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.

Total overhead cost variance can be subdivided into budget or spending variance and efficiency variance.

Budget or spending variance is the difference between the budget and the actual cost for the actual hours of operation. This variance can be compared to the price and quantity variance developed for direct materials and direct labor.

Budget or spending variance measures the following:

  • The differences between the standard prices and the actual prices of manufacturing overhead materials and services
  • The difference between the standard and actual quantities used

By contrast, efficiency variance measures efficiency in the use of the factory (e.g., machine hours employed in costing overheads to the products).

Formulas to Calculate Overhead Variances

The formulas that are useful for calculating different overhead variances are as follows:

Standard rate per unit = Budgeted overheads / Budgeted output

Standard rate per hour = Budgeted overheads / Budgeted hours

Standard hours for actual output = (Budgeted output / Budgeted hours) x Actual output

Standard output for actual time = (Budgeted output / Budgeted hours) x Actual output

Recovered or absorbed overheads = Standard rate x Actual output

Budgeted overheads = Standard rate per unit x Budgeted output

Or

= Standard rate per hour x Budgeted hours

Standard overheads = Standard rate per unit  x Standard output for actual time

or 

= Standard rate per hour x Actual hours

Actual Overheads = Actual rate per unit x Actual output

or

= Actual rate per unit x Actual hours

The different overhead variances can now be specified as follows:

Total overhead cost variance = Recovered overheads – Actual overheads

The total overhead cost variance may be separated into:

  1. Variable overhead cost variance =  Recovered variable overheads – Actual variable overheads
  2. Fixed overhead cost variance = Recovered fixed overheads – Actual fixed overheads

Fixed overhead cost variance consists of:

  1. Expenditure variance = Budgeted overheads – Actual overheads
  2. Volume variances = Recovered overheads – Budgeted overheads

Volume variance further consists of:

  1. Efficiency variance = Recovered overheads – Standard overheads
  2. Capacity variance = Standard overheads – Budgeted overheads

Causes of Overhead Variance

The main causes of overhead variances are described in this section.

Fixed Overhead Expenditure Variance: Spending more money than budgeted.
Fixed Overhead Volume Variance: Change in demand, interruption or stoppage of work due to defective planning, shortage of materials, absence of or faulty instructions, etc.
Fixed Overhead Efficiency: Actual operational efficiency is not in line with expectations.
Capacity Variance: Change in the utilization of capacity due to low demand, lack of power, and raw materials shortages, among other factors.

Example

This example provides an opportunity to practice calculating the overhead variances that have been analyzed up to this point.

For XYZ Company for the month of October, calculate the various overhead variances from the following information:

  • Normal overhead rate = $2
  • Actual hours operated = 20,000
  • Allowed hours for actual production = 22,000
  • Allowed overheads for budgeted hours = $60,000
  • Actual overheads = $62,000

Solution

Budgeted overhead = $60,000
Recovered overhead = Standard rate per hour x Standard hours for actual output
= 2 x 22,000 = $44,000
Standard overhead = Standard rate per hour x Actual hours
= 2 x 20,000 = $40,000
Overhead cost = Recovered overhead – Actual overhead variance
= 44,000 – 62,000 = 18,000 (unfavorable)

The total overhead cost variance can be analyzed into a budgeted or spending variance and a volume variance. Namely:

Overhead spending variance = Budgeted overheads – Actual overheads
= 60,000 – 62,000 = 2,000 (Unfavorable)

Overhead volume variance = Recovered overheads – Budgeted overheads
= 44,000 – 60,000 = 16,000 (Unfavorable)

True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.