Variable Overhead Efficiency Variance


Variable Overhead Efficiency Variance:

Learning Objective of the article:

  1. Define and explain variable overhead efficiency variance.
  2. How is variable overhead efficiency variance calculated?
  3. What are the reasons / causes of unfavorable variable overhead efficiency variance.

When companies adopt four variance analysis approach they divide the overhead efficiency variance  (which is calculated when three variance approach is used) into its variable and fixed components. Variable component is called variable overhead efficiency variance and fixed component is called fixed overhead efficiency variance.

Formula of Variable overhead Efficiency Variance:

Following formula is used for the calculation of variable overhead efficiency variance:

[Budgeted allowance based on actual hours worked* –  Budgeted allowance based on standard hours allowed**]

*Fixed expenses budgeted + (Actual hours worked × Standard variable rate)

**Fixed expenses budgeted + (Standard hours allowed × Standard variable rate)

Example:

Following is the flexible budget of a department of a manufacturing company.

Department 3
Monthly Flexible Budget

Capacity 80% 90% 100%
Standard production 800 1,000 1,200
Direct labor hours 3,200 4,000 4,800
Variable factory overhead:
Indirect labor $1,600 $2,000 $2,400 $0.50 / dlh
Indirect materials 960 1,200 1,440 $0.30
Supplies 640 800 960 $0.20
Repairs 480 600 720 $0.15
Power and light 160 200 240 $0.05
———- ———- ———- ———-
Total variable factory overhead $3,840 $4,800 $5,760 $1.20 per dlh
====== ====== ====== ======
Fixed factory overhead:
Supervisor $1,200 $1,200 $1,200
Depreciation on machinery 700 700 700
Insurance 250 250 250
Property tax 250 250 250
Power and light 400 400 400
Maintenance 400 400 400
———- ———- ———-
Total fixed factory overhead $3,200 $3,200 $3,200 $3,200 per month
———- ———- ———- ======
Total factory overhead $7,040 $8,000 $8,960 $3,200 per month
+ $1.20 per dlh
====== ====== ====== ======

Following data is also provided:

Actual factory overhead is $7,384. Actual production is 850 units of finished product. Actual hours used are 3,475 hours. 4 standard hours are allowed to complete a unit of finished product.

Required: Calculate variable overhead efficiency variance.

Calculation of Standard Overhead Rate:

Assuming that 90% column represents normal capacity, the standard overhead rate is computed as follows:

Total factory overhead / Direct labor hours

= $8,000 / 4,000

= $2 per standard direct labor hour

At 90% capacity level, the rate consists of:

Total variable factory overhead / Direct labor hours

= $4,800 / 4,000

= $1.20 variable factory overhead rate

Total fixed factory overhead / Direct labor hours

= $3,200 / 4,000

= $0.80 fixed factory overhead rate

Total factory overhead rate at normal capacity:

($1.20 + $0.80) = $2.00

Calculation of  variable overhead efficiency variance:

Budgeted allowance based on actual hours worked:
    Fixed expenses budgeted $3,200
    Variable expenses (3,475 actual hours × 1.20 standard rate) $4,170
———- $7,370
Budgeted allowance based on standard hours allowed:
    Fixed expenses budgeted $3,200
    Variable expenses (*3,400 standard hours × 1.20 standard rate) $4,080
———- $7,280
———-
Variable overhead efficiency variance $90 unfav.
======

*850 × 4 = $3,400

This variance recognizes the difference between the 3,475 actual hours worked and the 3,400 standard (or allowed) hours for the work performed. Multiplying the difference of 75 hours times $1.20 (variable expense rate) results in $90. The sum of the spending variance  and variable efficiency variance equals the controllable variance, $104, of the two variance method.

When variable overhead efficiency variance and fixed overhead efficiency variance are combined, they equal the efficiency variance of the three variance method. This concept is further explained by the following equation:

Overhead efficiency variance = Variable overhead efficiency variance + Fixed overhead efficiency variance

$150* = $90 + $60**

*See efficiency variance page

**See fixed overhead efficiency variance page

You may also be interested in other articles from “standard costing and variance analysis” chapter

  1. Standard Costs and Management By Exception
  2. Setting Standard Costs – Ideal Versus Practical Standards
  3. Direct Materials Price and Quantity Standards
  4. Direct Materials Price Variance
  5. Direct Materials Quantity Variance
  6. Direct Labor Rate and Efficiency Standards
  7. Direct Labor Rate/Price Variance
  8. Direct Labor Efficiency | Usage | Quantity Variance
  9. Manufacturing Overhead Standards
  10. Overall or net factory overhead variance.
  11. Controllable variance
  12. Volume variance
  13. Spending variance
  14. Idle capacity variance
  15. Efficiency variance
  16. Spending variance
  17. Variable efficiency variance
  18. Fixed efficiency variance
  19. Idle capacity variance
  20. Mix and Yield Variance – Definition and Explanation
  21. Materials Mix and Yield Variance
  22. Labor Yield Variance
  23. Factory Overhead Yield variance
  24. Variance Analysis and Management By Exception
  25. Managerial importance and usefulness of variance analysis
  26. Advantages and Disadvantages of Standard Costing System
  27. Standard Costing Discussion Questions and Answers
  28. Standard Costing and Variance Analysis Formulas
  29. Standard Costing and Variance Analysis Problems and Solution
  30. Standard Costing and Variance Analysis Case Study

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