lot of demand for our product. We cut down on production. Well, often time, you cannot cut down on fixed cost, at least not in the short term. That's why it's called fixed cost by nature. It does not change with production. So when there's an economic downturn, your fixed cost stay the same. You're producing less than your, quote, capacity. Guess what? You're going to have an unfavorable volume and this is what happened in this situation. What should you do now? I'm going to ask you again to learn this. You have to go to Farhat Lectures, work MCQs through false exercises to reinforce the concept. Invest in yourself. This topic is considered bit challenging for some. I can make it easy for you by practicing, utilizing your resources as well. You will get there. Good luck, study hard, and of course, stay safe.