# 8 4 Compute and Evaluate Overhead Variances Principles of Accounting, Volume 2: Managerial Accounting Since the formula for this variance does not involve absorbed overhead, the basis of absorption of overhead is not a factor to be considered in finding this variance. The variance calculation is normally applied to each individual line item within this general category of expense. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.

Before we take a look at the variable overhead efficiency variance, let’s check your understanding of the cost variance. Whenever the actual expense is greater than the budgeted or standard expense, the difference is called an unfavorable variance. 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. An unfavorable variance may occur if the cost of indirect labor increases, cost controls are ineffective, or there are errors in budgetary planning. In this case, the variance is favorable because the actual costs are lower than the standard costs.

Theoretically, the reduction in cost is not due to employees using less material. 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). Boulevard Blanks has decided to allocate overhead based on direct labor hours (DLH). The standard variable OH rate per DLH is \$0.80 (see introduction page), and actual variable overhead for the month was \$1,395 for 2,325 actual direct labor hours giving an actual rate of \$0.60. Recall that the standard cost of a product includes not only materials and labor but also variable and fixed overhead. It is likely that the amounts determined for standard overhead costs will differ from what actually occurs. Using the flexible budget, we can determine the standard variable cost per unit at each level of production by taking the total expected variable overhead divided by the level of activity, which can still be direct labor hours or machine hours. 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, could go down. Often, explanation of this variance will need clarification from the production supervisor.

In a standard cost system, overhead is applied to the goods based on a standard overhead rate. The standard overhead rate is calculated by dividing budgeted overhead at a given level of production (known as normal capacity) by the level of activity required for that particular level of production. The Variable Overhead Expenditure Variance is the difference between the standard variable overhead cost for actual input and the actual variable overhead incurred. Usually, the level of activity is either direct labor hours or direct labor cost, but it could be machine hours or units of production. Budget or spending variance is the difference between the budget and the actual cost for the actual hours of operation.

## What is the Variable Overhead Spending Variance?

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• If the outcome is unfavorable (a positive outcome occurs in the calculation), this means the company was less efficient than what it had anticipated for variable overhead.
• By contrast, efficiency variance measures efficiency in the use of the factory (e.g., machine hours employed in costing overheads to the products).
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• This is because the responsibility for overhead costs is difficult to pin down.

The factory worked for 26 days putting in 860 hours work every day and achieved an output of 2,050 units. The expenditure incurred as overheads was 49,200 towards variable overheads and 86,100 towards fixed overheads. The spending variance for fixed overhead is known as the fixed overhead spending variance, and is the actual expense incurred minus the budgeted expense. A spending variance is the difference between the actual and expected (or budgeted) amount of an expense. Thus, if a company incurs a \$500 expense for utilities in January and expected to incur a \$400 expense, there is a \$100 unfavorable spending variance. The production department is usually responsible for unfavorable variable overhead spending variance.

Variable overhead spending variance is favorable if the actual costs of indirect materials — for example, paint and consumables such as oil and grease—are lower than the standard or budgeted variable overheads. 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. A company may even use both machine and labor hours as a basis for the standard (budgeted) rate if the use both manual and automated processes in their operations. The variance is negative because actual variable overhead costs were \$1,395, but if the company had actually incurred the expected amount of variable overhead costs at \$0.80 per unit, total VOH would have been \$1,860.

## What are the causes of an overhead variance?

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Controlling overhead costs is more difficult and complex than controlling direct materials and direct labor costs. This is because the responsibility for overhead costs is difficult to pin down. The other component of the total variable overhead variance is the variable overhead efficiency variance.

## Example of Variable Overhead Spending Variance

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## Taking time for input and days for periods

If the outcome is favorable (a negative outcome occurs in the calculation), this means the company was more efficient than what it had anticipated for variable overhead. If the outcome is unfavorable (a positive outcome occurs in the calculation), this means the company was less efficient than what it had anticipated for variable overhead. Thus, any spending variance should be evaluated in light of the assumptions used to develop the underlying expense standard or budget. A favorable variance may occur due to economies of scale, bulk discounts for materials, cheaper supplies, efficient cost controls, or errors in budgetary planning. This example provides an opportunity to practice calculating the overhead variances that have been analyzed up to this point. To enable understanding we have worked out the illustration under the three possible scenarios of overhead being absorbed on output, input and period basis.

For example, the purchasing department may have set a standard price of \$2.00 per widget, but that price may only be achievable if the company purchases in bulk. If it instead purchases in small quantities, the company will likely pay a higher price per unit and incur an unfavorable spending variance, but will also have a smaller investment in inventory and a lower risk of inventory obsolescence. This could be for many reasons, and the production supervisor would need to determine where the variable cost difference is occurring to better understand the variable overhead reduction. Variable Overhead Spending Variance is essentially the difference between what the variable production overheads actually cost and what they should have cost given the level of activity during a period. Total overhead cost variance can be subdivided into budget or spending variance and efficiency variance. The spending variance for direct materials is known as the purchase price variance, and is the actual price per unit minus the standard price per unit, multiplied by the number of units purchased.