project on factory Overhead Variances Analysis

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COST ACCOUNTING

FACTORY OVERHEAD VARIANCE ANALYSIS

Submitted To: SIR HAMMAD Submitted by:

Course Code # 5530

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ACKNOWLEDGEMENT

We are really humble persons and would unable to complete this presentation without the help and grace of almighty Allah. We would like to acknowledge the efforts of our parents they made for our education and it is their continuous encouragement and support that we are able to complete our presentation successfully. We would like to acknowledge the efforts of our teacher Sir who provides us the opportunity to explore the nuts and bolts of Business Communications. “Only that education deserves emphatically to be termed cultivation of

the mind which teaches young people how to begin to think ”. (Mary Wollstonecraft)

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EXECUTIVE SUMMARY

This project is related with standard cost and variances shown by these cost and the organization we chose for this matter is Bata shoe because it is also concern with manufacturing concern material, labor and FOH. As there is actual and standard cost set by the organization and these cost set by the organization and these cost changes with time and does not remain same. As Bata shoe is one of the larger manufacture of shoe in Pakistan and they provide and produce shoe foe each type of person for earning more and more customer. The cost of producing and product are changes with time and it does not remain same and the variances shown in the cost.

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Table of Contents

Introduction .......................................................................................... 5 Factory Overhead Variance ................................................................ 5 Factory overhead variance formulas ................................................ 17 Introduction to Organization ............................................................ 18 Brief history of Organization ............................................................. 18 Significance of the issue ................................................................... 19 PRACTICAL STUDY ........................................................................... 21 SWOT Analysis................................................................................... 24 Data Collection Methods.................................................................... 25 SUGGESTIONS / RECOMMENDATIONS RECOMMENDATIONS ........................................... 26 CONCLUSION

........................................................................... 26

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INTRODUCTION TO TOPIC Overhead variances analysis FACTORY OVERHEAD VARIANCES: V ARIANCES: Remember that manufacturing costs consist of direct material, direct labor, and factory overhead. You have just seen how variances are computed computed for direct material and direct labor. Similar variance analysis analysis should be performed to evaluate spending and utilization for factory overhead. But, overhead variances are a bit more challenging challenging to calculate and and evaluate. As a result the techniques techniques for factory overhead evaluation vary considerably from company c ompany to company (and textbook to textbook). If you progress to advanced managerial managerial accounting courses, you will likely learn about a variety of alternative alternative techniques. For now, let's focus on one comprehensive approach.

VARIABLE VERSUS FIXED OVERHEAD: To begin, recall that overhead has both variable and fixed components (unlike direct labor and direct material that are exclusively variable in nature). The variable components may consist of items like indirect material, indirect labor, and factory supplies. Fixed factory overhead overhead might include include rent, depreciation, depreciation, insurance, maintenance, and and so forth. Because variable and fixed costs behave in a completely different fashion, it stands to t o reason that proper evaluation of variances between expected and actual overhead costs must take into account the intrinsic cost behavior. behavior. As a result, variance variance analysis for overhead overhead is split between variances related to variable overhead and variances related to fixed overhead.

VARIANCES RELATING TO VARIABLE FACTORY OVERHEAD: The cost behavior for variable factory overhead is not unlike direct material and

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accounting objective is no different than observed for direct material and direct labor! On the left-hand side of the following graphic, notice that more is spent on actual variable factory overhead than is applied applied based on standard rates. This scenario produces unfavorable variances (also known as "underapplied overhead" since not all that is spent is applied to production). The right-hand side is the the opposite scenario (favorable/overapplied overhead). Beneath the graphics are T-accounts intending to illustrate the cost flow. As monies are spent on overhead (wages, (wages, utilization of indirect materials, etc.), the cost (xxx) is transferred to the Factory Overhead account. As production occurs, overhead is applied/transferred to Work in Process (yyy). When more is spent than applied (as on the left scale), the the balance (zz) is transferred to variance accounts representing the unfavorable outcome. When less is spent than applied (as on the right scale), the the balance (zz) represents the favorable overall variances.

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EXPLORING VARIABLE OVERHEAD VARIANCES: A good manager will want to explore the nature of variances relating to variable overhead. It is not sufficient to simply conclude that that more or less was spent spent than intended. As with direct material and direct labor, it is possible that the prices prices paid for underlying components deviated from expectations (a variable overhead spending variance). On the other hand, hand, it is possible that the company's productive efficiency drove the variances (a variable overhead efficiency variance). Thus, the Total Variable Overhead Variance  can be divided into a Variable Overhead Spending Variance  and a Variable Overhead Efficiency  Variance.

Before looking closer at these variances, it is first necessary to recall that overhead is usually applied based on a predetermined rate, such as $X per direct labor hour (you may may find it helpful to review this concept from Chapter 19). This means that the amount debited to work in process is driven by the overhead application approach. approach. This will become clearer with the following illustration. AN ILLUSTRATION OF VARIABLE OVERHEAD OVERHEAD VARIANCES: VARIANCES: Let's return to the illustration for Blue Rail. Variable factory overhead overhead for August August consisted primarily of indirect materials (welding rods, grinding disks, paint, etc.), indirect labor (inspector time, shop foreman, etc.), and other items. Extensive budgeting and analysis had been performed, and it was estimated that variable factory overhead should be applied applied at $10 per direct labor labor hour. During August, $105,000 $105,000 was actually spent on variable factory overhead overhead items. The standard cost for August's production was as follows:

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while overhead efficiency efficiency was not so good. Remember that 12,500 12,500 hours were actually worked. Since variable overhead is consumed consumed at the presumed presumed rate of $10 per hour, this means that $125,000 of variable overhead (actual hours X standard rate) was was attributable to the the output achieved. achieved. Comparing this figure ($125,000) to the standard cost ($102,000) reveals an unfavorable variable overhead efficiency variance variance of $23,000. $23,000. However, this inefficiency inefficiency was significantly offset by the $20,000 favorable variable overhead spending variance ($105,000 vs. $125,000). $125,000). The following diagram diagram may prove useful in helping you sort out the variable overhead variances:

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8-31-XX Work in Process Inventory Variable Overhead Efficiency Variance Variable OH Spending Variance Factory Overhead

102,000 23,000

20,000 105,000

To increase work in process for the  standard variable overhead, and  record the related efficiency and  spending variances 

CAREFUL INTERPRETATION OF VARIABL V ARIABLE E OVERHEAD VARIANCES: Material and labor variances are more easily interpreted than variable overhead variances. The variable overhead overhead efficiency variance can be somewhat somewhat confusing because it may reflect efficiencies or inefficiencies experienced with the base used to apply overhead, rather rather than overhead itself. For Blue Rail, remember remember that the total number of hours was "run up" beyond plan because of inexperienced labor. A good manager manager will want to keenly evaluate the cause and meaning of variable overhead variances. In fact, the variances are likely only only the point of beginning for a proper evaluation. Remember that variable overhead is made up of many components. components. For Blue Rail, it is conceivable that the inexperienced inexperienced

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How important is control of overhead? overhead? A study of self-made self-made 50-year old old millionaires revealed very little correlation between wealth and income, and a strong correlation between between wealth and life-long savings savings patterns. Although the study is related to individuals, the message rings equally true for business. Careful control of spending is essential to long-term value building. Businesses vary considerably in their attitudes and and discipline as it relates to control of overhead. Some businesses are rather cavalier about controlling things like light/electricity usage, control over low cost parts, efficiency in shipping methods, etc. etc. Others are rather fanatical about maintaining absolute and stringent controls. For instance, one controller of a manufacturing plant was frustrated with the number of screws that were dropped and left to be swept away at the end of of each business day. These were seemingly seemingly insignificant to the employees. In frustration, the controller scattered a box of nickels onto the the factory floor -- by the end of the day none remained for the janitorial staff to sweep away. A subsequent memo was was issued reminding everyone that screws cost 5¢ each. The rather obvious point was was to draw a comparison between the nickels that everyone was eager to recover and the screws for which there was little concern. To build a successful business, a good manager manager will keep a keen eye on all overhead items, and and control them with vigor. The variable overhead variances are macro indicators of success in accomplishing this goal.

VARIANCES RELATING TO FIXED FACTORY OVERHEAD: Frequently (but not always), actual fixed factory overhead will show l ittle variation from budget. budget. This results because of the intrinsic nature of a fixed cost. For

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outcome). Here our accounting objective will be to allocate the $70,000 actually actually spent between work work in process and variance accounts. The temptation would would be to book $72,000 into work in process and reflect a $2,000 offsetting favorable variance -- but that would be the wrong approach! Instead, the Work in Process account should s hould reflect the standard fixed overhead cost for the output actually actually produced. We get to this calculated value by reconsidering the company's original assumptions assumptions about production. production. Assume that Blue Rail had planned on producing 4,000 rail systems during the month; remember that only 3,400 systems were actually produced -- output was disappointing, perhaps due due to the inexperienced inexperienced labor pool. This means that the planned fixed overhead overhead was $18 per per rail ($72,000/4,000 = $18). Because three labor hours are needed per rail, the fixed overhead allocation rate is $6 per direct labor hour ($18/3). Use this new information to consider c onsider the following illustration for fixed factory overhead (remember from the earlier discussion disc ussion that the standard labor hours for the actual output were 10,200):

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budgeted amount of fixed overhead by $10,800, representing an unfavorable Fixed Overhead Volume Variance . In other words, words, since production did not rise to

the anticipated level of 4,000 units, much of the fixed cost (that was in place to support 4,000 units of output) was "wasted" or "under-utilized." Thus, the measured volume variance is highly highly unfavorable. If more units units had been been produced than originally anticipated, the fixed overhead volume variance would be favorable (this would reflect total budgeted fixed overhead being spread over more units than originally anticipated). For Blue Rail, the volume variance is offset by the more easily understood favorable Fixed Overhead Spending Variance  of $2,000; $70,000 was spent versus the budgeted budgeted $72,000. $72,000. Together, the two two variances combine to reveal a net $8,800 unfavorable Total Fixed Overhead  Variance .

JOURNAL ENTRY FOR FIXED OVERHEAD VARIANCES: The diagram at right illustrates the flow of fixed costs into the Factory Overhead account, and on to Work in

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RECAPPING STANDARDS AND VARIANCES: The foregoing provided a painstakingly detailed account of the variances for Blue Rail. Before moving on, it is best to put the entire subject in perspective. The goal is to compare standard costs to actual costs. Blue Rail's work in process is recorded at the standard costs found in the Blue circles (hint -- the work in process inventory of blue rails is recorded at the amounts found in blue circles), while actual costs are found in the red circles. These amounts are recapped recapped in the table below:

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EXAMINING VARIANC V ARIANCES: ES: Not all variances need to be analyzed. One must consider consider the circumstances under which the variances resulted and the materiality of amounts amounts involved. One should also understand that not all unfavorable unfavorable variances are bad. For example, buying raw materials of superior quality (at higher than anticipated prices) may be offset by reduction in waste and spoilage. Likewise, favorable variances are not always good. Blue Rail's very favorable labor labor rate variance resulted from using inexperienced, less expensive expensive labor. Was this the reason for the unfavorable unfavorable outcomes in efficiency and volume? volume? Perhaps! The challenge for a good good manager manager is to take the variance information, examine the root causes, and take necessary corrective measures to fine tune business operations. In closing this discussion of standards and variances, be mindful that care should be taken in examining examining variances. If the original standards are not accurate and fair, the resulting variance signals will themselves thems elves can prove quite misleading.

BALANCED SCORECARD APPROACH TO PERFORMANCE EVALUATION:

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approach may include target thresholds that should be met, the primary mantra is on improvement. This means that all participants participants are continually striving to beat pre-existing scores for each measure. We saw how responsibility accounting concepts caused performance reports to be prepared for different steps in the corporate ladder. ladder. This notion is equally applicable to the balanced balanced scorecard approach. approach. The overall corporate entity entity may have macro targets and and measures. Similarly, sub-units will have their own unique goals. A scorecard approach can even be pushed down to the individual individual employee level. For instance, a retail store may may require that tellers complete a certain number of transactions transactions per hour. This "quota" in essence would would represent a nonfinancial metric that can be scored for each employee.

THE BALANCED SCORECARD IN OPERATION: We saw for Blue Rail Manufacturing a number of examples of financial fi nancial goals that could be included included in a balanced scorecard assessment. assessment. Examples include the standard cost for material, the standard labor hours per rail set, the expected production level, and so forth. But, what would be some examples of customer outcomes and business process outcomes?

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o

Lost production days due to out-of-stock raw materials or equipment failure

o

Employee turnover rate

o

Employee morale survey results

o

Employee accident rates/claims for workers' compensation

o

Average experience level of employees

In reviewing this list of potential items for inclusion in a balanced scorecard performance appraisal, you have probably thought of some additional items for inclusion. The choice is up to management. The idea is to find those items that drive business success in a way that is consistent with the corporate philosophy. Perhaps Blue Rail has has a goal of 100% customer satisfaction with respect to quality, but knows that its it s price will be 20% higher than

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Factory Overhead Variances: Factory overhead controllable variance formula: (Actual factory overhead)  – (Budgeted allowance based on standard hours

allowed*) Factory overhead volume variance:

(Budgeted allowance based on standard hours allowed*)  – (Factory overhead applied or charged to production**) Factory overhead spending variance: (Actual factory overhead)  – (Budgeted allowance based on actual hours

worked***)

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INTRODUCTION TO ORGANIZATION: Bata had traditionally targeted the lower middle and middle class segments of the society and was now considering changes in its strategy to be able to survive in the market. The MD of Bat a was considering the efforts necessary to realign Bata Pakistan’s manufacturing, outsourcing,

distribution and brand strategy in the light of increased local competition and Chinese imports. BRIEF HISTORY OF THE COMPANY

The business that became the Bata Shoe Organization was

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By 1905 Tomas had taken the new enterprise to 2200 pairs of shoes per day, produced by 250 employees - utilizing resourceful imaginations, skilled hands and modern machinery to keep up with demand. Under this ‘manufacturing’ system, productivity was greater then even before. Demand grew rapidly in the early 1900’s desp ite material and manpower shortages,

cartel and the outbreak of World War 1, sales continued to increase, reaching two million mil lion pairs per pe r year by b y 1917 1917.. As the enterprise prospered, so did the communities where it operated, Tomas believed that a focus on people and public service was critical for business success. The enterprise built housing, schools and a hospital near the shoemaking plant in Zlin. It provided food and inexpensive

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2. Material Yield Variance: The difference between the actual output and the

standard expected output is the Material Yield Variance. There are two methods of calculating Material Yield Variance. They are as follows: Input Method: MYV = (Standard Input - Actual Input) x Average Cost / unit

Output Method: MYV = (Actual Output - Standard Output) x Total Cost / unit

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PRACTICAL STUDY OF ORGANIZATION BATA BUSINESS Bata Shoe Organization companies are involved in every facet of the business of shoes. Throughout the world, Bata companies service

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Bata Shoe Organization production facilities are world renowned for their commitment to quality and customers, and have attracted production contracts from many international international footwear footwear brands.

BATA PAKISTAN LIMITED

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EXAMPLE The following data pertain to the first week of Bata Shoe in April. Material

Actual purchases Actual Actual usage usa ge

1500 @ Rs. 3.80 per unit 13 50 units units

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Factory overhead variance taken by Bata shoes Annual Financial Report. Cost of Sales

2010

2009

Raw material consumed

1,798,712

1,204,315

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variance between 2010 and 2009 factory overhead is calculated below: Factory overhead 2009Factory overhead 2010-

97,932 (less) 134,452

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SWOT ANALYSIS

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2. Competitors

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