Standard Costing - Overhead Variances

COST AND MANAGEMENT ACCOUNTING

STANDARD COSTING

(VARIANCE ANALYSIS)

OVERHEAD VARIANCES

 

Part A: Discussion of basic theories including different relevant formulas

Part B: 3 Illustrations with solutions

Part A: 

Definition of Standard Costing

Standard Costing is a method of costing where actual costs/revenues are compared with pre-determined standard costs/revenues in order to:-

1. Calculate different variances (namely Material Variances, Labour Variances, Overhead Variances and Sales Variances);

2. Analyse the reasons for the variances, which may be positive as well as negative;

3.  Identify the concerned departments responsible for such variances;

4.  Fix responsibilities for the concerned departmental heads towards achieving   certain standards in the future; and

5. Take necessary steps wherever required either for achieving the standards or for modifying the standards.

 

Therefore, in standard costing the most important pre-requisite is ‘fixing the standards’ which is actually carried out by the technical persons. Once the standards are determined, then only different variances can be calculated by comparing the actual results with the pre-determined standards. The variances are basically of two types: (a) Cost Variances and (b) Sales Variances.

 

Cost Variances may be of the following four types:

1.  Material Variances

2.  Labour Variances

3.  Variable Overhead Variances

4.  Fixed Overhead Variances

 

Sales Variances may be of the following two types:

1.  Sales Turnover Variances

2.  Sales Margin Variances

 

Standard Costing is also termed as Variance Analysis because the whole of the Standard Costing System revolves around calculating the variances and analysing them in order to control different costs and operations of the business.

  Variable Overhead Variances (Using Hours)

1	Variable Overhead Cost Variance	= V3 – V1
2	Variable Overhead Budget / Expenditure Variance	= V2 – V1
3	Variable Overhead Efficiency Variance	= V3 – V2

 

  Where,

V1	= AR x AH
V2	= SR x AH
V3	= SR x SHAO
AR	= Actual Rate
AH	= Actual Hour
SR	= Standard Rate
SHAO	= Standard Hours for Actual Output

 

  Variable Overhead Variances (Using Output)

1	Variable Overhead Cost Variance	= V3 – V1
2	Variable Overhead Budget / Expenditure Variance	= V2 – V1
3	Variable Overhead Efficiency Variance	= V3 – V2

 

  Where,

V1	= AR x AO
V2	= SR x SOAH
V3	= SR x AO
AR	= Actual Rate
AO	= Actual Output
SR	= Standard Rate
SOAH	= Standard Output in Actual Hours

 

Important note:

Negative variances are adverse variances and positive variances are favourable variances.

Check:

1.   Variable Overhead Cost Var. (V₃ – V₁)

= VOH Expenditure Var. (V₂ – V₁) + VOH Efficiency Var. (V₃ – V₂)

 

  Fixed Overhead Variances (Using Hours)

1	Fixed Overhead Cost Variance	= F5 – F1
2	Fixed Overhead Budget / Expenditure Variance	= F2 – F1
3	Fixed Overhead Volume Variance	= F5 – F2
4	Fixed Overhead Calendar (Idle Time) Variance	= F3 – F2
5	Fixed Overhead Capacity Variance	= F4 – F3
6	Fixed Overhead Efficiency Variance	= F5 – F4

 

 Where,

F1	= AR x AH = Actual Cost
F2	= SR x BH = Budgeted Cost
F3	= SR x RBH
F4	= SR x AH
F5	= SR x SHAO = Standard Cost of Actual Output
AR	= Actual Rate
AH	= Actual Hours
SR	= Standard Rate
BH	= Budgeted Hours
RBH	= Revised Budgeted Hours
SHAO	= Standard Hours for Actual Output

 

  HOW TO CALCULATE ‘SR’, ‘RBH’ AND ‘SHAO’

SR	= Budgeted Fixed Overhead per Budgeted Hours
	= (Budgeted Fixed Overhead for a Budget Period) ÷ (Budgeted Hours    for the Budget Period)
RBH	= (Budgeted Hours for the Budget Period) x [(Actual Days Available    during the Budget Period) ÷ (Budgeted Days for the Budget Period)]
SHAO	= Actual Output x Standard Hours required per unit of output
	= Actual Output x [(Standard or Budgeted Hours) ÷ (Standard or    Budgeted Output)]

  Fixed Overhead Variances (Using Output)

1	Fixed Overhead Cost Variance	= F5 – F1
2	Fixed Overhead Budget / Expenditure Variance	= F2 – F1
3	Fixed Overhead Volume Variance	= F5 – F2
4	Fixed Overhead Calendar (Idle Time) Variance	= F3 – F2
5	Fixed Overhead Capacity Variance	= F4 – F3
6	Fixed Overhead Efficiency Variance	= F5 – F4

 

  Where,

F1	= AR x AO = Actual Cost
F2	= SR x BO = Budgeted Cost
F3	= SR x RBO
F4	= SR x SO
F5	= SR x AO = Standard Cost Of Actual Output
AR	= Actual Rate
AO	= Actual Output
SR	= Standard Rate
BO	= Budgeted Output
RBO	= Revised Budgeted Output
SO	= Standard Output

 

  HOW TO CALCULATE ‘SR’, ‘RBO’ AND ‘SO’

SR	= Budgeted Fixed Overhead per Budgeted Unit Of Output
	= (Budgeted Fixed Overhead for a Budget Period) ÷ (Budgeted Output for    the Budget Period)
RBO	= (Budgeted Output for the Budget Period) x [(Actual Days Available    during the Budget Period) ÷ (Budgeted Days for the Budget Period)]
SO	= Standard Output per Hour x Actual Hours Utilised

 

Note:

If “actual days available during the budget period” and “budgeted days for the budget period” are not given in the problem,

1.   RBH/RBO and F₃ will not be calculated,

2.   Fixed Overhead Calendar (Idle Time) Variance will not be calculated, and

3.   Fixed Overhead Capacity Variance will be = F₄ – F₂

Important note:

Negative variances are adverse variances and positive variances are favourable variances.

Check:

1.   Fixed Overhead Cost Var. (F₅ – F₁)

= FOH Expenditure Var. (F₂ – F₁) + FOH Volume Var. (F₅ – F₂)

2.   Fixed Overhead Volume Var. (F₅ – F₂)

= FOH Idle Time Var. (F₃ – F₂) + FOH Cap. Var. (F₄ – F₃)

+ FOH Eff. Var. (F₅ – F₄)

 

Part B:

Illustration: 1

The following information was obtained from the records of a manufacturing unit using standard costing system:

Particulars	Standard	Actual
Production	4,000 units	3,800 units
Working days	20	21
Fixed overhead	Rs. 40,000	Rs. 39,000
Variable overhead	Rs. 12,000	Rs. 12,000

 

 Required:

1.       Calculate –

       (a)    Variable overhead variances, and

          (b)    Fixed overhead variances;

  2.   Prepare a reconciliation statement showing reconciliation between standard overhead cost and actual overhead cost.

 

 Solution: 1

V1	= AR × AO	= Rs. 12,000
V2	= SR × SOAH	= Rs. 3 × 4,200 units	= Rs. 12,600
V3	= SR × AO	= Rs. 3 × 3,800 units	= Rs. 11,400
F1	= AR × AO	= Rs. 39,000
F2	= SR × BO	= Rs. 10 × 4,000 units	= Rs. 40,000
F3	= SR × RBO	= Rs. 10 × 4,200 units	= Rs. 42,000
F4	= SR × SO	= Rs. 10 × 4,000 units	= Rs. 40,000
F5	= SR × AO	= Rs. 10 × 3,800 units	= Rs. 38,000

 Variances:

VOH Expenditure Variance	=V2 – V1	=12,600– 12,000	= Rs. 600	F
VOH Efficiency Variance	= V3 – V2	=11,400– 12,600	= Rs. 1,200	A
VOH Cost Variance	= V3 – V1	=11,400– 12,000	= Rs. 600	A
FOH Expenditure Variance	= F2 – F1	=40,000– 39,000	= Rs. 1,000	F
FOH Volume Variance	= F5 – F2	=38,000– 40,000	= Rs. 2,000	A
FOH Idle Time Variance	= F3 – F2	=42,000– 40,000	= Rs. 2,000	F
FOH Capacity Variance	= F4 – F3	=40,000– 42,000	= Rs. 2,000	A
FOH Efficiency Variance	= F5 – F4	=38,000– 40,000	= Rs. 2,000	A
FOH Cost Variance	= F5 – F1	=38,000– 39,000	= Rs. 1,000	A

 

Statement showing reconciliation between

Standard Overhead Cost and Actual Overhead Cost

Particulars	Rs	Rs
Standard overhead cost (V3 + F5)    ⇒ [11,400 + 38,000]		49,400
Add: Adverse cost variances:
VOH Efficiency Variance	1,200
FOH Capacity Variance	2,000
FOH Efficiency Variance	2,000	5,200
		54,600
Less: Favourable cost variances:
VOH Expenditure Variance	600
FOH Expenditure Variance	1,000
FOH Idle Time Variance	2,000	(3,600)
Actual overhead cost (V1 + F1)      ⇒ [12,000 + 39,000]		51,000

 

 Workings:

SR (VOH)	= Rs. 12,000 ÷ 4,000 units	= Rs. 3
SOAH	= 4,000 units × (21 days ÷ 20 days)	= 4,200 units
SR (FOH)	= Rs. 40,000 ÷ 4,000 units	= Rs. 10
RBO	= 4,000 units × (21 days ÷ 20 days)	= 4,200 units

 

Illustration: 2

XYZ Ltd. has furnished you the following information for the month of August, 2019:

Particulars	Budget	Actual
Output (units)	30,000	32,500
Hours	30,000	33,000
Fixed overhead	Rs. 45,000	Rs. 50,000
Variable overhead	Rs. 60,000	Rs. 68,000
Working days	25	26

 

Calculate:

(a)    Variable overhead variances, and

(b)    Fixed overhead variances

 

  Solution: 2

V1	= AR × AO	= Rs. 68,000
V2	= SR × SOAH	= Rs. 2 × 33,000 units	= Rs. 66,000
V3	= SR × AO	= Rs. 2 × 32,500 units	= Rs. 65,000
F1	= AR × AO	= Rs. 50,000
F2	= SR × BO	= Rs. 1.50 × 30,000 units	= Rs. 45,000
F3	= SR × RBO	= Rs. 1.50 × 31,200 units	= Rs. 46,800
F4	= SR × SO	= Rs. 1.50 × 33,000 units	= Rs. 49,500
F5	= SR × AO	= Rs. 1.50 × 32,500 units	= Rs. 48,750

 

  Variances:

VOH Expenditure Variance	= V2 – V1	= 66,000 – 68,000	= Rs. 2,000	A
VOH Efficiency Variance	= V3 – V2	= 65,000 – 66,000	= Rs. 1,000	A
VOH Cost Variance	= V3 – V1	= 65,000 – 68,000	= Rs. 3,000	A
FOH Expenditure Variance	= F2 – F1	= 45,000 – 50,000	= Rs. 5,000	A
FOH Volume Variance	= F5 – F2	= 48,750 – 45,000	= Rs. 3,750	F
FOH Idle Time Variance	= F3 – F2	= 46,800 – 45,000	= Rs. 1,800	F
FOH Capacity Variance	= F4 – F3	= 49,500 – 46,800	= Rs. 2,700	F
FOH Efficiency Variance	= F5 – F4	= 48,750 – 49,500	= Rs. 750	A
FOH Cost Variance	= F5 – F1	= 48,750 – 50,000	= Rs. 1,250	A

 

  Workings:

SR (VOH)	= Rs. 60,000 ÷ 30,000 units	= Rs. 2
SOAH	= 30,000 units × (33,000 hours ÷ 30,000 hours)	= 33,000 units
SR (FOH)	= Rs. 45,000 ÷ 30,000 units	= Rs. 1.50
RBO	= 30,000 units × (26 days ÷ 25 days)	= 31,200 units
SO	= (30,000 units ÷ 30,000 hours) × 33,000 hours	= 33,000 units

 Illustration: 3

The Cost Accountant of a Co. was given the following information regarding the Fixed OHs for February, 2013:

a.   Fixed Overhead Cost Variance: Rs 1,400 (A)

b.   Fixed Overheads Volume Variance: Rs 1,000 (A)

c.   Budgeted Hours for February, 2013: 1,200 hours

d.   Budgeted Fixed OH for February, 2013: Rs 6,000

e.    Actual Rate of Recovery of Fixed OH: Rs 8 per hour

 

You are required to assist him in computing the following for February, 2013

1.   Fixed OH Expenditure Variance

2.   Actual Fixed OH incurred

3.   Actual Hours for Actual Production

4.   Fixed OH Capacity Variance

5.    Fixed OH efficiency Variance

6.    Standard Hours for Actual Production

 

Solution: 3

1.    Fixed OH Expenditure Variance

Budgeted Fixed OH (Given), F₂ = Rs 6,000

⇒ SR × BH = Rs 6,000

 

Budgeted Hours (Given), BH = 1,200 hours

∴ SR = 6,000 ÷ 1,200 = Rs 5 per hour

 

Fixed OH Volume Variance (Given), F₅ – F₂ = 1,000 (A)

⇒ F₅ – F₂ = − 1,000

⇒ F₅ – 6,000 = − 1,000

⇒ F₅ = Rs 5,000

 

Fixed OH Cost Variance (Given), F₅ – F₁ = 1,400 (A)

⇒ F₅ – F₁ = − 1,400

⇒ 5,000 – F₁ = − 1,400

⇒ F₁ = Rs 6,400

∴ Fixed OH Expenditure Variance

= F₂ – F₁ = 6,000 – 6,400 = Rs 400 (A)

 

2.    Actual Fixed OH incurred

Actual Fixed OH incurred = F₁ = Rs 6,400

 

3.    Actual Hours for Actual Production

F₁ = AR × AH

⇒ 6,400 = 8 × AH [AR = Actual Rate of Recovery of Fixed OH = Rs 8 (Given)]

⇒ AH = 800 hours

 

4.    Fixed OH Capacity Variance

F₄ = SR × AH = 5 × 800 = 4,000

∴ Fixed OH Capacity Variance = F₄ – F₂

= 4,000 – 6,000 = 2,000 (A)

 

5.    Fixed OH efficiency Variance

F₅ – F₄ = 5,000 – 4,000 = 1,000 (F)

 

6.    Standard Hours for Actual Production

F₅ = SR × SHAO [SHAO ⇒ Standard Hours for Actual Output]

⇒ 5,000 = Rs 5 per hour × SHAO

⇒ SHAO = 5,000 ÷ 5 = 1,000 hours