Chapter 9.A, Problem 12P

Selection of a Denominator: Overhead Analysis: Standard Cost Card

Morton Company's budgeted variable manufacturing overhead is S4.50 per direct labor-hour and its budgeted fixed manufacturing overhead is S270.000 per year.

The company manufactures a single product whose standard direct labor-hours per unit is 2 hours. The standard direct labor wage rate is $15 per hour. The standards also allow 4 feet of raw material per unit at a standard cost of $8.75 per foot.

Although normal activity is 30.000 direct labor-hours each year, the company expects to operate at a 40.000-hour level of activity this year.

Required:

1. Assume that the company chooses 30.000 direct labor-hours as the denominator level of activity. Compute the predetermined overhead rate, breaking it down into variable and fixed cost elements.
2. Assume that the company chooses 40.000 direct labor-hours as the denominator level of activity. Compute the predetermined overhead rate, breaking it down into variable and fixed cost elements.
3. Complete two standard cost cards as outlined below.

4. Assume that the company actually produces 18.000 units and works 38.000 direct labor-hours during the year. Actual manufacturing overhead costs for the year are:

Do the following:

a. Compute the standard direct labor-hours allowed for this year's production.

b. Complete the Manufacturing Overhead T-account below. Assume that the company uses 30.000 direct labor-hours (normal activity) as the denominator activity in computing predetermined overhead rates, as you have done in (1) above.
c. Determine the cause of the underapplied or overapplied overhead for the year by computing the variable overhead rate and efficiency variances and the fixed overhead budget and volume variances.

5. Looking at the variances you have computed, what appears to be the major disadvantage of using normal activity ratherthan expected actual activity as a denominator in computing the predetermined overhead rate? What advantages can you see to offset this disadvantage?

To determine

Predetermined overhead rate

It is a rate that is used by a company to allocate its manufacturing overhead cost to all the products. A predetermined overhead rate consists of a fixed portion and a variable portion.

To calculate: Predetermined overhead rate for 30,000 direct labor hours, fixed and variable portion of predetermined overhead rate.

Answer to Problem 12P

Predetermined overhead rate is calculated as $13.5 per hour. Variable portion in the rate is $4.5 per hour and fixed portion is $9 per hour.

Explanation of Solution

A predetermined overhead rate can be calculated by the sum of variable manufacturing overhead rate and fixed manufacturing overhead rate. So, it can be written as:

  $\begin{array}{l}\text{Predetrmined overhaed rate = Variable manufacturing overhead rate }\\ \text{ + Fixed manufacturing overhead rate }\end{array}$

Here, variable overhead rate is given as $4.5for each hour and fixed manufacturing overhead rate will be calculated as:

  $\begin{array}{l}\text{Fixed overhead rate = }\frac{\text{Fixed manufacturing overheads}}{\text{Direct labor hours}}\\ \text{ = }\frac{\$270,000}{30,000}\\ \text{ = \$9 per hour }\end{array}$

So, the predetermined overhead rate will be:

  $\begin{array}{l}\text{Predetrmined overhaed rate = \$(4}\text{.5 + 9)}\\ \text{ = \$13}\text{.5 per hour }\end{array}$

Therefore, predetermined overhead rate is $13.5 per hour. Fixed portion of the predetermined overhead rate is $9 and variable portion is $4.5.

To determine

Predetermined overhead rate

It is a rate that is used by a company to allocate its total manufacturing overhead cost to all the products. A predetermined overhead rate consists of a fixed portion and a variable portion.

To calculate: Predetermined overhead rate for 40,000 direct labor hours, fixed and variable portion of predetermined overhead rate.

Answer to Problem 12P

Predetermined overhead rate is calculated as $11.25 per hour. Variable portion in the rate is $4.5 per hour and fixed portion is $6.75 per hour.

Explanation of Solution

A predetermined overhead rate is the sum of variable manufacturing overhead rate and fixed manufacturing overhead rate. So, it can be written as:

  $\begin{array}{l}\text{Predetrmined overhaed rate = Variable manufacturing overhead rate }\\ \text{ + Fixed manufacturing overhead rate }\end{array}$

Here, variable overhead rate is given as $4.5 for each hour and fixed manufacturing overhead rate will be calculated as:

  $\begin{array}{l}\text{Fixed overhead rate = }\frac{\text{Fixed manufacturing overheads}}{\text{Direct labor hours}}\\ \text{ = }\frac{\$270,000}{40,000}\\ \text{ = \$6}\text{.75 per hour }\end{array}$

So, the predetermined overhead rate will be:

  $\begin{array}{l}\text{Predetrmined overhaed rate = \$(4}\text{.5 + 6}\text{.75)}\\ \text{ = \$11}\text{.25 per hour }\end{array}$

Therefore, predetermined overhead rate is $11.25 per hour. Fixed portion of the predetermined overhead rate is $6.75 and variable portion is $4.5.

To determine

Standard cost card

A standard cost card helps in the calculationof the total standard cost of one unit by showing necessary information about standard rate, price, quantity and hours.

To prepare: Standard cost cards for 30,000 and 40,000 direct labor hours.

Answer to Problem 12P

Total standard cost of one unit for 30,000 hours is $92 and for 40,000 hours is $87.5.

Explanation of Solution

For 30,000 labor hours, standard cost card will be prepared as follows:

Particulars	Standard quantity or hours	Standard price or rate	Standard cost
Direct material	3 feet	$8.75 per foot	$35
Direct labor	2 hours	$15 per hour	$30
Variable manufacturing overhead	2 hours	$4.5 per hour	$9
Fixed manufacturing overhead	2 hours	$9 per hour	$18
Total standard cost			$92

Therefore, total standard cost of one unit while using 30,000 hours is $54.

For 40,000 labor hours, standard cost card will be prepared as follows:

Particulars	Standard quantity or hours	Standard price or rate	Standard cost
Direct material	3 feet	$8.75 per foot	$35
Direct labor	2 hours	$15 per hour	$30
Variable manufacturing overhead	2 hours	$4.5 per hour	$9
Fixed manufacturing overhead	2 hours	$6.75 per hour	$13.5
Total standard cost			$87.5

Therefore, total standard cost of one unit while using 40,000 hours is $87.5.

To determine

Standard hours

Standard hours represent number of hours that should be used by labors in the production process. These hours are compared with actual hours used and variance is computed.

Manufacturing overheads account

This account shows actual amount of variable manufacturing overhead, actual fixed manufacturing overheads, applied variable and fixed manufacturing overheads and helps in the calculation of over or under applied overheads.

To calculate: Number of standard labor hours allowed, over applied overheads in manufacturing overheads account, variances related to variable overheads and fixed overheads.

Answer to Problem 12P

Allowed Standard direct labor hours are 36,000 and overapplied overheads in manufacturing overheads account are $39,600.

Variable overhead rate variance is $3,800 (U), variable overhead efficiency variance is 9,000 (U), fixed overhead budget variance is $1,600 (U) and fixed overhead volume variance is $54,000 (U).

Explanation of Solution

Part 4a

Allowed standard labor hours are calculated by the following formula:

  $\text{Standard direct labor hours allowed = Total number of units }\times \text{ Standard hours allowed for one unit }$

Here, actual number of units produced are 18,000 and standard hours allowed for one unit are 2. So, total standard hours will be calculated as:

  $\begin{array}{l}\text{Standard direct labor hours allowed = 18,000 }\times \text{ 2 }\\ \text{ = 36,000 hours}\text{. }\end{array}$

Part 4b

Manufacturing overhead account will be prepared as follows:

Manufacturing overhead account

Particulars	Amount ($)	Particulars	Amount ($)
Actual Variable manufacturing overheads incurred	174,800	Variable overhead applied ($4.5*18,000*2)	162,000
Fixed manufacturing overheads incurred	271,600	Fixed overhead applied ($9*18,000*2)	324,000
Overheadsoverapplied (balance)	39,600
	486,000		486,000

Overapplied overheads are $39,600.

Part 4c

Formula to calculate variable overhead rate variance is,

  $\text{Variable overhead rate variance = (Standard rate - Actual rate)}\times \text{Actual hours}$

Here, standard rate is $4.5 (given), actual hours are 38,000 and actual rate is $4.6 (174,800/38,000). So, the variance will be:

  $\begin{array}{l}\text{Variable overhead rate variance = (Standard rate - Actual rate)}\times \text{Actual hours }\\ \text{ = (\$4}\text{.5 - \$4}\text{.6)}\times 38,000\\ \text{ = \$3,800 Unfavorable}\end{array}$

Formula to calculate variable overhead efficiency variance is,

  $\text{Variable overhead efficiency variance = (Standard hours - Actual hours)}\times \text{Standard rate }$

Here, standard rate is $4.5, actual hours are 38,000 and standard hours are 36,000 (2 hours * 18,000 units). So, the variance will be,

  $\begin{array}{l}\text{Variable overhead efficiency variance = (Standard hours - Actual hours)}\times \text{Standard rate }\\ \text{ = (36,000 - 38,000)}\times 4.5\\ \text{ = \$9,000 Unfavorable}\end{array}$

Formula to calculate fixed overhead budget variance is,

  $\text{Fixed overhead}\text{Budget}\text{variance}\text{= Actual fixed overhead - Budgeted fixed overhead}$

Here, budgeted overheads are $270,000 and actual fixed overheads are $271,600. So, the variance will be:

  $\begin{array}{l}\text{Fixed overhead}\text{Budget}\text{variance}\text{= Actual fixed overhead - Budgeted fixed overhead}\\ \text{Fixed overhead}\text{Budget}\text{variance}\text{=}\text{\$271,600}\text{-}270,000\\ \text{Fixed overhead}\text{Budget}\text{variance}\text{=}\text{\$1,600 Unfavorable}\text{. }\end{array}$

Formula to calculate fixed overhead volume variance is,

  $\text{Fixed overhead}\text{volume}\text{variance}\text{= Budgeted fixed overhead - Fixed overhead applied to WIP}$

Here, budgeted fixed overheads are $270,000 and fixed overheads applied to WIP are $324,000 (18,000 units *2 hours* $9). So, the variance will be:

  $\begin{array}{l}\text{Fixed overhead}\text{volume}\text{variance}\text{= Budgeted fixed overhead - Fixed overhead applied to WIP}\\ \text{Fixed overhead}\text{volume}\text{variance}\text{=}\text{\$270,000}\text{-}324,000\\ \text{Fixed overhead}\text{volume}\text{variance}\text{=}\text{\$54,000 Unfavorable}\text{. }\end{array}$

Variable overhead rate variance is $3,800 unfavorable, variable overhead efficiency variance is $9,000 unfavorable, fixed overhead budget variance is $1,600 unfavorable and fixed overhead efficiency variance is $54,000 unfavorable.

To determine

Predetermined overhead rate

It is a rate that a company calculates using the estimated cost and estimated hours. It helps in the process of allocation of cost.

To explain: Disadvantages of using normal activity as denominator activity in the calculation of predetermined overhead rate rather than estimated activities and one advantage that can cover those advantages.

Explanation of Solution

Predetermined overhead rate is computed using the estimated or expected data and not the actual data. This rate is known as predetermined rate because it uses budgeted activities rather than the normal or actual activities.

In this question, company has used 30,000 hours and 40,000 hours as the denominator activities rather than the estimated data and all the variances related to variable overheads and fixed overheads (computed in sub parts 4) are unfavorable.

So, disadvantages of using normal activities rather than estimated activities may include, 1. Accurate standard rate, price or rates for the calculation of several variances cannot be calculated, 2. Using normal activities in mist cases make all the variances related to manufacturing overhead negative or unfavorable, 3 As wrong standard rates or hours are used in the calculation of variances, correct amount of variances may not be calculated.

Only estimated data should be used for the calculation of predetermined overhead rate. An advantage that can cover the above disadvantages is that it saves the company from the calculation of standard rate or standard hours.