What is the difference between the standard cost of overhead allowed and the actual overhead incurred?

Overhead cost variance can be defined as the difference between the standard cost of overhead allowed for the actual output achieved and the actual overhead cost incurred. In other words, overhead cost variance is under or over absorption of overheads.

The formula for the calculation is:

Overhead Cost Variance:

Actual Output X Standard Overhead Rate per unit – Actual Overhead Cost or Standard Hours for Actual Output X Standard Overhead Rate per hour – Actual Overhead Cost

Classification:

Overhead cost variance can be classified as:

(1) Variable Overhead Variance

(2) Fixed Overhead Variance.

1. Variable Overhead Variance:

It is the difference between the standard variable overhead cost allowed for the actual output achieved and the actual variable overhead cost. This variance is represented by expenditure variance only because variable overhead cost will vary in proportion to production so that only a change in expenditure can cause such variance.

It is expressed as:

Actual Output x Standard Variable Overhead Rate – Actual Variable Overheads

or St. Hours for Actual Output x St. Variable Overhead Rate per hour – Actual Variable Overheads

Some accountants also find out variable overhead efficiency variance just like labour efficiency variance. Variable overhead efficiency variance can be calculated if information relating to actual time taken and time allowed is given.

In such a case variable overhead variance can be divided into two parts as given below:

(а) Variable Overhead Expenditure Variance Or Variable Overhead Budget Variance:

= Actual hours worked x Standard variable overhead rate per hour – Actual variable overhead

or Actual Hours (Standard Variable Overhead Rate per Hour – Actual Variable Overhead Rate per Hour)

Variable overhead expenditure variance is calculated in the same way as labour rate variance is calculated.

(b) Variable Overhead Efficiency Variance:

= Standard time for actual production x Standard variable overhead rate per hour — Actual hours worked x Standard variable overhead rate per hour

or Standard Variable Overhead Rate per Hour (Standard Hours for Actual Production – Actual Hours)

Variable overhead efficiency variance resembles labour efficiency variance and is calculated like labour efficiency variance.

Illustration 24:

From the following data, calculate variable overhead variances:

2. Fixed Overhead Variance:

It is that portion of total overhead cost variance which is due to the difference between the standard cost of fixed overhead allowed for the actual output achieved and the actual fixed overhead cost incurred.

The formula for the calculation of this variance is Actual Output x Standard Fixed Overhead Rate per Unit – Actual Fixed Overheads, or Standard Hours Produced x Standard Fixed Overhead Rate per Hour – Actual Fixed Overheads (Standard Hours Produced = Time which should be taken for actual output i.e., Standard Time for Actual Output)

Or Fixed Overheads Absorbed – Actual Fixed Overheads

This variance is further analysed as under:

(а) Budget or Expenditure Variance. It is that portion of the fixed overhead variance which is due to the difference between the budgeted fixed overheads and the actual fixed overheads incurred during a particular period.

It is expressed as:

Expenditure Variance = Budgeted Fixed Overheads – Actual Fixed Overheads

Expenditure Variance = Budgeted Hours x Standard Fixed Overhead Rate per Hour – Actual Fixed Overheads.

(b) Volume Variance:

It is that portion of the fixed overhead variance which arises due to the difference between the standard cost of fixed overhead allowed for the actual output and the budgeted fixed overheads for the period during which the actual output has been achieved. This variance shows the over or under absorption of fixed overheads during a particular period.

If the actual output is more than the budgeted output, there is over-recovery of fixed overheads and volume variance is favourable and vice versa if the actual output is less than the budgeted output. This is so because fixed overheads are not expected to change with the change in output.

This variance is expressed as:

Volume Variance = Actual Output x Standard Rate – Budgeted Fixed Overheads

or Standard Rate (Actual Output – Budgeted Output)

or Volume Variance = Standard Rate per hour (Standard Hours Produced – Actual Hours)

Standard hours produced means number of hours which should have been taken for the actual output as per the standard laid down.

Volume variance can be further subdivided into three variances as given below:

(i) Capacity Variance:

It is that portion of the volume variance which is due to working at higher or lower capacity than the budgeted capacity. In other words, this variance is related to the under and over utilisation of plant and equipment and arises due to idle time, strikes and lock-out, break-down of the machinery, power failure, shortage of materials and labour, absenteeism, overtime, changes in number of shifts. In short, the variance arises due to more or less working hours than the budgeted working hours.

It is expressed as:

Capacity Variance = Standard Rate (Revised Budgeted Units – Budgeted Units)

or Capacity Variance = Standard Rate (Revised Budgeted Hours – Budgeted Hours)

(ii) Calendar Variance:

It is that portion of the volume variance which is due to the difference between the number of working days in the budget period and the number of actual working days in the period to which the budget is applicable. If the actual working days are more than the standard working days, the variance will be favourable and vice versa if the actual working days are less than the standard days.

It is calculated as:

Calendar Variance = Increase or decrease in production due to more or less working days at the rate of budgeted capacity x Standard rate per unit.

(iii) Efficiency Variance:

It is that portion of the volume variance which is due to the difference between the budgeted efficiency of production and the actual efficiency achieved. This variance is related to the efficiency of workers and plant and is calculated as:

Standard Rate per unit (Actual Production (in units) – Standard Production (in units)

or Standard Rate per hour (Standard Hours Produced — Actual Hours)

Here, standard production or hours means budgeted production or hours adjusted to increase or decrease in production due to capacity or calendar variance.

Suppose, budgeted production is 10,000 units, 5% capacity is increased and factory works for 27 days instead of 25 days during the month. Standard production in this case should be 11,340 units calculated as follows:

Revised Budgeted Production = 10,000 units/25 × 27 = 10,800 units

Production increased due to 5% increase in capacity = 10,800 x 5/100 = 540 units

Production increased due to 2 more working days is:

Within 25 days, Standard production is 10,000 units

Within 2 days, production should be 10,000/25 x 2 = 800 units.

Hence, total standard output is 10,000 + 540 + 800 = 11,340 units.

Suppose further that actual output is 10,600 units and standard fixed overheads rate is Rs 2 per unit. In such a case, efficiency variance will be:

Standard Rate (Actual Production — Standard Production)

Rs 2 (10,600 units – 11,340 units) = Rs 1,480 Unfavourable

Methods:

Total Overhead Cost Variance can be analysed as follows:

Two Variance Method of Analysis of Overhead Variances:

Analysis of overhead variance can also be made by two variance, three variance and four variance methods. The analysis of overhead variances by expenditure and volume is called two variance analysis. When the volume variance is further analysed to know the reasons of change in output, it is called three variance analysis.

Change in output occurs due to:

(i) Change in capacity i.e., change in working hours per day giving rise to capacity variance.

(ii) Change in number of working days giving rise to calendar variance.

(iii) Change in the level of efficiency resulting into efficiency variance.

Three Variance Method of Analysis of Overhead Variances:

(i) Expenditure variance

(ii) Volume variance further analysed into:

(a) Capacity variance,

(b) Calendar variance, and

(c) Efficiency variance.

Four Variance Method of Analysis of Overhead Variances:

(i) Expenditure Variance or Spending Variance

(ii) Variable Overhead Efficiency Variance

(iii) Fixed Overhead Capacity Variance

(iv) Fixed Overhead Efficiency Variance.

Illustration 25:

From The Following Data, Calculate Overhead Variances:

(2) Variable Overhead Expenditure Variance:

Actual Units x Standard Rate – Actual Variable Overhead Cost

16,000 x Rs 3 – Rs 47,000 = Rs 1,000 Favourable.

(3) Fixed Overhead Variance:

Actual Units x Standard Rate (Fixed Overheads) – Actual Fixed Overheads

16,000 x Rs 2 – Rs 30,500 = Rs 1,500 Favourable

(4) Volume Variance:

Actual Units x Standard Rate – Budgeted Fixed Overheads

16,000 x Rs 2 – Rs 30,000 = Rs 2,000 Favourable

(5) Expenditure Variance:

Budgeted Fixed Overheads – Actual Fixed Overheads

= Rs 30,000 – Rs 30,500 = Rs 500 Unfavourable.

(6) Capacity Variance:

Standard Rate (Revised Budgeted Units – Budgeted Units)

Budgeted units for 25 days = 15,000 units

Budgeted units for 27 days =15,000/25 x 27 = 16,200 units

Revised budgeted units after 5% increase in capacity

= 17,010 i.e., 16,’200 +1/100 × 16,200

Capacity Variance = Rs 2 (17,010 – 16,200) = Rs 1,620 Fav.

(7) Calendar Variance:

Increase or decrease in production due to more or less working days x Standard rate per unit

Within 25 days, Standard production = 15,000 units

Within 2 days (27 – 25), production will be increased by

15,000 x 2/25 = 1,200 Units

Calendar Variance = 1,200 units x Rs 2 = Rs 2,400 Favourable.

(8) Efficiency Variance:

Standard Rate (Actual Production – Standard Production)

Actual man hours per day = 5,500

Actual output per man hour = 1.9

Actual output = 27 x 5,500 x 1.9 = 2, 82,150 units.

(1) Fixed Overhead Variance:

Actual Output x Standard Rate – actual overheads

2, 82,150 x Rs 1.50 – Rs 3, 77,500= Rs 4, 23,225 – Rs 3, 77,500 = Rs 45,725 Favourable.

(2) Expenditure Variance:

Budgeted Overheads – Actual Overheads

Rs 3, 75,000 – Rs 3, 77,500 = Rs 2,500 Unfavourable.

(3) Volume Variance:

Actual Output x Standard Rate – Budgeted Overheads

2, 82,150 units x RS1.50 – Rs 3, 75,000

= Rs 4, 23,225 – Rs 3, 75,000 = Rs 48,225 Favourable

(4) Capacity Variance:

Standard Rate (Revised Budgeted Units — Budgeted Units)

Revised Budgeted Units

Actual Working days = 27

Revised man hours due to increase in capacity = 5,500

Standard Output per man hour = 2

Revised Budget Units = 27 x 5,500 x 2 = 2, 97,000 units

Budgeted units = 27 x 5,000 x 2 = 2, 70,000 units

Capacity Variance = Rs 1.50 (2, 97,000 – 2, 70,000)

= Rs 40,500 Fav.

(5) Calendar Variance:

Within 25 days, budgeted production = 2, 50,000 units

Within 2 more working days, production will increase by

= 2,50,000/25 X 2 = 20,000 units

Calendar Variance = 20,000 units x Rs 1.50 = RS30,000 Fav.

(6) Efficiency Variance:

Standard Rate (Actual Production – Standard Production) Standard Production, i.e., number of units which should have been produced if there had been no increase or decrease in efficiency.

Illustration 28:

A company is operating a system of standard costing and closing its books quarterly. The budgeted overheads were Rs 2, 55,000. The overhead rate was predetermined at Rs 5.1 per labour hour and during a period actually utilised 52,000 labour hours, whereas it should have spent only 51,000 hours. The actual overheads gave a rate of Rs 4.9 per labour hour. How would you record the variances?

Solution:

Standard overheads per labour hour = Rs 5.1

Standard time for actual production = 51,000 hours

Standard overheads for actual output = 51,000 x 5.1 = Rs 2, 60,100

Actual overheads per labour hour = Rs 4.9

Actual time taken = 52,000 labour hours

Actual overheads = 52,000 x 4.9 = Rs 2, 54,800.

(1) Volume Variance:

Standard Overheads – Budgeted Overheads

= Rs 2, 60,100 – Rs 2, 55,000 = Rs 5,100 Favourable

Note:

Standard overheads = Standard overheads for time allowed for actual production.

(2) Expenditure Variance:

Budgeted Overheads – Actual Overheads

= Rs 2, 55,000 – Rs 2, 54,800 = Rs 200 Favourable.

(3) Fixed Overhead Cost Variance:

Standard Overheads – Actual Overheads

= Rs 2, 60,100 – Rs 2, 54,800 = Rs 5,300 Favourable

Or Fixed Overheads Cost Variance is the aggregate of volume variance and expenditure variance.

Or Fixed Overheads Cost Variance = Volume Variance + Expenditure Variance

= Rs 5,100 + Rs 200 = Rs 5,300 Favourable.

An Alternative Method of Analysis of Fixed Overhead Variance:

Some accountants analyse fixed overhead variance into three classifications as given below:

(a) Expenditure Variance

(b) Efficiency Variance

(c) Volume Variance.

(а) Expenditure Variance:

It is that portion of fixed overhead variance which is due to the difference between the budgeted fixed overhead and the actual fixed overhead incurred during a particular period.

(b) Efficiency Variance:

It is that portion of fixed overhead variance which is due to the difference between the standard recovery of fixed overhead and the standard fixed overhead for actual hours.

It is calculated as follows:

Standard fixed overhead rate per hour (Standard hours for actual production – Actual hours).

(c) Volume Variance:

It is that portion of fixed overhead variance which is due to the difference between the standard fixed overhead for actual hours and the budgeted hours.

It is calculated as given below:

Standard fixed overhead rate per hour (Actual hours – Budgeted hours)

The analysis of fixed overhead variance according to the above method is made clear in the example given below:

Illustration-31:

From the data given below prepare a table to include overhead variances analyzed into Efficiency, Volume and Expenditure.