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968 Part 6 Control in a Management Accounting System | EM
Compute and
interpret variable
overhead cost
variances. 5
Variable Manufacturing Overhead
Variances in Cost Centers
Manufacturing overhead is the third type of product cost that must be controlled
and accounted for. In this section we will cover variable overhead. Fixed overhead
will be covered in the next section.
Measuring and Controlling Variable Manufacturing
Overhead Costs
Variable manufacturing overhead includes such costs as indirect materials, indirect
labor, utilities, and repairs and maintenance. Like direct materials and direct labor,
variable manufacturing overhead is measured and controlled by establishing standard
costs, measuring actual costs, analyzing variances from standard, and reporting the variances
to managers so they can take necessary corrective action.
Identifying Variable Overhead Elements, Cost Drivers, and Per-Unit Costs
The first step in controlling variable manufacturing overhead is to study the behavior of each
overhead cost to determine whether it is fixed, variable, or mixed. 7 The second step is to
identify a cost driver for each variable manufacturing overhead element that relates the variable
manufacturing overhead cost to specific activities or volume changes. For simplicity in
illustrating variable overhead variances, we will assume that variable manufacturing overhead
costs vary with direct labor hours. However, you should be aware that, where possible,
costs are assigned to activities based on cost drivers that reflect the actual usage of costs
for each activity. Thus, instead of using one cost driver, such as direct labor hours, a company
might identify different cost drivers for each type of variable overhead cost. 8
To illustrate the calculation of variable manufacturing cost variances using direct labor
hours as the cost driver, we will return again to our Sunbird Boat Company example.
Assume for Sunbird that direct labor hours worked fluctuate between 7,000 and 9,000
hours each year. At the beginning of the year, Sunbird’s management team and accountants
analyzed the company’s cost behavior patterns over this relevant range to create an
annual budget. Based on their sales budget, they also established a production budget to
produce 105 15-foot boats. 9 As you recall from its standard costs (Exhibit 3 on page 950),
Sunbird allows 80 standard direct labor hours for each 15-foot boat produced. This means
that 8,400 direct labor hours (105 boats 80 standard hours) were originally forecasted
to be used in the current year. These data were then used to establish standard variable
manufacturing overhead rates as shown below.
Annual Divided by the Variable
Budgeted Total Standard Direct Manufacturing
Costs Labor Hours Allowed Overhead Rate
Indirect materials . . . . . . . . . . . . . . . $12,600 8,400 hours $1.50 per hour
Indirect labor . . . . . . . . . . . . . . . . . . 42,000 8,400 hours 5.00 per hour
Utilities . . . . . . . . . . . . . . . . . . . . . . . 8,400 8,400 hours 1.00 per hour
Variable manufacturing overhead . . . $63,000 $7.50 per hour
7 We will study issues related to cost behavior and mixed costs in Chapter 20.
8 Chapter 17 on activity-based costing provided important insight on the need to intelligently select cost drivers that effectively
impact overhead costs. In most organizations, effective analysis of overhead costs requires the use of multiple cost
drivers. For simplicity, we will assume in this chapter that all variable overhead costs can be analyzed using a single cost
driver. Although this is rarely the case, the variable overhead variances discussed here are equally relevant to organizations
with multiple overhead cost drivers.
9 These are the same production and sales numbers we created in Chapter 18 to illustrate operational budgeting. In fact, all standard
costs and budgets used in the Sunbird Boat Company example in this chapter are based on data established in Chapter 18.
You’re encouraged to review the previous chapter if needed to better understand these standard (or budgeted) cost data.