FOH cost variance scenario

ChocoDelight Cookies allocates fixed overhead (FOH) costs related to facility maintenance for its production facility. These costs include utilities, equipment upkeep, and general building maintenance. Management wants to evaluate how effectively fixed overhead costs are being utilized and absorbed into production.

Standard FOH data

In the master budget, ChocoDelight Cookies allocated a total fixed overhead cost of $400 for the production of 1,000 cookies. The standard production process requires 10 direct labor hours per 1,000 cookies.

Actual FOH data

The actual production resulted in a batch of 1,500 cookies. The company incurred actual fixed overhead costs of $650. The production process utilized 16 actual direct labor hours for this level of production.

Calculate the FOH variances:

1. FOH spending variance
2. Production volume variance
3. FOH capacity variance
4. FOH efficiency variance
5. FOH cost variance

Each formula below is written so that a positive result is favorable (F) and a negative result is unfavorable (U) - favorable means the item raises operating income relative to the benchmark being compared against. Briefly: the FOH spending variance compares actual fixed overhead to budgeted fixed overhead, the production volume variance compares overhead absorbed by production to the budgeted amount, and that volume variance splits into the FOH capacity variance (based on hours worked vs. budgeted hours) and the FOH efficiency variance (based on standard hours allowed vs. actual hours worked).

Scenario 1.1. FOH spending variance

$$\begin{array}{rl}\text{FOH spending variance}& =\text{Budgeted FOH − actual FOH}\\ & =400-650\\ & =250(\text{U})\end{array}$$

The unfavorable variance of $250 indicates that the company incurred higher fixed overhead costs than budgeted for the production facility.

Note that unlike other variances discussed previously, the FOH spending variance actually uses the amount in the master budget rather than calculating the standard based on actual production.

Scenario 1.2. Production volume variance

$$\begin{array}{rl}\text{Production volume variance}& =\text{Absorbed FOH − budgeted FOH}\\ & =600-400\\ & =200(\text{F})\end{array}$$

The $\text{Absorbed FOH}$ can be computed solely from unit-level FOH allocation (ignoring the direct labor hour allocations which will be relevant only if we want to split the volume variance into FOH capacity and FOH efficiency variances).

The FOH absorption rate would be $\$400/1,000\text{ cookies}=\$0.40\text{ per cookie}$.

At production of 1,500 cookies, the absorbed FOH is $\$0.40\text{ per cookie}\times 1,500\text{ cookies}=\$600$.

The favorable variance of $200 indicates that the company produced 500 more cookies than planned, leading to better absorption of fixed overhead costs. Because fixed overhead doesn’t change with output, though, this favorable variance only reflects over-absorption of a fixed cost - it isn’t a cost saving, and it says nothing about whether fixed overhead spending was controlled. Producing more than needed just to generate a favorable volume variance can simply build unsold inventory.

Scenario 1.3. FOH capacity variance

$$\text{FOH capacity variance}=\text{(SFR × AH) − (SFR × BH)}$$

Where:

• $\text{SFR}$ is the standard FOH rate. This could be calculated using the master budget.
• $\text{BH}$ are the budgeted (denominator) hours in the master budget.
• $\text{AH}$ are the actual hours incurred by production.

The $\text{Standard FOH rate (SFR)}$ should be computed per direct labor hour (cost driver) and not per unit produced (i.e., cookie).

In this case, the SFR should be: $\$400/10\text{ hours}=\$40\text{ per hour}$.

$$\begin{array}{rl}\text{FOH capacity variance}& =\text{(SFR × AH) − (SFR × BH)}\\ & =(40\times 16)-(40\times 10)\\ & =640-400\\ & =240(\text{F})\end{array}$$

The favorable variance of $240 indicates that more direct labor hours were worked than the standard hours allocated for the budgeted production, meaning more fixed overhead was applied to production than the $400 budgeted.

Scenario 1.4. FOH efficiency variance

$$\text{FOH efficiency variance}=\text{(SFR × SH) − (SFR × AH)}$$

Where:

• $\text{SFR}$ is the standard FOH rate. This could be calculated using the master budget.
• $\text{SH}$ are the standard hours allowed for the actual units produced.
• $\text{AH}$ are the actual hours incurred by production.

The portion of the formula $\text{(SFR × SH)}$ refers to the $\text{Absorbed FOH}$.

Standard hours allowed for actual output: $\text{SH}=\frac{10\text{ hours}}{1,000\text{ cookies}}\times 1,500\text{ cookies}=15\text{ hours}$. So absorbed FOH $=\$40\times 15=\$600$, which matches the unit-based figure in Scenario 1.2.

$$\begin{array}{rl}\text{FOH efficiency variance}& =\text{(SFR × SH) − (SFR × AH)}\\ & =(40\times 15)-(40\times 16)\\ & =600-640\\ & =40(\text{U})\end{array}$$

The unfavorable variance of $40 reflects that the actual labor hours exceeded the standard hours required for the actual production volume, resulting in less efficient use of fixed overhead resources.

Check: The total of the FOH capacity and efficiency variances should be the production volume variance:

$$\begin{array}{rl}\text{Production volume variance}& =\text{FOH capacity variance + FOH efficiency variance}\\ & =240(\text{F})+40(\text{U})\\ & =200(\text{F})\end{array}$$

Scenario 1.5. FOH cost variance

$$\begin{array}{rl}\text{FOH cost variance}& =\text{FOH spending variance + production volume variance}\\ & =250(\text{U})+200(\text{F})\\ & =50(\text{U})\end{array}$$

Alternatively:

$$\begin{array}{rl}\text{FOH cost variance}& =\text{Absorbed FOH - actual FOH}\\ & =600-650\\ & =50(\text{U})\end{array}$$

The unfavorable variance of $50 indicates that the $\text{Actual FOH}$ incurred ($650) exceeded the $\text{FOH absorbed}$ by production ($600). Although the company produced more than the budgeted volume, resulting in favorable absorption of overhead costs, the higher actual fixed overhead spending ultimately led to an overall unfavorable variance. This highlights the need to control fixed overhead spending to prevent similar variances in the future.