Overhead Costs - Planning and Variance Analysis

Variable overhead costs are related to the production volumes of products and services but their usage is not measured with respect to the specific products. The cost incurred on these heads of expenditure is pooled together and allocated to the products periodically.

Fixed overhead costs are facility maintenance costs and are not related to the production volume. Fixed overhead costs include factory building maintenance, Factory or plant manager's salary, reception department for the factory, Hospital expenditure etc.

Planning Variable Overhead Costs

Horngren et al. bring in the concept of nonvalue added activities and specify that a firm has to undertake only those variable overhead activities that add value for consumers using the related product or service. So this prescription suggests that a firm has to question each of its variable overhead costs and justify its incurrence.

Planning Fixed Overhead Cost

In the case of fixed overhead costs also, each head has to be justified and the activity has to be done efficiently. The important decision issue in the case fixed overhead is the capacity decision. Fixed cost is mostly a top management decision, while variable cost is an operating decision.

Developing Budgeted Variable Overhead Cost-Allocation Rates

As the overhead costs are allocated to cost objects (products), and in job costing, the allocation is to be done immediately after a job is finished, cost allocation rates are calculated.

The steps involved are:
1. The time period to compute the budget is decided. Variable over costs are budgeted.
2. Selection of the cost-allocation base to use in allocating variable overhead costs to the cost objects.
3. Identify the variable over costs associated with each cost allocation base and create the cost pool
4. Computer the rate per unit of each cost allocation base used by dividing the cost pool/budgeted allocation base.

Flexible Budget Analysis of Overhead Variance

Variable Overhead                          =  Actual cost  - Flexible budget amount
flexible budget variance

Variable overhead efficiency variance     =  (Actual units of CAB consumed - Budgeted units of CAB)*
(For each allocation base (CAB) )              Budgeted variable overhead rate for the CAB unit

Variable Overhead Spending Variance

VOSV = (Act. Var. over head cost per unit of CAB - Budgeted Var. overhead cost per unit of CAB)*
              Actual quantity of Var. overhead CAB used for the actual output.

Original Knol - http://knol.google.com/k/narayana-rao/overhead-costs-planning-and-variance/2utb2lsm2k7a/3145