The fixed factory overhead variance is caused by the difference between which of the following?

Types of Overhead Variances

Overhead variances arise when the actual overhead costs incurred differ from the expected amounts. Managers want to understand the reasons for these differences, and so should consider computing one or more of the overhead variances described below. Each of these variances applies to a different aspect of overhead expenditures. It is not necessary to calculate these variances when a manager cannot influence their outcome.

Fixed Overhead Spending Variance

The fixed overhead spending variance is the difference between the actual fixed overhead expense incurred and the budgeted fixed overhead expense. An unfavorable variance means that actual fixed overhead expenses were greater than anticipated. The formula for this variance is:

Actual fixed overhead - Budgeted fixed overhead = Fixed overhead spending variance

The amount of expense related to fixed overhead should (as the name implies) be relatively fixed, and so the fixed overhead spending variance should not theoretically vary much from the budget.

Fixed Overhead Volume Variance

The fixed overhead volume variance is the difference between the amount of fixed overhead actually applied to produced goods based on production volume, and the amount that was budgeted to be applied to produced goods. For example, a company budgets for the allocation of $25,000 of fixed overhead costs to produced goods at the rate of $50 per unit produced, with the expectation that 500 units will be produced. However, the actual number of units produced is 600, so a total of $30,000 of fixed overhead costs are allocated. This creates a fixed overhead volume variance of $5,000.

Variable Overhead Efficiency Variance

The variable overhead efficiency variance is the difference between the actual and budgeted hours worked, which are then applied to the standard variable overhead rate per hour. The formula is:

Standard overhead rate x (Actual hours - Standard hours)
= Variable overhead efficiency variance

 A favorable variance means that the actual hours worked were less than the budgeted hours, resulting in the application of the standard overhead rate across fewer hours, resulting in less expense being incurred. However, a favorable variance does not necessarily mean that a company has incurred less actual overhead, it simply means that there was an improvement in the allocation base that was used to apply overhead.

Variable Overhead Spending Variance

The variable overhead spending variance is the difference between the actual and budgeted rates of spending on variable overhead. The variance is used to focus attention on those overhead costs that vary from expectations. The formula is:

Actual hours worked x (Actual overhead rate - standard overhead rate)
= Variable overhead spending variance

A favorable variance means that the actual variable overhead expenses incurred per labor hour were less than expected.

Fixed overhead volume variance is the difference between the amount budgeted for fixed overhead costs based on production volume and the amount that is eventually absorbed. This variance is reviewed as part of the cost accounting reporting package at the end of a given period.

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.

Because they are fixed within a certain range of activity, these overhead costs are fairly easy to predict. This simplicity of prediction sees some businesses create a fixed overhead allocation rate that is used throughout the year. The allocation rate is the expected monthly amount of fixed overhead costs divided by the number of units produced.

However, if a company is experiencing rapid changes in its production systems, it may need to revise its overhead allocation rate more frequently, say monthly.

When can fixed overhead volume variance occur?

When the actual amount budgeted for fixed overhead costs based on production volume differs from the figure that is eventually absorbed, fixed overhead volume variance occurs.

There are a number of reasons why this can happen, aside from simply poor forecasting. If sales on a product are seasonal, production volumes on a monthly basis can fluctuate.

If production volume relies on the labor hours of workers and a company implements new efficient practices that reduce the number of hours needed to produce a product, more units will be made than budgeted.

Similarly, if the allocated volume is down to the number of machine hours and a company outsources some or all of its production, the budgeted amount of machine hours will be much less than expected.

Example of fixed overhead volume variance

Chuck is the manager of a company in New York selling tiles. In its New Jersey factory, the company budgets for the allocation of $75,000 of fixed overhead costs to produce the tiles at a rate of $25 per unit produced.

The expectation is that 3,000 units will be produced during a time period of two months. However, the actual number of units produced is only 2,000, resulting in a total of $50,000 fixed overhead costs. This creates an unfavorable fixed overhead volume variance of $25,000.

Fixed overhead volume variance is subdivided into:

• Fixed overhead capacity variance

• Fixed overhead efficiency variance 

The sum of these two variances need to equal the fixed overhead volume variance.

Fixed overhead capacity variance is the difference between absorbed fixed production overheads attributable to the change in number of manufacturing hours, compared to what was budgeted.

It is calculated as (budgeted production hours minus actual production hours) x (fixed overhead absorption rate divided by time unit),

Fixed overhead efficiency variance is the difference between absorbed fixed production overheads attributable to the change in the manufacturing efficiency during a period.

It is calculated as (standard production hours minus actual production hours) x (fixed overhead absorption rate divided by time unit)

Fixed overhead volume variance limitations

Beside from its role as a balancing agent, fixed overhead volume variance does not offer more information from what can be ascertained from other variances such as sales quantity variance.

The calculation of the sub-variances also doesn’t provide a meaningful analysis of fixed production overheads. For example, if the workforce utilized fewer manufacturing hours during a period than the standard, it is hard to imagine a significant benefit of calculating a favorable fixed overhead efficiency variance.

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Which of the following is the difference between actual overhead incurred and budgeted overhead?