Aenergy Technical

10 9: Fixed Manufacturing Overhead Variance Analysis Business LibreTexts

Suppose the company budgeted $60,000 for its fixed manufacturing overhead costs for the month, which includes things like rent for the factory, the salaries of permanent staff, and depreciation of machinery. Thus our 1,200 units produced should have taken 6,000 hours (1.200 x 5 hours, and should have cost $12,000. (6,000 hours x $2 standard FOAR). Consequently a further favourable variance of $1,200 is recorded for efficiency reasons (the company was efficient because it produced 6,000 standard hours worth of product in 5,400 hours). Assume a company budgeted to produce 1,000 units of product in 5,000 labour hours (each unit therefore taking 5 standard hours of labour). Consider a company with budgeted fixed production overheads of $10,000 for the coming year. In a standard cost system, overhead is applied to the goods based on a standard overhead rate.

Fixed overhead volume variance is the difference between fixed overhead applied to production for a given accounting period and the total fixed overheads budgeted for the period. The fixed manufacturing overhead volume variance is the difference between the amount of fixed manufacturing overhead budgeted to the amount that was applied to (or absorbed by) the good output. If the amount applied is less than the amount budgeted, there is an unfavorable volume variance. This means there was not enough good output to absorb the budgeted amount of fixed manufacturing overhead.

Overhead Variances

It compares the actual overhead costs per unit that were achieved to the expected or budgeted cost per item. When calculated using the formula above, a positive fixed overhead volume variance is favorable. The fixed overhead costs included in this variance tend to be only those incurred during the production process, such as factory rent, equipment depreciation, staff salaries, insurance of facilities and utility fees. A portion of these fixed manufacturing overhead costs must be allocated to each apron produced. This is known as absorption costing and it explains why some accountants say that each product must “absorb” a portion of the fixed manufacturing overhead costs.

Other variances, such as the fixed overhead spending variance, should be analyzed for that purpose. If actual production is greater than budgeted production, the production volume variance is favorable. That is, the total fixed overhead has been allocated to a greater number of units, resulting in a lower production cost per unit. It is important to start by noting that fixed overhead in the

master budget is the same as fixed overhead in the flexible budget

because, by definition, fixed costs do not change with changes in

units produced.

Variable Overhead Efficiency Variance

Examples of fixed overhead costs are factory rent, equipment depreciation, the salaries of production supervisors and support staff, the insurance on production facilities, and utilities. This result of $950 of unfavorable https://turbo-tax.org/hsa-tax-information-for-your-employees/ can be used together with the fixed overhead budget variance to determine the total fixed overhead variance. Fixed Overhead Total Variance is the difference between the actual fixed production overheads incurred during a period and the ‘flexed’ cost (i.e. fixed overheads absorbed). Usually, the level of activity is either direct labor hours or direct labor cost, but it could be machine hours or units of production.

Fixed manufacturing overhead costs remain the same in total even though the production volume increased by a modest amount. For example, the property tax on a large manufacturing facility might be $50,000 per year and it arrives as one tax bill in December. The amount of the property tax bill did not depend on the number of units produced or the number of machine hours that the plant operated.

Production Volume Variance: Definition, Formula, Example

The flexible budget amount for fixed overhead does not change with changes in production, so this amount remains the same regardless of actual production. † $140,280 is the original budget

presented in the manufacturing overhead budget shown in Chapter 9. The flexible budget amount for fixed overhead does not change with

changes in production, so this amount remains the same regardless

of actual production. In our example, we budgeted the annual fixed manufacturing overhead at $8,400 (monthly rents of $700 x 12 months). If DenimWorks pays more than $8,400 for the year, there is an unfavorable budget variance; if the company pays less than $8,400 for the year, there is a favorable budget variance. For simplicity assume that there was no fixed overhead expenditure variance, that is that actual overhead expenditure was as budgeted.

A favorable variance means that the actual variable overhead expenses incurred per labor hour were less than expected. Calculating its overhead costs per unit is important for a business because so many of its overhead costs are fixed. When the cumulative amount of the variance becomes too large over time, a business should alter its budgeted allocation rate to bring it more in line with actual volume levels. Fixed overhead volume variance helps to ‘balance the books’ when preparing an operating statement under absorption costing.

Fixed Overhead Spending Variance

Connie’s Candy also wants to understand what overhead cost outcomes will be at 90% capacity and 110% capacity. The following information is the flexible budget Connie’s Candy prepared to show expected overhead at each capacity level. † $140,280 is the original budget presented in the manufacturing overhead budget shown in Chapter 9 “How Are Operating Budgets Created?”.

• Connie’s Candy also wants to understand what overhead cost outcomes will be at 90% capacity and 110% capacity.
• The company also estimated that it would produce 1,000 pieces of furniture during the month, working 5,000 hours in total.
• This simplicity of prediction sees some businesses create a fixed overhead allocation rate that is used throughout the year.
• A portion of these fixed manufacturing overhead costs must be allocated to each apron produced.

This could be for many reasons, and the production supervisor would need to determine where the variable cost difference is occurring to make production changes. This example provides an opportunity to practice calculating the overhead variances that have been analyzed up to this point. The variance is favorable because Motors PLC yielded a higher output than anticipated in the budget. The graph shows that absorption costing takes what is a fixed cost ($10,000 per year), and converts it to a cost per unit of activity, effectively treating it as a variable cost ($10 per unit). Fixed Overhead Volume Variance is necessary in the preparation of operating statement under absorption costing as it removes the arithmetic duplication as discussed earlier. Nevertheless, volume variance is a useful number that can help a business determine whether and how it can produce a product at a low enough price and a high enough volume to run at a profit.