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:
Budget | Actual | |
Output (tonnes) | 1,000 | 1,200 |
Standard labour hours per tonne | 1 |
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