Question

Alexandria Company uses a standard costing system. At the beginning of the 2020 financial year Alexandria adopted the following standards:

	Inputs	Total
Direct materials	3 kg @ $2.50 per kg	$7.50
Direct labour	5 hrs @ $7.50 per hr	37.50
Factory overhead:
Variable	$3.00 per direct labour hour	15.00
Fixed	$4.00 per direct labour hour	20.00
Standard cost per unit		$80.00

Alexandria’s July 2019 budget was based on the denominator volume of 40,000 direct labour hours. Alexandria’s actual July production was 7,800 units. The records for July indicated the following:

Direct materials purchased	25,000kg @ $2.60/kg
Direct materials used	23,100kg
Direct labour	40,100 hours at $7.30/hour
Total actual factory overhead: Variable $125,000 Fixed $175,000	$300,000

The company’s policy is to record materials variances at the time materials are purchased.

Required

1. Compute all possible variances from the case facts for the month of July. Label each variance calculated and indicate whether each variance is favourable (F) or unfavourable (U).
2. Maggie is rushing to prepare for her ACFI2003 final exam. She cannot understand why variable overhead has an efficiency variance, but fixed overhead does not. She is puzzled why fixed overhead has a volume variance and variable overhead does not. She reasoned that, “After all, overhead is overhead. So fixed and variable overhead should have the same type of variances”. Do you agree with Maggie? Explain in full why you agree or disagree.

Answer 1

Following are the possible variances:

She cannot understand why variable overhead has an efficiency variance, but fixed overhead does not.

Answer:- As you know variable OH's change with respect to change in manufacturing hours. However Fixed OH's donot change with respect to manufacturing hours. Efficiency variance is used to quantify the manufacturing efficiency acquired by change in manufacturing hours from the budgeted manufacturing hours.

She is puzzled why fixed overhead has a volume variance and variable overhead does not.

Answer:- Same as above variable OH's change with respect to volume produced, but fixed OH's remain the same irrespective of volume. But if you were to take OH for each unit, variable OH per unit will be same of each unit, however fixed OH's per unit is absorbed based on volume. So if you were to look in perspective of each unit Fixed OH per unit will change but Variable OH per unit will remain same.

“After all, overhead is overhead. So fixed and variable overhead should have the same type of variances”.

Answer:- I strongly disagree, Fixed OH's and Variable OH's are differently correlated with volume, machine hours etc. So it is not logical to have same type of variance for them. Two practical examples are explained above.