DISPOSAL OF VARIANCE IN STANDARD COSTING:how standard costs are used by managers to help control costs.

Company in highly competitive industries likeFederal Express,Southwest airlines,Dell Computer,Shell Oil, andToyotamust be able to provide high quality goods and services at low cost. If they do not, they will perish. Stated in the starkest terms, managers must obtain inputs such as raw materials and electricity at the lowest possible prices and must use them as effectively as possible - while maintaining or increasing the quality of the output. If inputs are purchased at prices that are too high or more inputs are used than is really necessary, higher costs will result. How do managers control the prices that are paid for inputs and the quantities that are used?They could examine every transaction in Standard Costing and Variance Analysis: After studying this chapter you should be able to: Explain how direct materials standard and direct labor standards are set. Compute the direct materials price and quantity variances and explain their significance. Compute the direct labor rate and efficiency variance and explain their significance. Compute the manufacturing overhead spending and efficiency variance.

In this section of the website we studymanagement control and performance measures. Quite often, these terms carry with them negative connotations - we may have a tendency to think ofperformance measurementas something to be feared. And indeed, performance measurements can be used in very negative ways - to cast blame and to punish. However, that is not the way they should be used. Performance measurement serves a vital function in both personal life and in organizations. Performance measurement can provide feedback concerning what works and what does not work, and it can help motivate people to sustain their efforts. In this section we see how various measures are used to control operations and to evaluate performance. Even though we are starting with the lowest levels in the organization, keep in mind that performance measures should be derived from the organization's overall strategy. For example, a company like Sony that bases its strategy on rapid introduction of innovative consumer products should use different performance measures than a company like Federal Express where on-time delivery, customer convenience, and low cost are key competitive advantages. Sony may want to keep close track of the percentage of revenues from products introduced within the last year; whereas Federal Express

may want to closely monitor the percentage of packages delivered on time. Later in this section when we discuss the balance scorecard, we will have more to say concerning the role of strategy in the selection of performance measures. But first we will see detail, but this obviously would be an inefficient use of management time. For many companies, the answer to this control problem lies at least partially in standard costing system. Definition and Explanation of Standard Cost and Management by Exception: A standard costis the predetermined cost of manufacturing a single unit or a number of product units during a specific period in the immediate future. It is the planned cost of a product under current and / or anticipated operating conditions. A standard is a "benchmark" or "norm" for measuring performance. Standards are found everywhere your doctor, for example, evaluates your weight using standards that have been set for individuals of your age, height and gender. the food we eat in restaurants must be prepared under specified standards of cleanliness. The buildings we live in must conform to standards set in building codes.Standards are also widely used in managerial accounting where they relate to the quantity and cost of inputs used in manufacturing goods and producing services.Engineersandaccountantsassistmanagersto set quantity and cost standards for each major input such as raw materials and direct labour time. Quantity standards specify how much of an input should be used tomake a productor provide a service. Cost or price standards specify how much should be paid for each unit of input. Actual quantities and actual costs are then compared with these standards. In case of significant deviations managers Investigate the discrepancies. The purpose is to find the problem and eliminate it so that it does not recur. This process is called management by exception. In our daily lives, we operate in a management by exception mode most of the time. Consider what happens when you sit down in the driver's seat of your car. You put the key in the ignition, your turn the key, and your car starts. Your exception (standard) that the car will start is met; you do not have to open the car hood and check the battery, the connecting cables, the fuel lines, and so on. If you turn the key and the car does not start, then you have a discrepancy (variance). Your exceptions are not met, and you need to investigate why. Note that even if the car is started after a second try, it would be wise to investigate anyway. The fact that exception was not met should be viewed as an opportunity to uncover the cause of the problem rather than as simply an annoyance. If the underlying cause is not discovered and corrected, the problem may recur and become much worse. This basic approach to identifying and solving problems is exploited in the variance analysis cycle, The cycle begins with the preparation of standard cost performance reports in the accounting department. These reports highlight the variances, which are the differences between actual results and what should have occurred according to the standards. The variances raise questions. Why did this variance occur? Why is this variance larger than it was last period? The significant variances are investigated to discover their root causes. Corrective actions are taken. And then next period's operations are carried out. The cycle then begins again with the preparation of a new standard cost performance for the latest period.

The emphasis should be on flagging problems for attention, finding their root causes, and then taking corrective actions. The goal is to improve operations - not to find blame.

VARIANCE ANALYSIS CYCLE Identify Questions Analyze Variances Prepare Standard Cost Performance Report BEGIN Who Uses Standard Costs? Manufacturing, service, food, and not-for-profit organizations all make use of standards to some extent. Auto service centers likeFirestone andSears, for example, often set specific labor time standards for the completion of certain work tasks, such as installing a carburetor or doing a valve job, and then measure actual performance against these standards. Fast-food outlets such asMcDonald'shave exacting standards for the quantity of meat going a sandwich, as well as standards for the cost of the meat. Hospitals have standards costs (for food, laundry, and other items) for each occupied bed every day, as well as standard time allowances for certain routine activities, such as laboratory tests. In short, you are likely to run into standard costs in virtually any line of business that you enter. Manufacturing companies often have highly developedstandard costing systemsin which standards relating todirect materials,direct laborand overhead are developed in detail for each separate product. These standards are listed on astandard cost cardthat provides themanagerwith a great deal of information concerning the inputs that are required to produce a unit and their costs. Receive Explanations Take Corrective Actions Conduct Next Period's Operations

In Business| Standard Costing at Parker Brass The Brass Products Division at Parker HannifinCorporation, Known as Parker Brass, is a world-class manufacturer of tube and brass fittings, valves, hose, and hose fittings. Management at the company uses variances from its standard costing system to target problem areas for improvement. If a production variance exceeds 5% of sales, the responsible manager is required the variance and to propose a plan of action to correct the detected problem. In the past, variances were reported at the

end of the month - often several weeks after a particular job had been completed. Now, a variance report is generated the day after a job is completed and summary variance reports are prepared weekly. These more frequent reports permit managers to take more timely action.

Direct Materials Price and Quantity Standards: Direct Materials Price Standards Direct Materials Quantity Standards Example of standard cost card

Direct Materials Price Standards: Definition and Explanation: Standard price per unit of direct materials is the price that should be paid for a single unit of materials, including allowances for quality, quantity purchased, shipping, receiving, and other such costs, net of any discounts allowed. Price standards for direct materialspermit checking the performance of the purchasing department and the influence of various internal and external factor sand measuring the effect of price increase or decrease on the company's profits. Determining the price or cost to be used as the standard cost often difficult, because the prices used are controlled more by external factors than by company's management. Prices selected should reflect current market price sand are generally used throughout the forthcoming fiscal period. If the actual price paid is more or less than the standard price, a price variance occurs. This is usually called direct materials price variance. Price increases or decreases occurring during the fiscal period are recorded in the materials price variance account(s).Price standards are revised at inventory dates or whenever there is a major change in the market price of any of the principle materials or parts Standard price per unit for direct materials should reflect the final delivered cost of materials, net of any discounts taken. Allowances for freights and handling should also be taken into account. Example: Calculation of standard price per unit of direct materials or raw materials:

Purchase price, top-grade pewter ingots, in 40-pounds ingots Freight, by truck, from suppliers warehouse Receiving and handling Less purchase discount Standard price per pound

3.60 +0.44 +0.05 -0.09 -------4.00 ====

Notice that the standard price reflects a particular grade of materials (top grade), purchased in particular lot size (40 pound ingots), and delivered by a particular type of carrier (truck). Allowances have also been made for handling and discounts. If every thing proceeds according to these expectations, the net cost of a pound of pewter (direct material in the example above) should therefore be $4.00. Direct Materials Quantity Standards: Definition and Explanation: Standard quantity per unit of direct materialsis the amount of direct materials or raw materials that should be required to complete a single unit of product, including allowances for normal waste, spoilage, rejects, and similar inefficiencies. Quantity of usage standards are generally developed from materials specifications prepared by the department of engineering(mechanical, electrical, or chemical) or product design. In a small or medium sized company, the superintendent or even the foremen will state basic specifications regarding type, quantity, and quality of raw materials need and operations to be performed. Quantity standards should be set after the most economical size, shape, and quality of the product and the results expected from the use of various kinds and grades of materials have been analyzed The standard quantity should be increased to include allowances for acceptable levels of waste, spoilage, shrinkage, seepage, evaporation, and leakage. The determination of spoilage or waste should be based on figures that prevail after the experimental and developmental stages of the product have been passed. The standard quantity per unit for direct materials should reflect the amount of material required for each unit of finished product, as well as an allowance for unavoidable waste, spoilage, and other normal inefficiencies. Example: Calculation of standard quantity per unit of direct materials or raw materials: Materials requirement (in pounds) per unit as specified in the bill of materials* Allowance for wastage and spoilage

2.7 0.2

Allowance for rejects Standard of materials requirements (in Rupees)

0.1 -----3.0 ====

*A bill of materialsis a list that shows the quantity of each type of material in a unit of finished product. It is a handy source of determining the basic material input per unit, but it should be adjusted for waste and other factors as shown above, when determining the standard quantity per unit of product. "waste and spoilage" in the table above refers to materials that are wasted as a normal part of the production process or that spoil before they are used. "Rejects" refers to the direct materialcontained in units that are defective and must be scrapped. Although it is common to recognize allowances for waste, spoilage, and rejects when setting standard costs, this practice is now coming into question. Those involved intotal quality management (TQM)and similar other business improvement programs argue that no amount of waste or defects should be tolerated. If allowances for waste, spoilage, and rejects are built into the standard cost, the levels of those allowances should be periodically reviewed and reduced over time to reflect improvement process, better training, and better equipment. Once the direct materials price and quantity standards have been set, the standard cost of a material per unit of finished product can be computed as follows. 3 pounds per unit $ 4.00 per pond = $ 12 per unit This $12 cost figure will appear as one item on the product's standard cost card as shown by the following example. Example of standard cost card: (1) Standard Quantity or Hours 3.0 pounds 2.5 hours 2.5 hours (2) (3)

Inputs

Standard StandardPrice or Cost Rate (1) (2) $ 4.00 $ 14.00 $ 3.00 $ 12.00 $ 35.00 $ 7.50 --------

Direct materials Direct labor Variable manufacturing overhead

Total standard cost per unit

$54.50 =====

An important reason for separating standards into two categories price and quantity - is that different managers are usually responsible for buying and for using inputs and these two activities occur at different points in time. In the case of raw materials the purchasing manager is responsible for the price, and this responsibility is exercised at the time of purchase. In contrast, the production manager is responsible for the amount of raw materials used, and this responsibility is exercised when the materials are used in production, which may be many weeks or months after the purchase date. It is important, therefore, that we cleanly separate discrepancies due to deviations from price standards from those due to deviations from quantity standards. Differences between standard prices and actual prices and standard quantities and actual quantities are called variances. The act of calculating and interpreting variances is called variance analysis. In Business |Standards in the Spanish Royal Tobacco Factory Standards have been used for centuries in commercial enterprises. For example, the Spanish Royal Tobacco Factory in Seville used standards to control costs in the 1700s. The Royal Tobacco Factory had a monopoly over snuff and cigar production in Spain and was the largest industrial building in Europe. Employee theft of tobacco was a particular problem, due to its high value. Careful records were maintained of the amount of tobacco leaf issued to each worker, the number of cigars expected to be made based on standards, and the actual production. The worker was not paid if the actual production was less than the expected production. To minimize theft, tobacco was weighed after each production step to determine the amount of wastage. Source: Salvador Carmona, Mahmoud Ezzamel, and Fernando Gutierrez, "Control and Cost Accounting Practices in the Spanish Royal Tobacco Factory, "Accounting, Organizations, and Society 22, no. 5, 1997, pp. 411-446"

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2. Direct Labor Standards and Variance Analysis: Direct labor price and quantity standards are usually expressed in terms of a labor rate and labor hours.

2.1 Direct Labor Rate Standards 2.2 Direct Labor efficiency | Usage | Quantity Standards 2.3 Example of Standard Cost Card

Direct Labor Rate Standards: The standard rate per hour for direct labor includes not only wages earned but also fringe benefit and other labor costs. Example of Standard rate per direct labor hour: Basic wages rate per hour Employment taxes at 10% of the basic rate Fringe benefits at 30% of the basic rate Standard rate per direct labor hour $10 $ 1 $ 3 ----$14 ====

Many companies prepare a single standard rate for all employees in a department. This standard rate reflects the expected "mix" of workers, even though the actual wage rates may very somewhat from individual to individual due to different skills of seniority. A single standard rate simplifies the use of standard costs and also permits the managers to monitor the use of employees within department. Direct Labor efficiency | Usage | Quantity Standards: The standard direct labor time required to complete a unit of product (called the standard hours per unit) is perhaps the most difficult standard to determine. One approach is to divide each operation performed on the product into elemental body movements (such as reaching, pushing, and turning over). Standard times for such movements are available in reference works. These standard times can be applied to the movements and then added together to determine the total standard time allowed per operation. Another approach is for an industrial engineer to do a time and motion study, actually clocking the time required for certain tasks. The standard time should include allowances for breaks, personal needs of employees, cleanup, and machine downtime. Example of standard labor hours per unit: Basic labor time per unit, in hours Allowance for breaks and personal need allowance for cleanup and machine downtime Allowance for rejection Standard labor hours per unit of product 1.9 0.1 0.3 0.2 ------2.5 ====

Standard labor hours per unit and standard direct labor rate per hours computed above shall be used in calculating labor rate variance and labor efficiency variance. Once the rate and time standards have been set, the standard labor cost per unit of product can be computed as follows:

2.5 hours per unit $14 per hour = $35 per unit This $35 per unit standards labor cost appears along with direct materials on the standard cost card of the product as shown by the following example. Example of Standard Cost Card: (1) Standard Quantity or Hours 3.0 pounds 2.5 hours 2.5 hours (2) (3)

Inputs

StandardPrice orStandard Cost Rate (1) (2) $ 4.00 $ 14.00 $ 3.00 $ 12.00 $ 35.00 $ 7.50 ----------

Direct materials Direct labor Variable manufacturing overhead

Total standard cost per unit

$54.50

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Manufacturing Overhead Standards and Variance Analysis:

Manufacturing overhead standards:Procedures for establishing and using standard factory overhead rates are similar to the methods of dealing with the estimated direct and indirect factory overhead and its application to jobs and products. An overhead budget for the rate calculation provides a budget allowance for a specific, predetermined level of activity, while a flexible budget provides allowance for various levels of activity. Both type of budgets aim for the control of factory overhead. Control is achieved by keeping actual expenses within ranges established by the budget. The maximum limit of a range is the amount set up in the flexible budget. However for costing jobs or products it is necessary to establish a normal overhead rate based on total estimated overhead rate at normal capacity volume. An example of the effect of volume on overhead cost per unit is as follows:

Production volume (units)

80,000 ----------

90,000 ----------

100,000 ----------

110,000 ----------

Factory overhead: Variable Fixed $112,000 60,000 ---------Total $172,000 ====== Factory overheadper unit: Variable Fixed $1.40 0.75 ---------Total unitoverhead cost $2.15 ====== $1.400 0.667 ---------$2.067 ====== $1.40 0.6 ---------$2.00 ====== $1.400 0.545 ---------$1.945 ====== $126,000 60,000 ---------$186,000 ====== $140,000 60,000 ---------$200,000 ====== $154,000 60,000 ---------$214,000 ======

The example indicates the basic pattern of overhead behavior. Fixed expenses remain fixed, within a normal range of activity, as volume (output) changes, but they vary per unit. The greater the number of units, the smaller the amount of fixed overhead per unit. Variable expenses, on the other hand, increase proportionately with each increase of volume (output) and remain fixed per unit. This characteristics of overhead behavior is important in establishing a standard factory overhead rate. Overhead absorption is accomplished by selecting a plant capacity as the base for charging variable and fixed overhead to jobs or products. Variable expenses should be measured and controlled at any volume by the supervisors with the help of a flexible budget. The variable expenses in the flexible budget correspond to applied variable overhead, and variable overhead variances result from a comparison of actual variable costs with the flexible budget(applied) variable factory overhead. Fixed expenses can be absorbed fully only by operating at the volume on which the rate is based. If the base set for overhead absorption is reached, budgeted and absorbed cost figures will be identical. Since this is highly improbable, a difference occurs between budgeted fixed expenses and absorbed fixed overhead, and fixed overhead variances from an analysis of this difference. For purposes of analysis, budgeted fixed overhead is used. Any difference that might occur between budgeted and fixed

overhead becomes a part of the variable overhead variances in the methods of analysis presented in this section of the website. Alternatively this difference can be identified as a separate variance, called the fixed spending variance. Standard Factory Overhead Rate: The standard factory overhead rate is a predetermined rate that is usually based on the direct labor hours. Other bases may also be used, e.g., direct labor dollars or machine hours. The use of direct labor dollars, however, may cause some distortion in the variance calculation. Because the actual direct labor dollar figure includes any labor rate variations from the standard rate. The data from the following flexible budget for department is used to illustrate the calculation of standard overhead rate and overhead variances. Department 3 Monthly Flexible Budget Capacity Standard production Direct labor hours Variable factory overhead: Indirect labor Indirect materials Supplies Repairs Power and light $1,600 960 640 480 160 ----------Total variable factory overhead $3,840 ====== Fixed factory overhead: Supervisor Depreciation on machinery Insurance $1,200 700 250 $1,200 700 250 $1,200 700 250 $2,000 1,200 800 600 200 ----------$4,800 ====== $2,400 1,440 960 720 240 ----------$5,760 ====== $0.50 / dlh $0.30 $0.20 $0.15 $0.05 ----------$1.20 per dlh ====== 80% 800 3,200 90% 1,000 4,000 100% 1,200 4,800

Property tax Power and light Maintenance

250 400 400 -----------

250 400 400 ----------$3,200 ----------$8,000

250 400 400 ----------$3,200 ----------$8,960 $3,200 per month ====== $3,200 per month + $1.20 per dlh ======

Total fixed factory overhead

$3,200 -----------

Total factory overhead

$7,040

======

======

======

Assuming that 90% column represents normal capacity, the standard overhead rate is computed as follows: Total factory overhead / Direct labor hours = $8,000 / 4,000 = $2 per standard direct labor hour At 90% capacity level, the rate consists of: Total variable factory overhead / Direct labor hours = $4,800 / 4,000 = $1.20 variable factory overhead rate Total fixed factory overhead / Direct labor hours = $8,000 / 4,000 = $0.80 fixed factory overhead rate Total factory overhead rate at normal capacity: ($1.20 + $0.80) = $2.00

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Factory Overhead Variances: Jobsor processes are charged with cost on the basis of standard hours allowed multiplied by the standard factory over head rate. The standard overhead rate or predetermined overhead rate is discussed in detail at our job order costing system page. The standard hours allowed figure is determined by multiplying the labor hours required to produce one unit (the standard labor hours per unit) times the actual number of units produced during the period. The units produced are the equivalent units of production for the departmental factory overhead cost being analyzed. At the end of

the month, overhead actually incurred is compared with the expenses charged into process using the standard factory overhead rate. The difference between these figures is called theoverallor net factory overhead variance. Over all or net factory overhead variance needs further analysis to reveal detailed causes for the variance and to guide management toward remedial action. This analysis may be made by using (1) the two variance method, (2) the three variance method, or (3) the four variance method. The two variance method: When an overall or net factory overhead variance is further analyzed by using two variance approach, the following two variances are calculated: Controllable variance Volume variance Controllable variance Definition: Factory overhead controllable variance is the difference between actual expenses incurred and the budget allowance based on standard hours allowed for work performed. Factory overhead controllable variance is the responsibility of the department managers to the extent that they can exercise control over the costs to which the variances relate. Formula of Factory Overhead Controllable Variance: Following formula/equation is used for the calculation of controllable variance: [Controllable Variance = Actual factory overhead Budgeted allowance based on standard hours allowed*] [*Fixed expenses budgeted + variable expenses (standard hours allowed for actual production variable overhead rate)] Example: Following is the flexible budget of a department of a manufacturing company. The data from this flexible budget is used to calculate all variances relating to factory overhead. Department 3 Monthly Flexible Budget

Capacity Standard production Direct labor hours Variable factory overhead: Indirect labor Indirect materials Supplies Repairs Power and light

80% 800 3,200

90% 1,000 4,000

100% 1,200 4,800

$1,600 960 640 480 160 -----------

$2,000 1,200 800 600 200 ----------$4,800 ======

$2,400 1,440 960 720 240 ----------$5,760 ======

$0.50 / dlh $0.30 $0.20 $0.15 $0.05 ----------$1.20 per dlh ======

Total variable factory overhead

$3,840 ======

Fixed factory overhead: Supervisor Depreciation on machinery Insurance Property tax Power and light Maintenance $1,200 700 250 250 400 400 ----------Total fixed factory overhead $3,200 ----------Total factory overhead $7,040 $1,200 700 250 250 400 400 ----------$3,200 ----------$8,000 $1,200 700 250 250 400 400 ----------$3,200 ----------$8,960 $3,200 per month ====== $3,200 per month + $1.20 per dlh ======

======

======

======

Following data is also provided: Actual factory overhead is $7,384. Actual production is 850 units of finished product. Actual hours used are 3,475 hours. 4 standard hours are allowed to complete a unit of finished product. Required: Calculate factory overhead controllable variance. Calculation of Standard Overhead Rate: Assuming that 90% column represents normal capacity, the standard overhead rate is computed as follows: Total factory overhead / Direct labor hours = $8,000 / 4,000 = $2 per standard direct labor hour At 90% capacity level, the rate consists of: Total variable factory overhead / Direct labor hours = $4,800 / 4,000 = $1.20 variable factory overhead rate Total fixed factory overhead / Direct labor hours = $3,200 / 4,000 = $0.80 fixed factory overhead rate Total factory overhead rate at normal capacity: ($1.20 + $0.80) = $2.00 Calculation of Controllable variance: Actual factory overhead Budgeted allowance based on standard hours allowed: Fixed expenses budgeted Variable expenses (3,400 standard hours allowed $1.20 variable overhead rate) $3,200 4,080 ---------7,280 $7,384

----------Controllable variance $104unfav. ====== Factory overhead controllable variance consists of variable expenses only and can also be calculated as follows: Actual variable expenses ($7,384 actual factory overhead $3,200 of fixed expenses budgeted) Variable expenses for standard hours allowed $4,184 $4,080 ---------Controllable variance $104 unfav. ====== Reasons / Causes of Unfavorable Controllable Variance: Possible reasons / causes for the unfavorable controllable variance are: Indirect materials were purchased from a different supplier with higher costs. More Indirect materials were used due to waste. Indirect labor rates were higher due to a change in personnel or higher negotiated raises than budgeted. Fixed overhead costs were more than budgeted.

2. Volume variance

Definition: Factory overhead volume variance represents the difference between the budget allowance and the standard expenses charged to work in process(standard hours allowed standard overhead rate) The volume variance indicates the cost of capacity available but not utilized or not utilized efficiently and is considered the responsibility of the executive and departmental management. Formula of Factory Overhead Volume Variance: Factory overhead volume variance is calculated by using the following formula/equation:

[Factory overhead volume variance = Budgeted allowance based on standard hours allowed* Overhead charged to production**] *Budgeted fixed expenses + variable expenses (standard hours allowed for actual production variable overhead rate) **Standard hours allowed Standard overhead rate Example: Following is the flexible budget of a department of a manufacturing company. Department 3 Monthly Flexible Budget Capacity Standard production Direct labor hours Variable factory overhead: Indirect labor Indirect materials Supplies Repairs Power and light $1,600 960 640 480 160 ----------Total variable factory overhead $3,840 ====== Fixed factory overhead: Supervisor Depreciation on machinery Insurance Property tax $1,200 700 250 250 $1,200 700 250 250 $1,200 700 250 250 $2,000 1,200 800 600 200 ----------$4,800 ====== $2,400 1,440 960 720 240 ----------$5,760 ====== $0.50 / dlh $0.30 $0.20 $0.15 $0.05 ----------$1.20 per dlh ====== 80% 800 3,200 90% 1,000 4,000 100% 1,200 4,800

Power and light Maintenance

400 400 -----------

400 400 ----------$3,200 ----------$8,000

400 400 ----------$3,200 ----------$8,960 $3,200 per month ====== $3,200 per month + $1.20 per dlh ======

Total fixed factory overhead

$3,200 -----------

Total factory overhead

$7,040

====== Following data is also provided:

======

======

Actual factory overhead is $7,384. Actual production is 850 units of finished product. Actual hours used are 3,475 hours. 4 standard hours are allowed to complete a unit of finished product. Required: Calculate factory overhead volume variance. Calculation of Standard Overhead Rate: Assuming that 90% column represents normal capacity, the standard overhead rate is computed as follows: Total factory overhead / Direct labor hours = $8,000 / 4,000 = $2 per standard direct labor hour At 90% capacity level, the rate consists of: Total Variable factory overhead / Direct labor hours = $4,800 / 4,000 = $1.20 variable factory overhead rate Total fixed factory overhead / Direct labor hours = $3,200 / 4,000 = $0.80 fixed factory overhead rate Total factory overhead rate at normal capacity:

($1.20 + $0.80) = $2.00 Calculation of factory overhead volume variance: Budgeted allowance based on standard hours allowed: Fixed expenses budgeted $3,200

Variable expenses (3400 standard hours allowed $1.20 variable overhead rate) $4,080 ----------Overhead charged to production (3400 standard hours allowed $2 standard overhead rate) $7,280 $6,800 ----------Unfavorable volume variance $480 Unfav. ====== Factory overhead volume variance consists of fixed expenses only and can be computed as follows: Normal capacity hours Standard hours allowed for actual production 4000 3400 -------Capacity hours not utilized or not utilized efficiently 600 ====== Unfavorable volume variance(600 hours 0.80*) *Fixed expenses rate at normal capacity The reasons of unfavorable overhead volume variance include the capacity available but not utilized or not utilized efficiently. $480