Variable indirect cost variations
The total variance in variable overhead is the difference between the standard variable overhead charged to production and the actual variable overhead incurred. It is normally assumed that variable indirect costs vary with incoming direct work hours and that therefore the total variance of variable indirect costs is due to one or both of the following factors;
• Actual expenses may differ from budgeted expenses.
• Actual input direct labor hours may be different from input direct labor hours that should have been used.
The ratios give rise to the two subvariances;
• Variable variation of general expenses
• Variable variation in the efficiency of general expenses
Variable Overhead Variation – To compare actual overhead to budgeted expenses, you need to flex your budget. Variable indirect costs are assumed to vary with direct input labor hours, and therefore the budget is set on this basis.
Variable Overhead Efficiency Variance – Variable Overhead Efficiency Variation is the difference between the standard check-out time and the actual check-in hours for the period multiplied by the standard variable overhead rate.
Fixed Production Overhead Cost Variations – You keep the fact that you are trying to explain the reasons for any under- or over-absorbing fixed production overhead a secret all the time.
Remember that the absorption rate is calculated as follows:
Overhead Absorption Rate = Budgeted Fixed Production Overhead / Budgeted Activity Level.
• Fixed Production Overhead Variation measures insufficient or excessive absorption caused by actual production overhead by betting different from budget, that is, the numerator is incorrect.
• Fixed production overhead volume variance measures insufficient or excessive absorption caused by actual production or uptime that are different from budgeted production or the budgeted number of hours used to calculate the absorption rate.
Fixed production overhead or expense variance – This variance seeks to identify the portion of the total variance in fixed overhead costs that is due to the actual fixed overhead that differs from the budgeted fixed overhead.
Volume Variation: This variation seeks to identify the part of the total variation in fixed overhead costs that is due to actual production being different from budgeted production. If actual production is less than budgeted production, the fixed overhead switched to production will be less than the budgeted cost and the volume change will be an adverse variance. The difference between actual production and budgeted production for a period multiplied by the standard fixed overhead rate.
The sum of these factors may be controllable by production or sales management, while others may not. If we want to identify the reasons for the volume change, we can ask why the actual production was different from the budgeted production. It could be due to two reasons,
• The workforce worked with a different level of efficiency than the one foreseen in the budget, and / or
• The company had not used the planned capacity.
The two reasons are related to the two subvariances of the changes in total volume;
Volume efficiency variance: The volume efficiency variance is the difference between the standard production hours and the actual input hours for the period multiplied by the standard fixed overhead rate, or the physical content of this variance is a measure of labor efficiency and is identical to the variance of labor efficiency. Consequently, the reasons for this variation will be identical to the variation in labor efficiency.
Volume capacity variance – The volume capacity variance is between the actual inbound hours and the budgeted inbound hours for the period multiplied by the standard fixed overhead rate, or the volume efficiency variance indicates a failure to utilize capacity efficiently, varying volume capacity indicates an inability to utilize capacity at all.