Variable Manufacturing Overhead Variance Analysis

A shortage in available indirect materials caused costs to increase unexpectedly. The difference between the actual activity level in the allocation base and the budgeted activity level in the allocation base according to the standards. If the outcome is favorable , this means the company was more efficient than what it had anticipated for variable overhead. If the outcome is unfavorable , this means the company was less efficient than what it had anticipated for variable overhead. Sometimes these flexible budget figures and overhead rates differ from the actual results, which produces a variance. VOCV is one of the parts of total variable overhead, with the other two being VOExV and VOEfV .

Before production begins, a business will typically calculate a standard or estimated variable manufacturing overhead for the year. Accountants come up with this figure by analyzing historical data and determining how much variable overhead expense the company tends to incur per unit produced. For example, if variable overhead costs are typically $300 when the company produces 100 units, the standard variable overhead rate is $3 per unit. The accountant then multiplies the rate by expected production for the period to calculate estimated variable overhead expense. If the business plans to produce 200 units in the next period and the standard rate is $3 per unit, the estimated variable expense is $600.

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Since most administrative costs are considered to be fixed, the amount of administrative variable overhead is usually considered to be so small as to not be worth reporting separately. This could be for many reasons, and the production supervisor would need to determine where the variable cost difference is occurring to make production changes.

• Anderson is CPA, doctor of accounting, and an accounting and finance professor who has been working in the accounting and finance industries for more than 20 years.
• Another variable overhead variance to consider is the variable overhead efficiency variance.
• Variable manufacturing overhead is a subset of variable overhead, because it only includes those variable overhead costs incurred in the manufacturing process.
• In case, it is not given, we need to calculate it using the total absorption or standard overhead, and the absorption or standard units.
• The difference between the actual activity level in the allocation base and the budgeted activity level in the allocation base according to the standards.

Recall from Figure 10.1 “Standard Costs at Jerry’s Ice Cream” that the variable overhead standard rate for Jerry’s is $5 per direct labor hour and the standard direct labor hours is 0.10 per unit. Review this figure carefully before moving on to the next section where these calculations are explained in detail. Figure 8.5 shows the connection between the variable overhead rate variance and variable overhead efficiency variance to total variable overhead cost variance. The variable overhead spending variance is unfavorable because the actual variable manufacturing overhead rate ($12.5) is higher than the standard variable manufacturing overhead rate ($12). Variable Overhead Efficiency Variance is traditionally calculated on the assumption that the overheads could be expected to vary in proportion to the number of manufacturing hours.

Formula For Variable Overhead Cost Variance

We will discuss how to report the balances in the variance accounts under the heading What To Do With Variance Amounts. Planning error (e.g. over calculating the impact of learning curve effect on the manufacturing efficiency). Decline in the productivity of manufacturing equipment due to for example technical problems or wear and tear. Free Financial Modeling Guide A Complete Guide to Financial Modeling This resource is designed to be the best free guide to financial modeling! Learn accounting fundamentals and how to read financial statements with CFI’s free online accounting classes.

Despite such a fact, it is important to calculate the overheads to avoid overspending, correctly set prices, make capital requirement plans, create reserve accounts, etc. This is the difference between the actual spending and the budgeted rate of spending on variable overhead.

Responsibility Of The Variance?

Variable Overhead Efficiency Variance is the measure of impact on the standard variable overheads due to the difference between standard number of manufacturing hours and the actual hours worked during the period. Suppose Company A has a standard output of 5,000 units, while its standard variable overheads are $2,000. However, the actual output is 4,000 units and the actual variable overheads are $3,000. It is assumed that the additional 8 hours caused the company to use additional electricity and supplies.

Cost of production refers to the total cost incurred by a business to produce a specific quantity of a product or offer a service. A fixed cost is a cost that does not change with an increase or decrease in the amount of goods or services produced or sold. A variable cost is an expense that changes in proportion to production or sales volume.

Causes Of Variable Overhead Efficiency Variance

The standard overhead rate is the total budgeted overhead of $10,000 divided by the level of activity of 2,000 hours. Notice that fixed overhead remains constant at each of the production levels, but variable overhead changes based on unit output. If Connie’s Candy only produced at 90% capacity, for example, they should expect total overhead to be $9,600 and a standard overhead rate of $5.33 . If Connie’s Candy produced 2,200 units, they should expect total overhead to be $10,400 and a standard overhead rate of $4.73 . In addition to the total standard overhead rate, Connie’s Candy will want to know the variable overhead rates at each activity level. As with direct materials and direct labor variances, all positive variances are unfavorable, and all negative variances are favorable.

Conversely, companies with more variable costs than fixed might have an easier time reducing costs during a recession since the variable costs would decline with any decline in production due to lower demand. The labor involved in production, or direct labor, might not be variable cost unless the number of workers increase or decrease with production volumes.

Variable Manufacturing Overhead: Standard Cost, Spending Variance, Efficiency Variance

Measured at the originally estimated rate of $2 per direct labor hour, this amounts to $16 (8 hours x $2). As a result, this is an unfavorable variable manufacturing overhead efficiency variance.

• Recall from Figure 10.1 “Standard Costs at Jerry’s Ice Cream” that the variable overhead standard rate for Jerry’s is $5 per direct labor hour and the standard direct labor hours is 0.10 per unit.
• A variable cost is an expense that changes in proportion to production or sales volume.
• This is because the variable overheads can only vary on the basis of units and not time.
• So, it is not possible to hold an executive or specific department responsible for this variance.
• The overhead cost is an ongoing expense, which means that it must be paid on a continuous basis whether or not the company is meeting its sales or profit objectives.

†$105,000 standard variable overhead costs matches the flexible budget presented in Figure 10.2 “Flexible Budget for Variable Production Costs at Jerry’s Ice Cream”. The expenses are then included in the calculations for determining the selling price of the product. It is important as setting minimum price levels ensures the profitability of the company. Represents the difference between the actual fixed overhead and the applied fixed overhead.

Responsibility Of The Variance:

Variable overhead tends to be small in relation to the amount of fixed overhead. Since it varies with production volume, an argument exists that variable overhead should be treated as a direct cost and included in the bill of materials for products.

• If the financial statements do not carry this detail, we will have to calculate it.
• The difference between actual costs for variable overhead and budgeted costs based on the standards.
• Standard costs are used to establish the flexible budget for variable manufacturing overhead.
• Now for calculation of VOCV we need to insert these values in our first formula.
• Hours refers to the number of machine hours or labor hours incurred in the production of output during a period.

A sudden decrease in the prices of indirect materials or the rates of indirect labor that were not expected at the time of setting overhead standards. The difference between actual costs for variable overhead and budgeted costs based on the standards. Connie’s Candy used fewer direct labor hours and less variable overhead to produce 1,000 candy boxes . Looking at Connie’s Candies, the following table shows the variable overhead rate at each of the production capacity levels.

One variance determines if too much or too little was spent on fixed overhead. The other variance computes whether or not actual production was above or below the expected production level. This is because the variable overheads can only vary on the basis of units and not time. However, some are of the opinion that variable overhead do vary on the basis of time too. And because of that the other two variances, namely variable overhead efficiency and expenditure variance arise. Hence, they believe that they can use actual time information to calculate such variance.

In the following month, the company receives a large order whereby it must produce 20,000 toys. At $1.50 per unit, the total variable overhead costs increased to $30,000 for the month. After the production period has ended, the business reviews costs and determines actual variable manufacturing overhead. Accountants do this by calculating how much was actually spent in variable manufacturing overhead during the period. When performing this calculation, accountants must be careful to calculate the amount of overhead used in production rather than the value of items purchased. For example, if the company purchased $500 worth of machine supplies but only used $400 of the supplies during the period, the accountant only includes $400 in the variable expense calculation.

Causes Of Favorable Variance

Now for calculation of VOCV we need to insert these values in our first formula. But, before that, we need to find Standard Variable Overhead for Actual Production. A more efficient use of fuel and power resources in production facility. For example, the installation of latest energy efficient equipment in the factory can result in a more optimized consumption of electricity. Decline in the efficiency of manufacturing machines because of continuous use or wear and tear. Use of substandard or low quality raw material that is difficult to process or convert into finished product. Harold Averkamp has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

Note that at different levels of production, total fixed costs are the same, so the standard fixed cost per unit will change for each production level. However, the variable standard cost per unit is the same per unit for each level of production, but the total variable costs will change.

Variable Cost Vs Fixed Cost: What’s The Difference?

Kelvin Corporation produces 10,000 digital thermometers per month, and its total variable overhead is $20,000, or $2.00 per unit. Kelvin ramps up its production to 15,000 thermometers per month, and its variable overhead correspondingly rises to $30,000, resulting in the variable overhead remaining at $2.00 per unit.