Question

Acme Financial issues letters of credit to importers for overseas purchases. The company charges a nonrefundable application fee of $4,000 and, on approval, an additional service fee of 2.0% of the amount of credit requested.

The company’s budget for the year just completed included fixed expenses for office salaries and wages of $600,000, leasing office space and equipment of $60,000, and utilities and other operating expenses of $10,000. In addition, the budget also included variable expenses for supplies and other variable overhead costs of $1,000,000. The company estimated these variable overhead costs to be $2,000 for each letter of credit approved and issued. The company approves, on average, 75% of the applications it receives.

During the year, the company received 600 requests and approved 70% of them. The total variable overhead was 10.0% higher than the standard amount applied; the total fixed expenses were 5.0% lower than the amount budgeted.

In addition to these expenses, the company paid a $270,000 insurance premium for the letters of credit issued. The insurance premium is 1.0% of the amount of credits issued in U.S. dollars. The actual amount of credit issued often differs from the amount requested due to fluctuations in exchange rates and variations in the amount shipped versus the amount ordered by importers. The strength of the dollar during the year decreased the insurance premium by 10.0%.

Required:

1. Calculate (or determine) the following budgeted overhead costs for the year:

(a) the variable overhead application rate (per letter of credit issued)

(b) the insurance cost percentage

(c) the fixed overhead application rate (per letter of credit issued)

2. Prepare an analysis of the overhead cost variances for the year just completed and in so doing answer the following questions:

(a) What is the total overhead flexible-budget variance for the period?

(b) What is the overhead volume variance for the period?

(c) What is the total overhead cost variance for the year?

Indicate whether each of the above variances is favorable (F) or unfavorable (U).

Answer 1

1. Budgeted Overhead (OH) for the year arrived at, based on attached table:

(a) Variable OH rate per letter of credit issued = $ 2000

(b) Insurance cost % to total OH = 15%

(c) Fixed OH Rate per letter of credit issued = $ 1,340

2. (a) Attached are the Total OH Flexible-budget variance:

(b) Total OH Volume variance = (Standard Volume - Actual volume) * Standard Rate = (500-420)*$3934 = $314720

Standard volume as per table provided in answer (1) above = 500 units

Actual volume as per table provided in answer (2) (a) above = 420 units

Standard rate as per table provided in answer (2)(a) above = $3,934

Thus, Total OH Volume variance = $ 314,720 Favorable

(c) Total OH Cost Variance = (Standard rate - Actual rate)*Actual volume = ($3934 - $4777)* 420 = ($421,500)

Actual volume as per table provided in answer (2)(a) above = 420 units

Standard rate as per table provided in answer (2)(a) above = $3,934

Actual rate as per table provided in answer (2)(a) above = $4,777

Thus, total OH Cost variance = $ 421,500 Unfavorable