# Variable Manufacturing Overhead Efficiency Variance

## Definition

Variable Overhead Efficiency Variance is the measure of impact on the standard variable overheads due to the difference between standard number of manufacturing hours and the actual hours worked during the period.

## Formula

 = Standard hours x Standard Variable Overhead Rate per hour Less = Actual hours x Standard Variable Overhead Rate per hour

where:

• Hours refers to the number of machine hours or labor hours incurred in the production of output during a period.

## Explanation

Variable Overhead Efficiency Variance is calculated to quantify the effect of a change in manufacturing efficiency on variable production overheads. As in the case of variable overhead spending variance, the overhead rate may be expressed in terms of labor hours or machine hours (or both) depending on the degree of automation of production processes.

## Example

AAA Sports LTD is a small manufacturing company specializing in the production of cricket bats. AAA Sports LTD currently manufactures 2 types of bats:

AAA Plus - a hand-crafted English Willow bat designed for professional use

AAA Gold - a machine-manufactured cheaper bat designed for casual cricket

Following is a break-up of the standard variable manufacturing overhead costs:

 AAA Plus AAA Gold Number of Hours 2 direct labor hours 1 machine hour Overheads: Indirect Labor \$10 - Polish \$5 \$1 Sand paper \$1 - Glue \$1 \$0.5 Machine lubricants - \$0.5 Electricity \$3 \$10 Total \$20(\$10 per direct labor hour) \$12(\$12 per machine hour)

Following information relates to the actual data from last month:

 Variable Manufacturing Overheads \$175,000 Direct Labor Hours 10,000 Machine Hours 5,000 Production (units) - AAA Plus 4,500 Production (units) - AAA Gold 5,200

Variable Overhead efficiency Variance shall be calculated as follows:

 AAAPlus AAAGold Total\$ Standard Hours x Standard Rate / hour Standard Hours (4500x2 / 5200x1) 9,000 5,200 Standard Variable Overhead Rate / hour x \$10 x \$12 90,000 62,400 152,400 Less: Actual Hours x Standard Rate / hour Actual Hours 10,000 5,000 Standard Variable Overhead Rate / hour x \$10 x \$12 100,000 60,000 152,400 Variable Overhead Efficiency Variance 7,600Adverse

## Proof check:

Adding variable overhead spending and efficiency variances to the standard cost should equal to actual variable overheads during the period.

 Standard Cost (Standard hours x Standard rate) = \$152,400 (see above) Variable overhead spending variance = \$15,000 A (see solution) Variable overhead efficiency variance = \$7,600 A (see above) Total = \$175,000 Actual Overheads \$175,000 (from question)

## Analysis

Favorable variable overhead efficiency variance indicates that fewer manufacturing hours were expended during the period than the standard hours required for the level of actual output.

Reasons for a favorable variance may include:

• Use of a raw material which is easier to work with (this should be evident in a favorable material usage variance and possibly an adverse material price variance)
• Employment of a higher skilled labor or improvement of skills of existing workforce through training and development leading to improved productivity (this should be indicated by a favorable labor efficiency variance and potentially an adverse labor rate variance)
• Installation of a more efficient manufacturing equipment
• Planning error (e.g. ignoring or under estimating the impact of learning curve effect on productivity)

An adverse variable overhead efficiency variance suggests that more manufacturing hours were expended during the period than the standard hours required for the level of actual production.

Possible causes for adverse variance include:

• Use of a cheaper raw material which is harder to work with (this should be corroborated with an adverse material usage variance and a favorable material price variance)
• Inefficient production caused by the employment of lower skilled labor (this shall be evident in an adverse direct labor efficiency variance and probably a favorable labor rate variance)
• Decline in the productivity of manufacturing equipment due to for example technical problems or wear and tear
• Planning error (e.g. over calculating the impact of learning curve effect on the manufacturing efficiency)

## Limitations

Variable Overhead Efficiency Variance is traditionally calculated on the assumption that the overheads could be expected to vary in proportion to the number of manufacturing hours. While there is usually correlation between manufacturing hours and variable overheads when considered on aggregate basis, the number of manufacturing hours may not be the factor that drives the cost of many types of variable overheads (e.g. setup costs vary with the number of setups). Using Activity based costing in the calculation of variable overhead variances might therefore provide more relevant information for management control purposes.

Also, in case where variable overhead rate is based on labor hours, the variable overhead efficiency variance does not offer any additional information than provided by the labor efficiency variance.