Question

Computing overhead variances

Refer to the Morgan, Inc. data in Short Exercise S23­9. Last month, Morgan reported the following actual results: actual variable overhead, \(10,800; actual fixed overhead, \)2,770; actual production of 7,000 units at 0.20 direct labor hours per unit. The standard direct labor time is 0.25 direct labor hours per unit (1,300 static direct labor hours / 5,200 static units).

Requirements

1. Compute the overhead variances for the month: variable overhead cost variance, variable overhead efficiency variance, fixed overhead cost variance, and fixed overhead volume variance.

2. Explain why the variances are favorable or unfavorable.

Short answer

Particular	(1) Amount	(2) Favorable/Unfavorable
Variable overhead cost variance	$11,970	Unfavorable
Variable overhead efficiency variance	$2,100	Favorable
Fixed overhead cost variance	$1,130	Favorable
Fixed overhead volume variance	$1,350	Favorable

Step-by-step solution

Meaning of Direct Labor Cost

Direct labor is the cost directly attached to producing goods and services and depends upon the direct labor hours.

Calculation of overhead variance

1. Calculation of variable overhead cost variance:

$\begin{array}{rcl}\mathbf{Variable}\mathbf{}\mathbf{overhead}\mathbf{}\mathbf{cost}\mathbf{}\mathbf{variance}& \mathbf{=}& \left(\mathrm{Actual}\mathrm{cost}-\mathrm{Standard}\mathrm{cost}\right)\mathbf{\times }\mathbf{Actual}\mathbf{}\mathbf{quantity}\\ & \mathbf{=}& \left(\frac{\$10,800}{7,000\times 0.20}-\$6\right)\mathbf{\times }\mathbf{7}\mathbf{,}\mathbf{000}\\ & \mathbf{=}& \left(\$7.71-\$6\right)\mathbf{\times }\mathbf{7}\mathbf{,}\mathbf{000}\\ & \mathbf{=}& \mathbf{\$}\mathbf{11}\mathbf{,}\mathbf{970}\mathbf{}\left(U\right)\end{array}$

Working note:

$\begin{array}{rcl}\mathbf{Standard}\mathbf{}\mathbf{variable}\mathbf{}\mathbf{overhead}\mathbf{}\mathbf{allocation}\mathbf{}\mathbf{rate}& \mathbf{=}& \frac{\mathbf{Static}\mathbf{}\mathbf{budget}\mathbf{}\mathbf{variable}\mathbf{}\mathbf{overhead}\mathbf{}}{\mathbf{Static}\mathbf{}\mathbf{budget}\mathbf{}\mathbf{direct}\mathbf{}\mathbf{labor}\mathbf{}\mathbf{hour}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{7}\mathbf{,}\mathbf{800}}{\mathbf{1300}\mathbf{}\mathbf{hours}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{6}\mathbf{}\mathbf{per}\mathbf{}\mathbf{direct}\mathbf{}\mathbf{labor}\mathbf{}\mathbf{hour}\end{array}$

1. Calculation of variable overhead efficiency variance:

$\begin{array}{rcl}\mathbf{Variable}\mathbf{}\mathbf{overhead}\mathbf{}\mathbf{efficiency}\mathbf{}\mathbf{variance}& \mathbf{=}& \left(\mathrm{Actual}\mathrm{quantity}-\mathrm{Standard}\mathrm{quantity}\right)\mathbf{\times }\mathbf{Standard}\mathbf{}\mathbf{cost}\\ & \mathbf{=}& \left(\left(7,000\times 0.02\right)-\left(\frac{1,300\times 7,000}{1,500}\right)\right)\mathbf{\times }\mathbf{\$}\mathbf{6}\\ & \mathbf{=}& \left(1400-1750\right)\mathbf{\times }\mathbf{\$}\mathbf{6}\\ & \mathbf{=}& \mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{100}\mathbf{}\left(F\right)\end{array}$

Fixed overhead cost variance:

Particular	Amount $
Actual fixed overhead	$2,770
Less: Budgeted fixed overhead	(3,900)
Fixed overhead cost variance (F)	$1,130

Fixed overhead volume variance:

Particular	Amount $
Budgeted fixed overhead	$3,900
Less: Allocated fixed overhead $\left(\frac{\$3,900}{5,200}\times 7,000\right)$	(5,250)
Fixed overhead volume variance (F)	$1,350

Explanation for variance

1. Variable overhead cost variance: This variance is unfavorable and adverse because the actual variable overhead rate is higher than the standard variable overhead rate.
2. Variable overhead efficiency variance: It is favorable because actual direct labor hours used in the production process are less than the standard direct labor hours.
3. Fixed overhead cost variance: fixed overhead cost variance is favorable because the actual fixed cost of the business entity is lower than the established standards.
4. Fixed overhead volume variance: It is favorable because the number of units produced is higher than the established standard.