Definition
Fixed Manufacturing Overhead Volume Variance quantifies the difference between budgeted and absorbed fixed production overheads.
Formula
Fixed Overhead Volume Variance:
|
= |
Absorbed Fixed Overheads |
- |
Budgeted Fixed Overheads |
|
= |
Actual Output x FOAR* |
- |
Budgeted Output x FOAR* |
* Fixed Overhead Absorption Rate per unit of output
Example
Motors PLC is a manufacturing company specializing in the production of automobiles.
Information from its last budget period is as follows:
|
Actual Production |
275,000 units |
|
Budgeted Production |
250,000 units |
|
Standard Fixed Overhead Absorption Rate |
$2,000 per unit |
Calculate the fixed overhead volume variance.
Fixed Overhead Volume Variance
|
Absorbed Fixed Overheads |
(275,000 x $2,000) |
$550 m |
|
Budgeted Fixed Overheads |
(250,000 x $2,000) |
($500 m) |
|
Fixed Overhead Volume Variance |
$50 m |
|
Note:
It may appear strange to you that even though the absorbed fixed overheads are higher than the budgeted overheads, the variance is described as being ‘favorable’ which is usually not how cost variances are interpreted. In short, this variance is used as a balancing exercise when fixed overhead expenditure variance is calculated. For more detail on this, see the explanation below.
Explanation
Fixed Overhead Volume Variance is the difference between the fixed production cost budgeted and the fixed production cost absorbed during the period. The variance arises due to a change in the level of output attained in a period compared to the budget.
The variance can be analyzed further into two sub-variances:
The sum of the above two variances should equal to the volume variance.
Fixed overhead volume variance helps to ‘balance the books’ when preparing an operating statement under absorption costing.
Sales Quantity Variance already takes into account the change in budgeted fixed production overheads as a result of increase or decrease in sales quantity along with other expenses.
At the same time, fixed overhead expenditure variance accounts for the difference between actual and budgeted expense rather than the flexed expense unlike other expenditure variances.
This implies that the difference between budgeted and flexed fixed cost is included twice in the operating statement. Sales volume variance removes the effect of such duplication.
As fixed costs are not absorbed under marginal costing system, fixed overhead volume variance (and its sub-variances) are to be calculated only when absorption costing is applied.
Fixed Overhead Capacity Variance
Fixed Overhead Capacity Variance calculates the variation in absorbed fixed production overheads attributable to the change in the number of manufacturing hours (i.e. labor hours or machine hours) as compared to the budget.
The variance can be calculated as follows:
Fixed Overhead Capacity Variance:
= (budgeted production hours – actual production hours) x FOAR*
* Fixed Overhead Absorption Rate / unit of hour
Fixed Overhead Efficiency Variance
Fixed Overhead Efficiency Variance calculates the variation in absorbed fixed production overheads attributable to the change in the manufacturing efficiency during a period (i.e. manufacturing hours being higher or lower than standard ).
The variance can be calculated as follows:
Fixed Overhead Efficiency Variance:
= (standard production hours – actual production hours) x FOAR*
* Fixed Overhead Absorption Rate / unit of hour
Example
Continuing the Motors PLC example above, we have the following data from its last period:
|
Actual Production |
275,000 units |
|
Budgeted Production |
250,000 units |
|
Standard Fixed Overhead Absorption Rate |
$2,000 per unit |
| Additional information: | |
|---|---|
|
Standard machine hours per unit |
10 hours |
|
Actual number of machine hours |
3,000,000 |
Calculate the fixed overhead capacity and fixed overhead efficiency variance.
| Fixed Overhead Capacity Variance | |
|---|---|
|
Budgeted production hours (250,000 x 10) |
2,500,000 |
|
Less: Actual production hours |
(3,000,000) |
|
|
500,000 |
|
Fixed Overhead Absorption Rate / unit of hour ($2,000 / 10) |
x 200 |
|
Variance |
100,000,000 |
The variance is favorable because Motors PLC managed to operate more manufacturing hours than anticipated in the budget.
| Fixed Overhead Efficiency Variance | |
|---|---|
|
Standard production hours (275,000 x 10) |
2,750,000 |
|
Less: Actual production hours |
(3,000,000) |
|
|
250,000 |
|
Fixed Overhead Absorption Rate / unit of hour ($2,000 / 10) |
x 200 |
|
Variance |
50,000,000 |
The variance is adverse because Motors PLC utilized more manufacturing hours in the production of 275,000 units than the standard.
| Proof Check | ||
|---|---|---|
|
Fixed Overhead Capacity Variance |
$100,000,000 |
Favorable |
|
Fixed Overhead Capacity Variance |
($50,000,000) |
Adverse |
|
Total |
$50,000,000 |
Favorable |
|
Fixed Overhead Volume Variance |
$50,000,000 |
Favorable |
Limitations
Fixed Overhead Volume Variance is necessary in the preparation of operating statement under absorption costing as it removes the arithmetic duplication as discussed earlier. However, besides its role as a balancing agent, the variance offers little information in its own right over and above what can be ascertained from other variances (e.g. sales quantity variance already illustrates the effect of an increase in sales quantity on the overall profitability).
The traditional calculation of sub-variances (i.e. fixed overhead capacity and efficiency variances) does not provide a meaningful analysis of fixed production overheads. For instance, if the workforce utilized fewer manufacturing hours during a period than the standard (the effect of which is more adequately reflected in labor efficiency variance), it is hard to imagine a significant benefit of calculating a favorable fixed overhead efficiency variance.