Definition
Variable Overhead Spending Variance is the difference between variable production overhead expense incurred during a period and the standard variable overhead expenditure. The variance is also referred to as variable overhead rate variance and variable overhead expenditure variance.
Formula
Variable Overhead Spending Variance
= Actual Manufacturing Variable Overheads Expenditure
Less
Actual hours x Standard Variable Overhead Rate per hour
where:
Actual Hours is the number of machine hours or labor hours during a period.
Explanation
Variable Overhead Spending Variance is essentially the difference between what the variable production overheads did cost and what they should have cost given the level of activity during a period.
Standard variable overhead rate may be expressed in terms of the number of machine hours or labor hours. So for example, in case of a labor intensive manufacturing business, standard variable overhead rate may be expressed in terms of the number of labor hours whereas in case of predominantly automated production processes, a standard rate based on the number of machine hours may be more appropriate. Very often however, companies have a combination of manual and automated business processes which may necessitate the use of both basis of variable overhead absorption.
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 standard variable manufacturing overhead cost:
| 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 |
$12 |
| Following information relates to the actual data from last month: | ||
|---|---|---|
|
Variable Manufacturing Overheads |
$175,000 |
|
|
Direct Labor Hours |
10,000 |
|
|
Machine Hours |
5,000 |
|
Variable Overhead Spending Variance shall be calculated as follows:
| AAA Plus | AAA Gold | Total $ | |
|---|---|---|---|
|
Actual Variable Overhead Expense |
|
|
175,000 |
|
Less: |
|||
|
Actual Hours |
10,000 |
5,000 |
|
|
Standard Variable O.H. Rate |
x $10 |
x $12 |
|
|
Standard Overhead Expense |
100,000 |
60,000 |
(160,000) |
|
Variable Overhead Expenditure Variance |
15,000 |
||
Analysis
Favorable variable manufacturing overhead spending variance indicates that the company incurred a lower expense than the standard cost.
Possible reasons for favorable variance include:
- Economies of scale (e.g. increase in order size of indirect material leading to bulk discounts on purchase).
- A decrease in the general price level of indirect supplies.
- More efficient cost control (e.g. optimizing electricity consumption through the installation of energy efficient equipment).
- Planning error (e.g. failing to take into account the learning curve effect which could have reasonably be expected to result in a more efficient use of indirect materials in the upcoming period).
An adverse variable manufacturing overhead spending variance suggests that the company incurred a higher cost than the standard expense.
Potential causes for an adverse variance include:
- A rise in the national minimum wage rate leading to a higher cost of indirect labor.
- A decrease in the level of activity not fully offset by a decrease in overheads (e.g. electricity consumption of machines during set up is usually same even if a smaller batch of output is required to be produced).
- In efficient cost control (e.g. not optimizing the batch production quantities leading to higher set up costs).
- Planning error (e.g. failing to take into account the increase in unit rates of electricity applicable for the level of activity budgeted during a period).
Limitations
Variable production overheads by their nature include costs that cannot be directly attributed to a specific unit of output unlike direct material and direct labor which vary directly with output. Variable overheads do however vary with a change in another variable. Traditional management accounting often define blanket variables such as machine hours or labor hours which seldom provides a meaningful basis of cost control. The use of activity based costing to calculate overhead variances can significantly enhance the usefulness of such variances.
