Unit 8 Fixed Overheads

I get the impression that those students working in accountancy practices tend to find standard costing so far from their own experience that it doesn't make sense, whereas even if you work in a small manufacturing business that doesn't use it you can understand how it might fit in.

I recently tried (with partial success) to explain budget and actual overhead differences by reference to sleeping beauty. Irrespective of whether fairy stories work for you it is important to recognise when each is used.

Budgeted overheads are our best estimate of the overhead cost before the period starts e.g 20 April for the May accounting period

Standard overheads absorbed are not known until after the period has finished e.g. 3rd June. It is found by multiplying the ACTUAL number of units produced by the standard hours per unit, a figure which we had set before the period started. This is multiplied by the standard overhead absorption rate per hour another figure which we had set before the period started

Actual cost is simply the total overhead cost incurred.

On April 20 I drew up my budget and identified that

1. fixed overheads for May would be £25,000.
2. Production for May would be 5,000 units
3. Labour hours for May would be 10,000 (2 hours per unit)

This means we have
a budgeted overhead absorption rate of £25,000/10,000 hrs = £2.50 per hour
and a standard time per unit of 10,000 hrs/5,000 units = 2 hrs per unit
Then May happened.
I then returned to my work on June 3rd and found

1. Actual fixed overhead was £24,500
2. Actual production was 4,800 units
3. Labour hours were 9,900

So our budgeted overhead was £25,000

Our standard overhead was 4,800 units x 2hrs per unit x £2.50 per hour = £24,000

And our actual overhead was £24,500


This enables us to find the expenditure variance (difference between the budgeted cost and the actual cost) £500 favourable
And the volume variance (difference between the standard overhead absorbed and the budget) £1,000 adverse

If you wanted to find out how the volume variance can be attributed to efficiency and to capacity we would have to find the standard overhead absorbed for the actual hours worked (in our case 9,900 hrs x £2.50 per hour)
£24,750
So we have an efficiency variance of £750 adverse
the standard labour time was 4,800 units x 2hrs per unit = 9,600 hrs But we took 9,900 hrs (300 hrs more than the standard) So we were inefficient and 300 hrs x £2.50 = £750 adverse
And a capacity variance of £250 adverse
the bugeted hours were 10,000 but we only worked for 9,900 so capacity was 100 less than budget (at £2.50 per hour) £250 adverse