Question

World Company expects to operate at 80% of its productive capacity of 50,000 units per month. At this planned level, the company expects to use 25,000 standard hours of direct labor. Overhead is allocated to products using a predetermined standard rate of 0.625 direct labor hours per unit. At the 80% capacity level, the total budgeted cost includes \(50,000 fixed overhead cost and \)275,000 variable overhead cost. In the current month, the company incurred $305,000 actual overhead and 22,000 actual labor hours while producing 35,000 units.

1. Compute the predetermined standard overhead rate for total overhead.

2. Compute and interpret the total overhead variance.

Short answer

The total overhead variance isunfavorable.

Step-by-step solution

Meaning of Variances

Inmanagerial accounting, variance denotes the difference betweenstandard and actual outputs. Managers perform analysis to determine the variances for making necessary decisions and future planning.

Computation of predetermined overhead rate  

$\begin{array}{c}\mathrm{Budgeted}\mathrm{production}=\mathrm{Number}\mathrm{of}\mathrm{units}\times \mathrm{Expected}\mathrm{capacity}\\ =50,000\times 80\%\\ =40,000\end{array}$

$\begin{array}{c}\mathbf{\text{Variableoverheadpredeterminedrateperunit}}\mathbf{=}\frac{\mathbf{\text{Variableoverheads}}}{\mathbf{\text{Budgetedproduction}}}\\ \mathbf{=}\frac{\mathbf{\$}\mathbf{275}\mathbf{,}\mathbf{000}}{\mathbf{40}\mathbf{,}\mathbf{000}}\\ \mathbf{=}\mathbf{\$}\mathbf{6.875}\end{array}$

localid="1661766760213" $\begin{array}{c}\mathbf{\text{Fixedoverheadpredeterminedrateperunit}}\mathbf{=}\frac{\mathbf{\text{Fixedoverheads}}}{\mathbf{\text{Budgetedproduction}}}\\ \mathbf{=}\frac{\mathbf{\$}\mathbf{50}\mathbf{,}\mathbf{000}}{\mathbf{40}\mathbf{,}\mathbf{000}}\\ \mathbf{=}\mathbf{\$}\mathbf{1.25}\end{array}$

$\begin{array}{c}\mathbf{\text{Fixedoverheadrateperhour}}\mathbf{=}\frac{\mathbf{\text{Fixedoverheads}}}{\mathbf{\text{Standarddirectlaborhours}}}\\ \mathbf{=}\frac{\mathbf{\$}\mathbf{50}\mathbf{,}\mathbf{000}}{\mathbf{25}\mathbf{,}\mathbf{000}}\\ \mathbf{=}\mathbf{\$}\mathbf{2}\mathbf{\text{perhour}}\end{array}$

Interpretation

Computation of total overhead variance:

Particulars	Predetermined overhead rate (A)	Standard units/hours (B)	Applied overhead cost (C=A*B)	Actual results (D)	Variance (C-D)
Variable overhead costs	$6.875	35,000	$240,625	$255,000	$14,375 (Unfavorable)
Fixed overhead costs	$2.270	22,000	$49,940	$50,000	$60 (Unfavorable)
Total overhead costs			$290,565	$305,000	$14,435 (Unfavorable)

Comment:

According to the above-presented table, the total overhead variance is unfavorable because the actual cost incurred by the company is higher than its standard costs.