The Portable MBA in Finance and Accounting, 3rd Edition

Measuring Productivity 219

is neither actual nor budgeted. It is really a miscomputed number. If the num-
ber of actual reams had been known in advance, one should have divided the
$4,000 by 1,200 reams, giving $3.33 per ream. In other words, one should have
used the f lexible budget. Using that rate would have led to the application of
$4,000 of fixed overhead exactly. The difference between the budgeted
amount of $4,000 and the amount actually applied, namely $800, is said to have
been over-applied—one might say over-applied in error. A correcting entry is
typically made in the accounting system to fix this error.
“The accounts of the company record that it actually had fixed overhead
costs of $4,680 and applied overhead of $4,800. This generates a credit vari-
ance of $120 in the accounts. Regardless of what appears in the accounts, the
spending variance that should be reported is an unfavorable $680—not a favor-
able $120. No matter the confusions in the ledger, the only variance that one is
interested in is:

“The difference between the variance produced by a standard cost system and
the variance wanted for budgetary control purposes is:

“In short, the error in the fixed overhead variance appearing in a standard cost
system is due to volume changing from 1,000 units to 1,200 units. The result is
a variance in the standard cost system that is useless for control purposes.
“The budgeted overhead will be equal to the applied overhead only when
the actual volume equals the budgeted volume, which rarely happens. More
commonly, a fixed cost variance is found in the ledger, but this is of no interest
for budgetary control. For control purposes, you should compute the spending
variance directly and simply ignore the net overhead variance derived in the
books.”
“Now I see why you ignored the fixed overhead when doing the variances
originally,” said Tom. “Let’s hope that my management understands this as well
as you seem to do!”

BUDGETARY CONTROL REVISITED

“Budgetary control, as we noted at the outset,” Jane continued, “consists of
comparing actual results with budget estimates. When doing this one is advised
to distinguish between revenues and costs that vary with volume and those that
are fixed with respect to volume changes. A revised budget, adjusted for the
actual volumes rather than the predicted volumes, yields a f lexible budget as
opposed to the original or static budget.

Budgeted Overhead Applied Overhead−=−

=× −×

=×

$, $,

($ , ) ($ , )

$

4 000 4 800

4 1 000 4 1 200

4 200

Applied Overhead Budgeted Overhead−=−$, $,4 680 4 000