Variable Overhead Efficiency Variance Overview, Formula, Risk of Error

By contrast, efficiency variance measures efficiency in the use of the factory (e.g., machine hours employed in costing overheads to the products). 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.

Because sometimes it’s not the hard work of the department which results in favorable variance, sometimes there are other factors also, which are not in control of the management. Thus, the production department does the same and provides an estimate of production costs that will be incurred in the following year. When variances are identified, conduct a thorough root cause analysis to understand the underlying factors.

The standard variable OH rate per DLH is $0.80 (calculated previously), and the actual variable overhead for the month was $1,395 for 2,325 actual direct labor hours, giving an actual rate of $0.60. When a favorable variance is achieved, it implies that the actual hours worked during the given period were less than the budgeted hours. It results in applying the standard overhead rate across fewer hours, which means that the total expenses being incurred are reduced by a factor of the decrease in hours worked. In addition to the total standard overhead rate, Connie’s Candy will want to know the variable overhead rates at each activity level. The hourly rate in this formula includes such indirect labor costs as shop foreman and security. If actual labor hours are less than the budgeted or standard amount, the variable overhead efficiency variance is favorable; if actual labor hours are more than the budgeted or standard amount, the variance is unfavorable.

Overhead Variance: What is a Variable Overhead Variance vs a Fixed Overhead Variance?

• Even though the answer is a negative number, the variance is favorable because we used less indirect materials than we budgeted.
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• By regularly analyzing and addressing variances, businesses can enhance their financial performance and make informed strategic decisions.
• The variable overhead rate variance, sometimes referred to as the variable overhead spending variance, is one of the main standard costing variances.
• An overhead cost variance is the difference between how much overhead was applied to the production process and how much actual overhead costs were incurred during the period.
• At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.
• Practical applications of overhead variance analysis demonstrate its value across various industries.

This may involve reviewing operational processes, supplier contracts, or employee performance. If the variable overhead efficiency variance variance is significant, the company must take appropriate measures to reduce such overheads to a minimum. The standard rate is adjusted per all price-increasing/decreasing factors (inflation rate, different suppliers, etc). Volume variance is further sub-divided into efficiency variance and capacity variance. This variance arises due to the difference in the number of working days when the actual number of working days is greater than standard working days.

Understanding overhead variance is not just about tracking costs but is a comprehensive tool for enhancing financial health, improving efficiency, and making informed strategic decisions. Regular analysis and management of overhead variances enable businesses to maintain better control over their finances and drive long-term success. While if the actual hours worked are higher than the budgeted hours estimated by management, we called it unfavorable variance.

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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. 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. The two variances used to analyze this difference are thespending variance and efficiency variance. Thevariable overhead spending variance18is the difference between actual costs for variable overhead andbudgeted costs based on the standards. Before we go on to explore the variances related to fixed indirect costs (fixed manufacturing overhead), check your understanding of the variable overhead efficiency variance. Looking at Connie’s Candies, the following table shows the variable overhead rate at each of the production capacity levels.

This indicates that the bakery was less efficient than planned, requiring an extra 100 hours to produce the 500 loaves of bread, which led to an additional $500 in variable overhead costs for that week. Variable overheads account for an important and significant part of the total operating cost for any business, particularly in the manufacturing business. Variable overheads change with operating efficiency and contribute an integral part of total variable cost. The Marginal costing method accounts for the variable overheads to calculate the contribution margin. Variances in planned overhead expenses can affect the contribution margins significantly especially if the sale prices are small and competition is severe. In this article, we will cover in detail about the variable overhead efficiency variance.

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• A favorable overhead (OH) rate variance indicated fewer hours taken to produce a product unit than expected or budgeted time.
• A consulting firm budgets $60,000 for fixed overhead costs to support 12,000 billable hours, resulting in a standard fixed overhead rate of $5 per hour.
• Consider a consulting firm that budgets a standard variable overhead rate of $10 per consulting hour.
• Thetotal standard cost for diesel oil is then calculated by multiplying thequantity with the standard rate at which diesel oil will be bought.
• The variance is negative because actual variable overhead costs were $1,395, but if the company had actually incurred the expected amount of variable overhead costs at $0.80 per unit, total VOH would have been $1,860.

Example Calculation of Variable Overhead Efficiency Variance

A variable overhead efficiency variance is one of the two contents of a total variable overhead variance. It is the difference between the actual hours worked and the standard hours required for budgeted production at the standard rate. A hotel chain uses overhead variance analysis to manage its fixed and variable overhead costs.

4: Compute and Evaluate Overhead Variances

Understanding variable overhead variance helps businesses identify inefficiencies and areas of overspending. By analyzing these variances, companies can implement corrective measures to control costs better and improve operational efficiency. Regular monitoring and analysis of variable overhead variance are essential for maintaining financial health and making informed business decisions.

Furthermore in a standard costing accounting system, variable overhead has two main variances, the variable overhead rate variance and the variable overhead efficiency variance. Standard costs are used to establish theflexible budget for variable manufacturing overhead. The flexiblebudget is compared to actual costs, and the difference is shown inthe form of two variances.

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All of our content is based on objective analysis, and the opinions are our own. The controller of a small, closely heldmanufacturing company embezzled close to $1,000,000 over a 3-yearperiod. With annual revenues of $30,000,000 and less than 100employees, the company certainly felt the impact of losing$1,000,000. Encourage them to identify and report areas of inefficiency or overspending, fostering a culture of continuous improvement. And that’s why the efficiency graph goes higherand in the end, the result is a favorable one.

In conclusion, the variable overhead rate variance can be an important factor in determining the total overhead variances, provided it is interpreted in conjunction with fixed overhead and variable overhead expenditure variances. Variable overhead variance can be an important performance measurement tool especially for the firms using marginal costing approach. Assume that the cost accounting staff of Company X has calculated that the company’s production staff works 10,000 hours per month. The company also incurs a cost of $100,000 per month as its variable overhead costs.