Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 67

Two-Variance Analysis: Service Company Example International Finance Incorporated issues letters of credit to importers for overseas purchases. The company charges a nonrefundable application fee of $3,000 and, on approval, an additional service fee of 2 percent of the amount of credit requested.

The firm’s budget for the year just completed included fixed expenses for office salaries and wages of $500,000, leasing office space and equipment of $50,000, and utilities and other operating expenses of $10,000. In addition, the budget also included variable expenses for supplies and other variable overhead costs of $1,000,000. The company estimated these variable overhead costs to be $2,000 for each letter of credit approved and issued. The company approves, on average, 80 percent of the applications it receives.

During the year, the company received 600 requests and approved 75 percent of them. The total variable overhead was 10 percent higher than the standard amount applied; the total fixed expenses were 5 percent lower than the amount budgeted.

In addition to these expenses, the company paid a $270,000 insurance premium for the letters of credit issued. The insurance premium is 1 percent of the amount of credits issued in U.S. dollars. The actual amount of credit issued often differs from the amount requested due to fluctuations in exchange rates and variations in the amount shipped from the amount ordered by importers. The strength of the dollar during the year decreased the insurance premium by 10 percent.

Required

1. Calculate the (a) variable, and (b) fixed overhead rates for the year.

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2. Prepare an analysis of the overhead variances for the year just completed. (a) What is the total controllable (i.e., flexible-budget) variance for the period? (b) What is the overhead volume variance for the period? (Hint: These two should sum to $88,000U.)

Step 1 of 7

Variance means difference. Variance analysis is an attempt to identify such difference between actual and budgeted or projected.

Variance analysis is generally conducted by manufacturers of products and service providers. Therefore, the variance analysis is an attempt to identify the difference between standard cost and the actual cost incurred to manufacture a unit of product or service.