Two-Variance Analysis: Service Company Example International Finance Incorporated issues let- ters

Two-Variance Analysis: Service Company Example International Finance Incorporated issues let- ters of credit to importers for overseas purchases. The company charges a nonrefundable applica- tion 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

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

Prepare an analysis of the overhead variances for the year just completed. (a) What is the total control- lable (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.)

Q551

Ethics and Overhead Variance New Millennium Technologies uses a standard cost system and budgeted 50,000 machine hours to manufacture 100,000 units in 2010. The budgeted total fixed factory overhead was $9,000,000. The company manufactured and sold 80,000 units in 2010 and would report a loss of $9,600,000 after charging the production-volume variance to cost of goods sold (CGS) of the period.

Bob Evans, VP–Finance, believes that the denominator activity level of 50,000 machine hours is too low. The maximum capacity of the firm is between 5,000,000 and 6,000,000 machine hours. Bob considers a denominator level at half the low-end capacity to be reasonable. Furthermore, he believes that the unfavorable production-volume variance should be capitalized (rather than written off against current period’s earnings) because the demand for the firm’s products has been increas- ing rapidly. A conservative projection of the firm’s sales places the total sales at a level that will require at least 5 million machine hours in less than 5 years. Bob was able to show a substantial improvement in operating income after revising the cost data. He used the revised operating result in briefing financial analysts.Required

Compute the net effect on operating income of the two changes made regarding fixed factory overhead.

Is it ethical for Bob to make the changes? (Consult www.imanet.org.)

Do the provisions of GAAP regarding inventory costing (i.e., FASB ASC 330-10-30, previously SFAS No. 151 —available at www.asc.fasb.org) bear upon the current issue? If so, how?

How does the choice of the denominator volume level in setting (fixed) overhead application rates pro- vide managers with an opportunity to manage earnings?

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