1. Calculate the variable overhead rate and efficiency variances and indicate whether each is favourable (F) or unfavourable (U)
General StudiesGeneralWorked Solution
Heather's Horse Spa (HHS) is an establishment that boards, trains, and pampers horses while their owners are on vacation. Heather sells her service as an "enchanting vacation experience for your horse while you vacation elsewhere." Horse feed, shampoos, ribbons, and other supplies are treated as variable indirect costs. Consequently, there are no direct materials involved in the vacation service. Other overhead costs, including indirect labour, amortization on the barn, and advertising, are fixed. Both variable and fixed overhead are allocated to each horse guest-week using the weight of the horse in pounds (lbs) as the basis of allocation.
REQUIRED
1. Calculate the variable overhead rate and efficiency variances and indicate whether each is favourable (F) or unfavourable (U).
2. Calculate the fixed overhead rate and production-volume variances and indicate whether each is favourable (F) or unfavourable (U).
3. Explain what the variable overhead rate variance means. What factors could have caused it?
4. What factors could have caused the variable overhead efficiency variance?
5. If fixed overhead is, in fact, fixed, how could a fixed overhead rate variance occur?
6. What caused the fixed overhead production-volume variance? What does it mean? What are the negative implications, if any, of the production-volume variance?
SOLUTION
1. Variable Overhead Variance Analysis for Heather’s Horse Spa for August 2013
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$7,500 $7,220 $6,840
$280 U $380 U
Rate variance Efficiency variance
2. Fixed Overhead Variance Analysis for Heather’s Horse Spa for August 2013
Actual Static Budget Budgeted input allowed for
Fixed Overhead Fixed Overhead Actual output × Budgeted Rate
(900 x 40 x $1.5) (900 × 38 × $1.5)
$50,000 $54,000 51,300
$4,000 F $2,700 U
Rate variance Production-volume variance
3. The variable overhead rate variance arises from the fact that the cost of horse feed, shampoo, ribbons and other supplies was higher, per weighted average horse-guest week, than expected ($7,500/(950×38)lbs = $0.208 per lb > $0.2 per lb). Unlike the material and labour price variances, which only reflect the prices paid, the rate variance could have both a cost and usage component. HHS would have a negative rate variance if they paid more for feed than expected or if the horses ate more feed than expected.
4. The $380 unfavourable variable overhead efficiency variance reflects the fact that the average weight of a horse was higher than expected. HHS expected horses to weigh an average of 900 lbs but during August, the horses weighed an average of 950 lbs. Larger horses are expected to consume more variable overhead, such as horse feed and shampoo, hence the unfavourable nature of the variance.
5. Fixed overhead is fixed with respect to horse weight. This does not mean that it can be forecasted with 100% accuracy. For example, salaries or actual costs for advertising may have been higher than expected, leading to the $4,000 unfavourable variance.
6. The production-volume variance of $2,700 exists because the fixed overhead rate was based on the forecasted number of horse guest-weeks, 40, while the fixed overhead was applied using the actual number of horse guest-weeks, 38. The overestimation of the number of horse guests in August would lead to an under absorption of fixed overhead, resulting in the unfavourable production-volume variance. If the estimate was too far off from the actual number of horses, HHS might potentially not charge enough to cover their costs.