Tackling costing questions

The indicative syllabus content includes the following in relation to standard absorption costing: fixed overhead expenditure and the fixed overhead volume variance, together with the sub-division of the volume variance to capacity and efficiency.

Mini case study

Pickering Feeds Ltd is a SME that produces a single animal feedstuff. Its budget and actual activity for the month of January X9 showed the following:

BudgetActual
Output (tonnes)1,0001,200
Standard labour hours per tonne1

Actual direct labour hours worked: 1,320

Budgeted fixed overhead: £30,000

Budgeted fixed overhead recovery rate: £30,000/1,000= £30 per hour.

Actual fixed overhead: £32,500

Let us now consider the approach to determining the fixed overhead variance and its analysis.

Fixed overhead variance

Firstly, determine the standard hours produced/achieved in the month: 1,200 tonnes x 1 standard hour = 1,200 standard hours.

Thus fixed overhead recovered/absorbed in production achieved: 1,200 standard hours x £30 = £36,000.

This is then compared with the actual fixed overhead incurred:

Fixed overhead recovered/absorbed£36,000
Actual fixed overhead£32,500
Variance £3,500 (an over-recovery)

This variance initially sub-divides to: fixed overhead expenditure and fixed overhead volume.

This is expressed simply as:

Budgeted fixed overhead£30,000
Actual fixed overhead£32,500
Variance£2,500 adverse
(this represents an overspend of fixed overhead)

Fixed overhead volume variance

This is expressed as (standard hours produced – budgeted hours) FORR (1,200-1,000) £30 = £6,000 Favourable: (the volume of output achieved was greater than budget and therefore has a favourable effect on fixed overhead recovery).

At this point we can consider the following summary:

Fixed overhead variance £3,500 Favourable

Comprises:

Fixed overhead expenditure£2,500
Fixed overhead volume£6,000

We now need to examine the fixed overhead volume variance and its sub-division to efficiency and capacity as these two elements effect the level of output achieved.

Fixed overhead efficiency variance

This is expressed as: (standard hours produced – actual hours worked) FORR (1,200 – 1,320) £30 = £3,600 Adverse (Here there is a lack of efficiency as the actual hours worked were greater than the hours allowed for the output achieved. This represents an efficiency ratio of 91%).

Fixed overhead capacity variance

This is expressed as (Actual hours worked – Budget hours) FORR (1,320 – 1,000) £30 = £9,600 Favourable. (The management allowed more hours to be worked than originally planned and this had an effect on achieving the additional volume of output. The plant was favourable utilised for an additional period of time.)

Summary

The fixed overhead volume variance favourable £6,000

Comprises:

Fixed Overhead Efficiency Variance Adverse£3,600
Fixed Overhead Capacity Variance Favourable£9,600

• Dr Philip E Dunn is a freelance author and technical editor for Kaplan and Osborne Books