Overhead costs are categorized into fixed and variable costs. Both these costs can change depending on several factors. Depending on the costing method in use, the contribution or profit margins can significantly change with variance in either fixed or variable overheads. Under the
Marginal costing method, overhead costs are charged directly to the income statement. Hence the variance will be only the difference in the actual and standard overhead budgets. Under Absorption costing, however, the variances will occur due to change in the
rate or volume as overhead costs are fully absorbed. The total fixed overhead variance can then be divided into fixed overhead expenditure and volume variances. Fixed overhead volume variance in Absorption terms can be defined as: “The difference between the budgeted fixed overheads and actual fixed overheads” The fixed overhead volume can further be
split into: We can calculate the fixed overhead volume variance as per the formula below: Causes for Favorable and Adverse VarianceAs the fixed overhead volume variances comprise of capacity and efficiency variances, it’s wise to see through the causes of favorable and adverse variance together as:
Interpretation and AnalysisBoth capacity and efficiency variances can be linked as changes in one often cause a change in the other measure. Because fixed overhead costs do not change with production volumes, hence the total fixed overhead volume variance will only occur if the production is increased or decreased. In the Absorption costing method particularly, the overhead costs are absorbed at the labor hours or machine hours, thus, the labor efficiency to utilize the existing facility will affect the volume variance. Production volumes can also be increased using existing facilities by increasing the total labor hours worked i.e. through capacity variance. When production capacity exceeds the targeted number of units, we observe favorable capacity variance. Similarly, an under-utilization of available production resources causes an adverse capacity variance. Working ExampleLet’s suppose that a company applies a standard or budgeted absorption rate of $ 15 per unit, and estimates a budgeted production of 1,500 units. Estimated or budgeted fixed overhead costs are $ 15,000. Within an ideal and totally efficient production system, there will be no variances and the company will see an actual output at the same production rate and costs. However, many factors can cause the number of units produced to change and the fixed overheads to increase or decrease. If the company manages to produce 1,300 units and spends $ 18,000 then: Actual fixed Overhead: $ 18,000 Less budgeted fixed overhead expenditure: $ 15,000 = $ 3,000 ADVERSE Less Actual units × overhead rate = 1,300 × 15 = $ 19,500 = $ 4,500 ADVERSE Adverse Fixed overhead volume variance can be due to several factors such as lower staff motivation, idle work hours, decreased production capacity, and so on. Capacity and Efficiency Variance ExampleAs the Absorption costing method charges or absorbs full fixed overhead costs at standard factory labor hours, the fixed overhead volume variance should be analyzed separately as capacity and efficiency variances. Let us suppose Techno blue Co. produces a product P1. It plans to produce 1,500 units of P1 in 6,000 labor hours. Therefore 4 labor hours per unit. It estimates a fixed overhead budget of $ 15,000. Under standard Absorption costing method: Budget overhead ÷ budgeted labor hours = 15,000 / 6,000 = 2.5 direct labor hours If the company produced 1,800 units using 6,500 labor hours, then: Fixed Overhead Volume Capacity Variance = (6,500 – 6,000) × 2.5 = $ 1,250 FAVORABLE. Because the company exceeded the budgeted capacity and produced more units of products Standard absorption costing would calculate the standard cost at $ 2.5 and 4 labor hours per unit. Therefore, Techno Blue’s 1,800 units should take 7,200 labor hours (1,800 × 4). The standard cost would then become 7,200 × 2.5 = $ 18,000. Whereas the company produced efficiently 6,500 units at 2.5, therefore Actual Cost is: $16,250. Hence, Fixed Overhead Volume Efficiency Variance = 18,000 – 16,250 = $ 1,750 FAVORABLE Advantages of Fixed Overhead Volume Variance
Disadvantages of Fixed Overhead Volume Variance
ConclusionFixed Overhead volume variances provide useful insights to the top-level management for the cost of goods sold analyses. Operating profit for both marginal costing and absorption costing remains the same, however, a detailed study of fixed overhead volume variances can provide valuable information on performance measurement. What causes fixed overhead volume variance?When the actual amount of the allocation base varies from the amount built into the budgeted allocation rate, it causes a fixed overhead volume variance.
What does Favourable fixed overhead volume variance mean?Favorable Variance
Fixed overhead volume variance is positive when the applied fixed overheads exceed budgeted fixed overheads. This indicates that the company has over-utilized its production facilities by producing many units with the available resources. This represents a favorable condition for the company.
How do you know if a fixed overhead production volume variance is Favourable?Fixed overhead volume variance is favorable when the applied fixed overhead cost exceeds the budgeted amount. This is because the units produced in such a case are more than the quantity expected from current production capacity and this reflects efficient use of fixed resources.
Which of the following is used to calculate the fixed overhead volume variance?The fixed-overhead volume variance can be determined by SUBTRACTING APPLIED fixed overhead from BUDGETED fixed overhead.
|