Understanding Fixed Overhead Costs and Costing Methods
What is a Budgeted Rate of Fixed Overhead Costs?
The budgeted fixed overhead cost rate is calculated by dividing the budgeted fixed overhead costs by the denominator level of the cost allocation base.
Interpreting Production Volume Variance
Managers should interpret the production volume variance cautiously. It measures the economic cost of unused capacity. This variance doesn’t account for any reduction in the selling price needed to stimulate greater demand to utilize idle capacity.
Reconciling Actual Indirect Costs
A company can reconcile actual indirect costs with budgeted amounts by analyzing the four variances: spending and efficiency for variable overhead costs, and budget and volume variances for fixed overhead.
Activity-Based Costing for Overhead Analysis
Yes, activity-based costing (ABC) can be used with flexible budgets to analyze overhead. Flexible budgets in ABC systems help understand why actual overhead costs differ from budgeted overhead costs for specific activities.
Impact of Skill Level on Fixed Overhead and Production Volume Variance
When the chosen production level exceeds the actual production level, there will be an unfavorable production volume variance. Conversely, when the chosen capacity level is below the actual production level, there will be a favorable production volume variance.
Variable Costing vs. Absorption Costing
Variable costing and absorption costing differ in how they account for fixed manufacturing costs. Under variable costing, fixed manufacturing costs are period costs and are excluded from inventoriable costs. Under absorption costing, fixed manufacturing costs are inventoriable and included as part of the cost of goods sold in the period when sales occur.
Income Statement Formats: Variable vs. Absorption Costing
Companies using variable costing prepare income statements based on the contribution margin format. Those using absorption costing use the gross margin format.
Impact of Sales and Production Levels on Operating Income
Under variable costing, operating income is driven by the unit level of sales. With absorption costing, operating income is influenced by both the unit level of sales and the unit level of production.
Absorption Costing and Inventory Buildup
Absorption costing can incentivize managers to build finished goods inventory. Producing more units for inventory absorbs more fixed manufacturing costs, reducing the costs expensed in the current period and potentially increasing current operating income.
Short-Term Costing vs. Variable and Absorption Costing
Short-term costing treats all costs, except direct materials, as period costs. This results in a lower amount of manufacturing costs being included in inventory compared to variable or absorption costing.
Factors in Choosing Capacity Level for Budgeted Fixed Manufacturing Cost
Key factors include:
- The effect on product costing and capacity management
- The effect on pricing decisions
- The effect on performance assessment
- The effect on financial statements
- Regulatory requirements
- Difficulties in forecasting capacity levels
Pricing Strategy for Companies with High Fixed Costs
Companies with high fixed costs and capacity should not necessarily increase selling prices to recover full costs. If demand decreases, continued price increases could lead to further reductions in sales. It’s important to consider variable costs and the impact on overall sales volume.