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Review Questions

11-6 How have advances in manufacturing technology affected overhead application?

11-8 Jeffries Company’s only variable-overhead cost is electricity. Does an unfavorable


variable-overhead spending variance imply that the company paid more than the
anticipated rate per kilowatt-hour?

11-10 Distinguish between the interpretations of the direct-labor efficiency variance and
variable-overhead efficiency variance

11-20 Give one example of a plausible activity base to use in flexible budgeting for each
of the following organizations: an auto insurance company, an express delivery service,
a restaurant, and a state tax-collection agency

Problems

11-36
Standard Hours Allowed; Flexible Budget; Multiple Products; Insurance Company
(LO 11-1, 11-2, 11-4)

Gibralter Insurance Company uses a flexible overhead budget for its application-processing department.
The firm offers five types of policies, with the following standard hours allowed for clerical processing.
Automobile 1 hour
Renter’s 1 hour
Homeowner’s 2 hours
Health 2 hours
Life 5 hours

The following numbers of insurance applications were processed during July.


Automobile 250
Renter’s 200
Homeowner’s 100
Health 400
Life 200

The controller estimates that the variable-overhead rate in the application-processing department is
$4.00 per clerical hour, and that fixed-overhead costs will amount to $2,000 per month.

Required:
1, How many standard clerical hours are allowed in July, given actual application activity?

2, Why would it not be sensible to base the company’s flexible budget on the number of applications
processed instead of the number of clerical hours allowed?

3, Construct a formula flexible overhead budget for the company.

4, What is the flexible budget for total overhead cost in July?


11-40
Linkages Between the Flexible Budget and Variances
(LO 11-1, 11-2, 11-5)
1. Medical assistants, budget: $11,060; Medical assistants, actual: $13,020
3. Variable-overhead spending variance: $20,856 F

Fall City Hospital has an outpatient clinic. Jeffrey Harper, the hospital’s chief administrator, is very
concerned about cost control and has asked that performance reports be prepared that compare
budgeted and actual amounts for medical assistants, clinic supplies, and lab tests. Past financial studies
have shown that the cost of clinic supplies used is driven by the number of medical assistant labor hours
worked, whereas lab tests are highly correlated with the number of patients served.

The following information is available for June:

Medical assistants Fall City’s standard wage rate is $14 per hour, and each assistant is expected to
spend 30 minutes with a patient. Assistants totaled 840 hours in helping the 1,580 patients seen, at an
average pay rate of $15.50 per hour.

Clinic supplies The cost of clinic supplies used is budgeted at $12 per labor hour, and the actual cost of
supplies used was $9,150.

Lab tests Each patient is anticipated to have three lab tests, at an average budgeted cost of $65 per
test. Actual lab tests for June cost $318,054 and averaged 3.3 per patient.

Required:

1, Prepare a report that shows budgeted and actual costs for the 1,580 patients served during June.
Compute the differences (variances) between these amounts and label them as favorable or
unfavorable.

2, On the basis of your answer to requirement (1), determine whether Fall City has any significant
problems with respect to clinic supplies and lab tests. Briefly discuss your findings.

3, By performing a detailed analysis, determine the spending and efficiency variances for lab tests. Does
it appear that Fall City has any significant problems with the cost of its lab tests? Briefly explain. (Hint: In
applying the overhead variance formulas, think of the number of tests as the activity level, and think of
the cost per test as analogous to the variable overhead rate.)

4, Compare the lab test variance computed in requirement 1, a flexible-budget variance, with the sum of
the variances in requirement 3. Discuss your findings and explain the relationship of flexible-budget
variances and standard cost variances for variable overhead.

11-45
Preparing and Using a Columnar Flexible Budget; Tour Company; Ethical Issues
(LO 11-1, 11-2, 11-6)
1. Total variable expenses, activity level (air miles), 38,000: $93,100
4. Total variable expenses, flexible budget: $78,400
Flaming Foliage Sky Tours is a small sightseeing tour company in New Hampshire. The firm specializes in
aerial tours of the New England countryside during September and October, when the fall color is at its
peak. Until recently, the company had not had an accounting department. Routine bookkeeping tasks,
such as billing, had been handled by an individual who had little formal training in accounting. As the
business began to grow, however, the owner recognized the need for more formal accounting
procedures. Jacqueline Frost has recently been hired as the new controller, and she will have the
authority to hire an assistant.

During her first week on the job, Frost was given the following performance report. The report was
prepared by Red Leif, the company’s manager of aircraft operations, who was planning to present it to
the owner the next morning. “Look at these favorable variances for fuel and so forth,” Leif pointed out,
as he showed the report to Frost. “My operations people are really doing a great job.” Later that day,
Frost looked at the performance report more carefully. She immediately realized that it was improperly
prepared and would be misleading to the company’s owner.

Required:
1, Prepare a columnar flexible budget for Flaming Foliage Sky Tours’ expenses, using air miles as the cost
driver at the following activity levels: 32,000 air miles, 35,000 air miles, and 38,000 air miles.

2, In spite of several favorable expense variances shown on the report above, the company’s September
operating income was only about two-thirds of the expected level. Why?
3, Write a brief memo to the manager of aircraft operations explaining why the original variance report
is misleading.

4, Prepare a revised expense variance report for September, which is based on the flexible budget
prepared in requirement 1.

5, Jacqueline Frost presented the revised expense report to Leif along with the memo explaining why
the original performance report was misleading. Leif did not take it well. He complained of Frost’s
“interference” and pointed out that the company had been doing just fine without her. “I’m taking my
report to the owner tomorrow,” Leif insisted. “Yours just makes us look bad.” What are Frost’s ethical
obligations in this matter? What should she do?

11-46
Eastern Auto Parts Company manufactures replacement parts for automobile repair. The company
recently installed a flexible manufacturing system, which has significantly changed the production
process. The installation of the new FMS was not anticipated when the current year’s budget and cost
structure were developed. The installation of the new equipment was hastened by several major
breakdowns in the company’s old production machinery.
The new equipment was very expensive, but management expects it to cut the labor time required by a
substantial amount. Management also expects the new equipment to allow a reduction in direct-
material waste. On the negative side, the FMS requires a more highly skilled labor force to operate it
than the company’s old equipment.

The following cost variance report was prepared for the month of July, the first full month after the
equipment was installed.
EASTERN AUTO PARTS COMPANY
Cost Variance Report
For the Month of July
Direct material:
Standard cost $602,450 
Actual cost 598,700 
Direct-material price variance 150 U
Direct-material quantity variance 3,900 F
Direct labor:  
Standard cost 393,000 
Actual cost 383,800 
Direct-labor rate variance 4,800 U
Direct-labor efficiency variance 14,000 F
Production overhead:  
Applied to work in process 400,000 
Actual cost 408,000 
Variable-overhead spending variance 8,000 U
Variable-overhead efficiency variance 10,000 F
Fixed-overhead budget variance 30,000 U
Fixed-overhead volume variance (20,000)†

† The sign of the volume variance is negative; applied fixed overhead exceeded budgeted fixed
overhead.
Required:

Comment on the possible interactions between the variances listed in the report. Which ones are likely
to have been caused by the purchase of the new production equipment? The company budgets and
applies production overhead on the basis of direct-labor hours. (You may find it helpful to review the
discussion of variance interactions in Chapter 10.)

11-48
Using a Flexible Budget
(LO 11-1, 11-2, 11-5)
3. $11 per machine hour
5. Standard variable-overhead rate per machine hour: $10.10 per machine hour
8. Variable-overhead efficiency variance: $10,100 U
11. Fixed overhead cost: $324,000

Rutherford Wheel and Axle, Inc., has an automated production process, and production activity is
quantified in terms of machine hours. A standard-costing system is used. The annual static budget for
20x1 called for 6,000 units to be produced, requiring 30,000 machine hours. The standard overhead rate
for the year was computed using this planned level of production. The 20x1 manufacturing cost report
follows.

Rutherford develops flexible budgets for different levels of activity for use in evaluating performance. A
total of 6,200 units was produced during 20x1, requiring 32,000 machine hours. The preceding page
manufacturing cost report compares the company’s actual cost for the year with the static budget and
the flexible budget for two different activity levels.

Required:

Compute the following amounts. For variances, indicate whether favorable or unfavorable where
appropriate. Answers should be rounded to two decimal places when necessary.

1. The standard number of machine hours allowed to produce one unit of product.
2. The actual cost of direct material used in one unit of product.
3. The cost of material that should be processed per machine hour.
4. The standard direct-labor cost for each unit produced.
5. The variable-overhead rate per machine hour in a flexible-budget formula. (Hint: Use the high-
low method to estimate cost behavior.)
6. The standard fixed-overhead rate per machine hour used for product costing.
7. The variable-overhead spending variance. (Assume management has determined that the
actual fixed-overhead cost in 20x1 amounted to $324,000.)
8. The variable-overhead efficiency variance.
9. The fixed-overhead budget variance.
10. The fixed-overhead volume variance. [Make the same assumption as in requirement 7.]
11. The total budgeted manufacturing cost (in thousands of dollars) for an output of 6,050 units.
(Hint: Use the flexible-budget formula.)
(CMA, adapted)

11–51
Comprehensive Problem on Overhead Accounting under Standard Costing; Journal Entries (Appendix A)
(LO 11-2, 11-3, 11-5, 11-8)
2. Flexible budget, variable overhead: $18,000
5. Fixed overhead applied to work-in-process: $25,000
8. Cost of goods sold (debit): $14,130

College Memories, Inc., publishes college yearbooks. A monthly flexible overhead budget for the firm
follows.
The planned monthly production is 6,400 yearbooks. The standard direct-labor allowance is .25 hour per
book and overhead is budgeted and applied on the basis of direct-labor hours. During February, College
Memories, Inc., produced 8,000 yearbooks and actually used 2,100 direct-labor hours. The actual
overhead costs for the month were as follows:

Actual variable overhead $19,530


Actual fixed overhead 37,600

Required:

1. Determine the formula-style flexible overhead budget for College Memories, Inc.

2. Prepare a display similar to Exhibit 11–6, which shows College Memories’ variable-overhead
variances for February. Indicate whether each variance is favorable or unfavorable.

3. Draw a graph similar to Exhibit 11–7, which shows College Memories’ variable-overhead variances
for February.

4. Interpret each of the variances computed in requirement 2.

5. Prepare a display similar to Exhibit 11–8, which shows College Memories’ fixed-overhead
variances for February.

6. Draw a graph similar to Exhibit 11–9, which depicts the company’s applied and budgeted fixed
overhead for February. Show the firm’s February volume variance on the graph.

7. Interpret each of the variances computed in requirement 5.

8. Prepare journal entries to record each of the following:

9. Incurrence of February’s actual overhead cost.

10. Application of February’s overhead cost to Work-in-Process Inventory.

11. Close underapplied or overapplied overhead into Cost of Goods Sold.

12. Draw T-accounts for all of the accounts used in the journal entries of requirement 8. Then post the
journal entries to the T-accounts.

Cases
11-54
Integrative Case on Chapters 10 and 11; Drawing Conclusion from Missing Data
(LO 11-1, 11-3, 11-5)
3. Actual fixed overhead: $43,250
7. Actual variable-overhead rate: $6.30 per direct-labor hour
10. Applied fixed overhead: $36,000
Your next-door neighbor recently began a new job as assistant controller for Conundrum Corporation.
As her first assignment, she prepared a performance report for January. She was scheduled to present
the report to management the next morning, so she brought it home to review. As the two of you
chatted in the backyard, she decided to show you the report she had prepared. Unfortunately, your dog
thought the report was an object to be fetched. The pup made a flying leap and got a firm grip on the
report. After chasing the dog around the block, you managed to wrest the report from its teeth.
Needless to say, it was torn to bits. Only certain data are legible on the report. This information follows:

In addition to the fragmentary data still legible on the performance report, your neighbor happened to
remember the following facts.

Planned production of Conundrum’s sole product was 500 units more than the actual production.
All of the direct material purchased in January was used in production.
There were no beginning or ending inventories.
Variable and fixed overhead are applied on the basis of direct-labor hours. The fixed-overhead rate is
$4.00 per hour.

Required
1. Feeling guilty, you have agreed to help your neighbor reconstruct the following facts, which will
be necessary for her presentation.
2. Planned production (in units).
3. Actual production (in units).
4. Actual fixed overhead.
5. Total standard allowed direct-labor hours.
6. Actual direct-labor rate.
7. Standard variable-overhead rate.
8. Actual variable-overhead rate.
9. Standard direct-material quantity per unit.
10. Direct-material price variance.
11. Applied fixed overhead.
12. Fixed-overhead volume variance.

11–55
(LO 11-4, 11-5, 11-7, 11-9)
4(a). Direct-material price variance, total: $133,000 U
4(e). Variable-overhead spending variance: $75,000 U
4(g). Sales-price variance: $45,000 U

Aunt Molly’s Old Fashioned Cookies bakes cookies for retail stores. The company’s best-selling cookie is
chocolate nut supreme, which is marketed as a gourmet cookie and regularly sells for $8.00 per pound.
The standard cost per pound of chocolate nut supreme, based on Aunt Molly’s normal monthly
production of 400,000 pounds, is as follows:

Cost Item Quantity Standard Unit Cost Total Cost


Direct materials:
Cookie mix 10 oz. $.02 per oz. $ .20
Milk chocolate 5 oz.   .15 per oz.  .75
Almonds 1 oz.   .50 per oz.  .50
$1.45
Direct labor:*
Mixing 1 min. $14.40 per hr. $ .24
Baking 2 min. 18.00 per hr.   .60
$ .84

Variable overhead† 3 min. $32.40 per direct-labor hr. $1.62


Total standard cost per pound $3.91
* Direct-labor rates include employee benefits.
† Applied on the basis of direct-labor hours.

Aunt Molly’s management accountant, Karen Blair, prepares monthly budget reports based on these
standard costs. April’s contribution report, which compares budgeted and actual performance, is shown
in the following schedule.

Contribution Report for April


Static Budget Actual Variance
Units (in pounds)    400,000 450,000 50,000 F
Revenue $3,200,000 $3,555,000 $355,000 F
Direct material $  580,000 $  865,000 $285,000 U
Direct labor    336,000    348,000   12,000 U
Variable overhead   648,000   750,000  102,000 U
Total variable costs $1,564,000 $1,963,000 $399,000 U
Contribution margin $1,636,000 $1,592,000 $ 44,000 U
Justine Madison, president of the company, is disappointed with the results. Despite a sizable increase
in the number of cookies sold, the product’s expected contribution to the overall profitability of the firm
decreased. Madison has asked Blair to identify the reason why the contribution margin decreased. Blair
has gathered the following information to help in her analysis of the decrease.
Usage Report for April
Cost Item Quantity Actual Cost
Direct materials:
Cookie mix 4,650,000 oz. $  93,000
Milk chocolate 2,660,000 oz.   532,000
Almonds    480,000 oz.   240,000
Direct labor:
Mixing 450,000 min.   108,000
Baking 800,000 min.   240,000
Variable overhead   750,000
Total variable costs $1,963,000

Required:

1. Prepare a new contribution report for April, in which:

The static budget column in the contribution report is replaced with a flexible budget column.

The variances in the contribution report are recomputed as the difference between the flexible
budget and actual columns.

2. What is the total contribution margin in the flexible budget column of the new report prepared for
requirement 1?

3. Explain (i.e., interpret) the meaning of the total contribution margin in the flexible budget column
of the new report prepared for requirement 1.

4. What is the total variance between the flexible budget contribution margin and the actual
contribution margin in the new report prepared for requirement 1? Explain this total contribution
margin variance by computing the following variances. (Assume that all materials are used in the
month of purchase.)

a. Direct-material price variance.

b. Direct-material quantity variance.

c. Direct-labor rate variance.

d. Direct-labor efficiency variance.

e. Variable-overhead spending variance.

f. Variable-overhead efficiency variance.


g. Sales-price variance.

5. a. Explain the problems that might arise in using direct-labor hours as the basis for applying
overhead.

b. How might activity-based costing (ABC) solve the problems described in requirement 5a?