Let us understand, why and how under absorption and over absorption of factory overhead happens in the case of factory overhead? Before detail discussion on the topic let us understand what is Spending variance and Idle capacity variance.
Over applied and Under applied Factory Overhead: In the factory overhead control account , actual factory overhead incurred during the period exceeds total factory overhead applied by $7,000. Therefore, factory overhead for the period was $7,000 under applied. If applied overhead had exceeded actual overhead, overhead would have been over-applied. In either case, the difference must he analyzed to determine the reason or reasons for the over or under applied factory overhead. Two separate variances are computed in making the analysis, i.e. Spending variance and Idle capacity variance.
- Spending-variance — a variance due to budget or expense factors
- Idle capacity variance — a variance due to volume or activity factors
The analysis can be made in the following manner :
Actual factory overhead 292000
Spending- variance (unfavorable) 750
Budget allowance — based on capacity utilized (direct labor hours worked):
Fixed factory overhead budgeted (in total) $ 1 25,000
Variable factory overhead (190,000 hours X $.875) 166,250 291250
Idle capacity variance (unfavorable) 6250
Factory overhead applied ( 1 90,000 hrs. X $ 1 . 50) 285000
Factory overhead — under applied ($292,000 —$285,000) 7000
Spending Variance: The $750 spending variance is the difference between the actual factory overhead incurred and the budget allowance estimated for capacity utilized. i.e. for the actual activity of 190,000 direct labor hours worked.
The spending variance can also be computed as follows, if the actual overhead had been less than budgeted, the spending variance would have been favorable.
A breakdown of the $750 spending variance and comparison of each actual expense with its budgeted figure are useful. Details of the actual Actual factory overhead incurred during the period 5292,000 Less budgeted fixed overhead 125,000
Actual variable expenses incurred during the period $167,000 Variable overhead applied during the period (190,000 hours X $.875).. .$166,250 Spending variance — unfavorable $750