Fixed Overhead Efficiency Variance:

Learning Objective of the article:

1. Define and explain fixed overhead efficiency variance.
2. How is fixed overhead efficiency variance calculated?
3. What are the reasons / causes of unfavorable fixed overhead efficiency variance?

When companies adopt four variance approach they divide the overhead efficiency variance  (which is calculated when three variance approach is used) into its variable and fixed components. Variable component is called variable overhead efficiency variance and fixed component is called fixed overhead efficiency variance.

Formula of Fixed overhead Efficiency Variance:

Following formula is used for the calculation of fixed overhead efficiency variance:

[(Actual hours worked × Fixed overhead rate) – (Standard hours allowed × Fixed overhead rate)]

Example:

Following is the flexible budget of a department of a manufacturing company.

Following data is also provided:

Actual factory overhead is $7,384. Actual production is 850 units of finished product. Actual hours used are 3,475 hours. 4 standard hours are allowed to complete a unit of finished product.

Required: Calculate fixed overhead efficiency variance.

Calculation of Standard Overhead Rate:

Assuming that 90% column represents normal capacity, the standard overhead rate is computed as follows:

Total factory overhead / Direct labor hours

= $8,000 / 4,000

= $2 per standard direct labor hour

At 90% capacity level, the rate consists of:

Total variable factory overhead / Direct labor hours

= $4,800 / 4,000

= $1.20 variable factory overhead rate

Total fixed factory overhead / Direct labor hours

= $3,200 / 4,000

= $0.80 fixed factory overhead rate

Total factory overhead rate at normal capacity:

($1.20 + $0.80) = $2.00

Calculation of fixed overhead efficiency variance:

When variable overhead efficiency variance and fixed overhead efficiency variance are combined, they equal the overhead efficiency variance of the three variance method. This concept is further explained by the following equation:

Overhead efficiency variance = Variable overhead efficiency variance + fixed overhead efficiency variance

$150* = $90** + $60

$150 = $150

*See overhead efficiency variance page

**See variable overhead efficiency variance page

 

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