Variable Overhead Spending Variance: Definition and Example

In this rare scenario, we can assume that production department cannot be held responsible for fixed overhead variances. Fixed overhead spending variance and fixed overhead volume are often linked. Suppose a company uses a standard absorption rate of $ 15 per unit, for an estimated production of 1,500 units.

There is no efficiency variance for fixed manufacturing overhead because, by definition, fixed costs do not change with changes in the activity base. It is important to start by noting that fixed overhead in the master budget is the same as fixed overhead in the flexible budget because, by definition, fixed costs do not change with changes in units produced. The level of activity can be in labor hours, machine hours, or units of production. In this case, the level of activity can either be labor hours or machine hours as it is paired in the formula that has the hours worked in it.

Direct Labor

Budget or spending variance is the difference between the budget and the actual cost for the actual hours of operation. This variance can be compared to the price and quantity variance developed for direct materials and direct labor. Applying this formula of variable overhead spending variance in the calculation, the favorable or unfavorable variance can be simply determined by whether the result of the calculation is positive or negative. If the result is positive, the variance is favorable; otherwise, the variance is unfavorable.

Businesses often give more importance to ADVERSE variances than FAVORABLE variances. However, it is important to know the real reasons behind the adverse variances. Now analyze the calculation, and you will find that the actual overhead rate is less than the standard rate which is $12.

Example of the Variable Overhead Spending Variance

The labor efficiency variance is the difference between the actual number of direct labor hours worked and budgeted direct labor hours that should have been worked based on the standards. The labor rate variance is the difference between actual costs for direct labor and budgeted costs based on the standards. Meanwhile, the actual variable overhead rate can be determined by dividing the actual variable overhead cost by the actual hours worked. Accounting Tools explains that the fixed overhead variance can be calculated in a number of ways. The fixed overhead expenditure variance, also called the cost variance, budget variance or spending variance, looks at the budgeted cost of overhead against the actual cost of overhead. Companies use an overhead variance formula because they are required to assign a portion of the fixed overhead costs to each product.

Variable overhead spending variance is the difference between actual variable overhead cost, which is based on the costs of indirect materials involved in manufacturing, and the budgeted costs called the standard variable overhead costs. Interpretation of the variable overhead rate variance is often difficult because the cost of one overhead item, such as indirect labor, could go up, but another overhead cost, such as indirect materials, https://turbo-tax.org/the-super-bowl/ could go down. Often, explanation of this variance will need clarification from the production supervisor. Another variable overhead variance to consider is the variable overhead efficiency variance. Other variances companies consider are fixed factory overhead variances. The total variable overhead cost variance is also found by combining the variable overhead rate variance and the variable overhead efficiency variance.

Interpretation of the Variance

If the standard variable overhead rate is higher than the actual variable overhead rate, the result is favorable variable overhead spending variance. 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.

• The actual hours can be labor hours or machine hours depending on how much manual or automated work is required in the production process.
• Businesses often give more importance to ADVERSE variances than FAVORABLE variances.
• The factory worked for 26 days putting in 860 hours work every day and achieved an output of 2,050 units.
• However, you will also have a smaller investment in inventory in a lower risk of your inventory becoming obsolescent.

The terms favorable and unfavorable relate to the impact the variance has on budgeted operating profit. A favorable variance is always a good sign for the company’s management as it shows that the company has achieved what was planned at the start of the period. A favorable variance may be observed in cases where economies of scale are used to advantage to obtain bulk discounts for materials, or when efficient cost control measures are put in place by the management. A favorable variance may occur due to economies of scale, bulk discounts for materials, cheaper supplies, efficient cost controls, or errors in budgetary planning.

Variable Overhead Expenditure Variance

The variable overhead efficiency variance calculation presented previously shows that 18,900 in actual hours worked is lower than the 21,000 budgeted hours. Again, this variance is favorable because working fewer hours than expected should result in lower variable manufacturing overhead costs. As with direct materials and direct labor variances, all positive variances are unfavorable, and all negative variances are favorable. Note that there is no alternative calculation for the variable overhead spending variance because variable overhead costs are not purchased per direct labor hour. 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.

As such, the total variable overhead variance can be split into a variable overhead spending variance and a variable overhead efficiency variance. The total direct labor variance consists of the labor rate variance and the labor efficiency variance. The labor rate variance reveals the difference between the standard rate and the actual rate for the actual labor hours worked. The labor efficiency variance compares the standard hours of direct labor that should have been used compared to the actual hours worked to develop the actual output. Figure 8.5 shows the connection between the variable overhead rate variance and variable overhead efficiency variance to total variable overhead cost variance. 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 the actual variable overhead cost.