8 4: Compute and Evaluate Overhead Variances Business LibreTexts

On the other hand, the standard variable overhead rate can be determined with the budgeted variable overhead cost dividing by the level of activity required for the particular level of production. Standard variable overhead rate may be expressed in terms of the number of machine hours or labor hours. Very often however, companies have a combination of manual and automated business processes which may necessitate the use of both basis of variable overhead absorption. Figure 8.5 shows the connection between the variable overhead rate variance and variable overhead efficiency variance to total variable overhead cost variance.

What is the Fixed Overhead Spending Variance?

This involves collecting detailed records of expenditures related to indirect materials, labor, and utilities. Businesses often leverage accounting software like QuickBooks or SAP for this purpose, as these tools provide comprehensive tracking and reporting capabilities. By using such software, companies can ensure data accuracy and facilitate the timely analysis of spending variances. Variable overhead costs fluctuate with production levels, making them dynamic and sometimes unpredictable.

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Furthermore in a standard costing accounting system, variable overhead has two main variances, the variable overhead rate variance and the variable overhead efficiency variance. The standard overhead rate is the total budgeted overhead of \(\$10,000\) divided by the level of activity (direct labor hours) of \(2,000\) hours. 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 \(\$5.33\) (rounded). If Connie’s Candy produced \(2,200\) units, they should expect total overhead to be \(\$10,400\) and a standard overhead rate of \(\$4.73\) (rounded). For example, the company ABC, which is a manufacturing company, incurs $11,000 of variable overhead costs with 480 direct labor hours of works during September. The company ABC has the standard variable overhead rate of $20 per direct labor hour.

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The fixed factory overhead variance represents the difference between the actual fixed overhead and the applied fixed overhead. The other variance computes whether or not actual production was above or below the expected production level. As an example of an unfavorable fixed overhead spending variance, a passing tornado delivers a glancing blow to the production facility of Hodgson Industrial Design, resulting in several hundred roofing tiles being blown off.

Taking time for input and days for periods

In this case, the variance is favorable because the actual costs are lower than the standard costs. Variable production overheads include costs that cannot be directly attributed to a specific unit of output. Costs such as direct material and direct labor, on the other hand, vary directly with each unit of output. Total overhead cost variance can be subdivided into budget or spending variance and efficiency variance.

What is a variable overhead variance?

Another component is indirect labor, which encompasses wages for employees who are not directly involved in production but whose roles are indispensable to the manufacturing process. Their work ensures that production lines run efficiently and that products meet quality standards, thereby indirectly influencing production costs. In case of a negative variable overhead spending variance, production department is usually responsible. An unfavorable variance may occur if the cost of indirect labor increases, cost controls are ineffective, or there are errors in budgetary planning.

On the other hand, if the actual variable overhead rate is higher, the variance is unfavorable. This means that the actual variable overhead cost during the period is higher than the overhead cost that is applied to the actual hours worked using the standard variable overhead rate. Variable production overheads by their nature include costs that cannot be directly attributed to a specific unit of output unlike direct material and direct labor which vary directly with output.

These costs are not directly tied to the production of a specific unit but are necessary for the overall manufacturing process. A primary component of variable overhead is indirect materials, which include items like lubricants, cleaning supplies, and other consumables that support production but are not part of the final product. These materials are essential for maintaining equipment and ensuring smooth operations. Connie’s Candy used fewer direct labor hours and less variable overhead to produce 1,000 candy boxes (units). Connie’s Candy used fewer direct labor hours and less variable overhead to produce \(1,000\) candy boxes (units).

• By addressing potential variances before they manifest, companies can maintain financial stability and improve their operational efficiency.
• The actual hours can be labor hours or machine hours depending on how much manual or automated work is required in the production process.
• On the contrary, as shown in our example above, an unfavorable variable overhead spending variance would be when the actual variable overhead rate per hour is greater than the standard variable overhead per hour rate.
• An adverse variable manufacturing overhead spending variance suggests that the company incurred a higher cost than the standard expense.

An unfavorable variable overhead spending variance indicates a decrease in budgeted profit and negatively affects the company. We apply the standard variable overheads over the hours worked by multiplying the standard rate of variable overheads by the actual hours worked. Variable overhead spending variance is the difference between the actual and budgeted rate of spending on variable overheads. The Variable Overhead Expenditure Variance is the difference between the standard variable overhead cost for actual input and the actual variable overhead incurred.

Double Entry Bookkeeping is here to provide you with free online information to help you learn and understand bookkeeping and introductory accounting. If the balances are insignificant in relation to the size of the business, then we can simply transfer them the cost of goods sold account. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology.

This name properly makes it easier to understand that the concept of this variance is about the difference between the standard variable overhead rate and the actual variable overhead rate. Alternatively, the variable overhead spending variable formula can also be written as the standard variable overhead rate multiplying with actual hours worked and then using the result to deduct depreciation tax shield depreciation tax shield in capital budgeting the actual variable overhead cost. Usually, the level of activity is either direct labor hours or direct labor cost, but it could be machine hours or units of production. The standard variable overhead rate is typically expressed in terms of the number of machine hours or labor hours depending on whether the production process is predominantly carried out manually or by automation.