What Is A Spending Variance?

It’s not enough to Simply conclude that more or less was spent than intended. As with direct material and direct labor, it’s possible that the prices you paid for underlying components deviated from the expectations. On the other hand, it is also possible that the company’s productive efficiency drove the variances.

The controller of a small, closely held manufacturing company embezzled close to $1,000,000 over a 3-year period. With annual revenues of $30,000,000 and less than 100 employees, https://turbo-tax.org/irs-extends-2020-form-1095-furnishing-deadline-and/ the company certainly felt the impact of losing $1,000,000. The variance calculation is normally applied to each individual line item within this general category of expense.

What is Fixed Overhead Spending Variance?

Either way, it is simply the difference in spending from budgeted and actual fixed overhead costs. Under normal circumstances, factory fixed overheads such as Electricity, Insurance, Indirect labor, and material should remain fixed. However, significant changes in production do require even fixed overheads to be adjusted.

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. Whenever the actual expense is greater than the budgeted or standard expense, the difference is called an unfavorable variance. This example provides an opportunity to practice calculating the overhead variances that have been analyzed up to this point.

Why Use Overhead Variance Formulas?

Before we take a look at the variable overhead efficiency variance, let’s check your understanding of the cost variance. This information can be used to perform fixed overhead cost variance analysis. Manufacturing companies are required to assign fixed manufacturing overhead costs to products for financial reporting purposes (this is called absorption costing). Many organizations also analyze fixed manufacturing overhead variances. Note that both approaches—direct labor rate variance calculation and the alternative calculation—yield the same result.

Since the calculation of variable overhead expenditure variance is not influenced by the method of absorption used, the value of the variance would be the same in all cases. Sometimes these flexible budget figures and overhead rates differ from the actual results, which produces a variance. An unfavorable variance may occur if the cost of indirect labor increases, cost controls are ineffective, or there are errors in budgetary planning. You must also have the actual materials cost and materials quantity data to calculate the variances described previously. The difference between the actual fixed overhead incurred and the amount of fixed overhead that had been budgeted. In situations where the actual expense is more than the budgeted or standard expense, the difference is known as an unfavorable variance.

The Effects of Underapplied Overhead

Your actual fixed factory overhead may show little variation from your budget. For example, rent is usually subject to a lease agreement that is certain. Even though budget and actual numbers may not be very different, the underlying fixed overhead variances are still worthy of taking a close look. Using the formula approach, calculate the variable overhead efficiency variance.

The company ABC has the standard variable overhead rate of $20 per direct labor hour. Recall from Figure 10.1 “Standard Costs at Jerry’s Ice Cream” that the variable overhead standard rate for Jerry’s is $5 per direct labor hour and the standard direct labor hours is 0.10 per unit. Figure 10.8 “Variable Manufacturing Overhead Variance Analysis for Jerry’s Ice Cream” shows how to calculate the variable overhead spending and efficiency variances given the actual results and standards information. Review this figure carefully before moving on to the next section where these calculations are explained in detail.

Direct Labor Efficiency Variance Calculation

Note that both approaches—the direct materials quantity variance calculation and the alternative calculation—yield the same result. Note that both approaches—the direct materials price variance calculation and the alternative calculation—yield the same result. Although the fixed overheads do not change often, however, whenever there is a change in fixed overheads it is ought to be significant. As fixed overheads can be easily pre-planned analyzing past patterns, so a change in fixed overheads would normally require approval from higher management. Sometimes, a non-cash item such as depreciation and amortization also causes a change in fixed overheads on reconciliation. It’s also important to consider the circumstances under which the variances resulted and the materiality of the amounts involved.

• To calculate this overhead variance, start with the overhead rate charged to each unit.
• Now analyze the calculation, and you will find that the actual overhead rate is less than the standard rate which is $12.
• Budget or spending variance is the difference between the budget and the actual cost for the actual hours of operation.
• Recall that the standard cost of a product includes not only materials and labor but also variable and fixed overhead.

The other component of the total variable overhead variance is the variable overhead efficiency variance. The fixed overhead production volume variance is a direct result of the difference in volume (units) between budgeted production and actual production. Variable manufacturing overhead variance analysis involves two separate variances.

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). The variable overhead spending variance is the difference between actual costs for variable overhead and budgeted costs based on the standards. On the other hand, the standard variable overhead rate can be determined with the budgeted variable overhead cost dividing by the level of activity required for the particular level of production. If actual overhead costs amount to $11,000, the fixed overhead budget variance is $1000, meaning the company is $1000 over budget in overhead costs that month. If, for example, 1,000 units were produced that month, and $10 of overhead cost is assigned to each unit, the calculation is done against the per-unit costs of $9 and $11, respectively.

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 efficiency reduction. The variable overhead spending concept is most applicable in situations where the production process is tightly controlled, as is the case when large numbers of identical units are produced. 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. By contrast, efficiency variance measures efficiency in the use of the factory (e.g., machine hours employed in costing overheads to the products).