84 12. 8: Using Variance Analysis with Activity-Based Costing

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• Last updated

  Dec 28, 2020

Let’s work through an example of variance analysis using activity-based costing. Suppose Jerry’s Ice Cream identified three significant activities and established three standard rates to allocate variable manufacturing overhead instead of one rate based on direct labor hours. Information for the three activities for last year is:

Recall that Jerry’s produced 210,000 units for the year. Figure 12.11 shows the resulting variable overhead variance analysis. Notice that the format for Figure 12.11 is the same as for Figure 12.8. The variance calculations are also the same except variances are calculated for three activities rather than one. Note that total actual variable overhead costs remain at $100,000, but they are simply broken out into 3 activities ($100,000 = $42,000 for purchase orders + $31,000 for product testing + $27,000 for energy costs). Also, the flexible budget presented in Figure 12.11, totaling $115,500, differs from the flexible budget presented earlier since Jerry’s is using a different cost system in this example, which often results in different budgeted amounts ($115,500 = $52,500 purchase orders + $42,000 product testing + $21,000 energy).

Figure 12.11 : – Variable Overhead Variance Analysis for Jerry’s Ice Cream Using Activity-Based Costing

Note: AQ = Actual quantity of activity . SR = Standard variable manufacturing overhead rate per unit of activity . SQ = Standard quantity of activity given actual production of 210,000 units.

*Standard quantity of 2,100 purchase orders = Standard of 0.01 purchase orders per unit × 210,000 actual units produced.

**$2,000 unfavorable variable overhead spending variance = $42,000 −$40,000. Variance is unfavorable because the actual variable overhead cost is higher than the expected cost given actual quantity of 1,600 purchase orders.

† $(12,500) favorable variable overhead efficiency variance = $40,000 – $52,500. Variance is favorable because the 1,600 actual purchase orders are lower than the 2,100 expected (budgeted) purchase orders.

This type of costing system and resulting variance analysis provides management with further information regarding variable overhead costs and variances. As discussed earlier, management often establishes criteria to decide which variances to investigate. Assume that management of Jerry’s Ice Cream chooses to investigate the $7,750 unfavorable efficiency variance associated with energy. The management would like to know why 575,000 minutes of actual machine time were used instead of the expected 420,000 minutes. Perhaps the machines were operating poorly due to cutbacks in maintenance, or maybe new employees were not as efficient using the machines. Whatever the cause, Jerry’s has identified the issue by integrating its activity-based costing system with the cost variance analysis concepts discussed in this chapter.