What causes fixed overhead volume variance?
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Fixed overhead spending variance Show
Posted in: Standard costing and variance analysis (explanations) By: Rashid Javed | Updated on: July 18th, 2022 Fixed overhead spending variance (also known as fixed overhead budget variance and fixed overhead expenditure variance) is the difference between the actual fixed manufacturing overhead and the budgeted fixed manufacturing overhead for a period. Fixed overhead spending variance is labeled “unfavorable” if actual fixed manufacturing overhead is more than the budgeted fixed manufacturing overhead and “favorable” if actual fixed manufacturing overhead is less than the budgeted fixed manufacturing overhead. Fixed overhead spending variance is an important variance for management because it indicates the cost deviations that were not expected at the time of setting standards and budgets. Formula:The formula of fixed overhead spending variance is given below: Fixed overhead spending variance = Actual fixed manufacturing overhead – Budgeted fixed manufacturing overhead Example 1The New York manufacturing company estimates that its fixed manufacturing overhead expenses should be $350,000 during the upcoming period. However, the company had to make some addition investment in overhead resources and the actual expenses for the period were therefore higher than expected at $375,000. Required: Compute fixed manufacturing overhead spending variance for the period. SolutionFixed overhead spending variance = Actual fixed overhead – Budgeted fixed overhead The fixed overhead spending variance of New York manufacturing company is unfavorable because the actual fixed overhead is higher than the budgeted fixed overhead for the period. Example 2(When fixed overhead spending variance is given and budgeted fixed manufacturing overhead is required) Tracking income and expenditure regularly as part of the process of monitoring and controlling budgets, is one of the primary purposes of standard costing Flexing budgets and comparing the volume adjusted figures gives accurate variances, but requires a good understanding of how costs behave and can be a little confusing when it comes to fixed overhead variances. Fixed overhead variancesUnderstanding fixed overhead variances requires us to build on our knowledge and understanding of calculating overhead absorption rates and determining over and under absorption, gained at the Advanced Diploma level. This means remembering that:
A business that is seasonal and has fluctuating production levels might well need to monitor its overheads carefully. Fixed overhead variance analysis exampleLet’s say that we’re setting a budget to produce 10,000 units, with an estimated overhead cost of £17,500 in the quarter. At this point we’ll either have used a previously calculated standard absorption rate to estimate the overheads, or we’ll have estimated the costs and now must calculate the overhead absorption rate (OAR). In this case, we can only calculate a rate per unit, which is £1.75 (£17,500 ÷ 10,000 units). Therefore, £1.75 is added to the direct cost of each unit produced during the period, to ensure that by the end of the quarter £17,500 will have been recovered to pay the overhead costs, as long as the estimated production levels and costs are accurate. Fast forwarding to the end of the quarter, let’s imagine that 12,500 units were actually produced. This means that £21,875 was recovered as the OAR would have been applied to all the units actually produced (12,500 units x £1.75). Let’s say the actual cost of the overheads incurred in the period was £20,000. Therefore, the business has over-absorbed because £1,875 has been recovered in excess of the amount required to pay for the overheads. In effect, we have calculated the total fixed overhead variance, we just didn’t call it that at Advanced level. Total fixed overhead varianceThe total fixed overhead variance is the difference between the amount that would be absorbed into the cost of the actual units produced, and the actual cost of the fixed overheads. An adverse variance occurs when overheads have been under-absorbed, and a favourable variance means overheads are over-absorbed. So, we could have said that the fixed overhead variance is favourable by £1,875 instead of being over-absorbed. Calculating sub-variancesThis total variance can be further understood by calculating two sub-variances, the volume and expenditure variances. The fixed overhead volume variance highlights how much of the total variance is caused by the increase or decrease in production levels, and the fixed overhead expenditure variance measures the difference between the budgeted cost and the actual cost. We know that planned production was 10,000 units and actual production was 12,500 units, so an additional 2,500 units were made and an extra £4,375 recovered (2,500 units x £1.75). This is the volume variance and it’s favourable as more units were made than budgeted. The expenditure variance is £2,500 adverse because the budgeted cost was £17,500 and the actual cost £20,000. As long as they’re correctly calculated, the sub-variances reconcile with the total variance: £4,375 favourable less £2,500 adverse equals £1,875 favourable. Whilst fixed costs do not vary with production levels, the over- or under-absorption of fixed overheads is directly linked to production levels. If fewer units than planned are produced, then insufficient overheads may be recovered to cover the actual costs. This will directly impact an organisation’s overall performance and any under-absorbed overheads will be charged as a cost against profit in the accounts. Over-absorption, like in this example, will result in additional income. Increased production can result in positive over-absorption, however, it can also be caused by inaccurate absorption rates being included in the standard cost which will result in unintentionally inflated sales prices. In summaryIt’s important to monitor all income and expenditure lines within a budget and understanding the reasons for the variances is essential to inform good decision making. Further reading on variance analysis:
Browse the full range of AAT study support resources here Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources. What causes the fixed overhead production volume variance?The variance value reflects the over or under absorption of fixed overheads, and it arises due to a change in the quantum of production against the budgeted quantum of production.
What does fixed overhead volume variance mean?Fixed overhead volume variance is the difference between the amount budgeted for fixed overhead costs based on production volume and the amount that is eventually absorbed. This variance is reviewed as part of the cost accounting reporting package at the end of a given period.
What is volume variance caused by?What Causes a Volume Variance? A volume variance is more likely to arise when a company sets theoretical standards, where the theoretically optimal number of units are expected to be used in production.
What causes the variable overhead rate variance?Variable overhead efficiency variance is a measure of the difference between the actual costs to manufacture a product and the costs that the business entity budgeted for it. Thus, it can arise from a difference in productive efficiency.
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