Overhead Variances

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on August 21, 2021

Controlling overhead costs is more difficult and complex than controlling direct materials and direct labor costs because responsibility for overhead costs is difficult to pin down. The total overhead cost variance can be sub-divided into a budget or spending variance and an efficiency variance.
The 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 material and direct labor. The budget or spending variance measure (1) the differences between the standard prices and actual prices of manufacturing overhead materials and services and (2) the difference between the standard and actual quantities used.
The efficiency variance measures efficiency in the use of the factor, e.g., machine hours employed in costing overheads to the products.

Formulas to Calculate Overhead Variances

The formula for calculating the various 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 put as follows:
Total Overhead Cost Variance = Recovered overheads – Actual overheads
The total overhead cost variance may be segregated into:

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

Fixed overheads cost variance can be segregated into:

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

Volume variance may be segregated into:

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

The Reasons for the Overhead Variance Are:

Fixed Overhead Expenditure Variance: Spending more money than budgeted.
Fixed Overhead Volume Variance: Change in demand. Interruption or stoppage of work from defective planning, shortage of material, absence of or faulty instructions, etc.
Fixed Overhead Efficiency: Actual efficiency in operations not as expected.
Capacity Variance: Change in the utilization of capacity from (i). Lack of demand (ii). Lack of Power (iii). Lack of raw material etc.

Example

Give the total variances that have been analyzed till now.
For the XYZ Company for the month of October, calculate the various overhead variances from the information given below:
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.
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)

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