Variable Overhead Efficiency Variance:

Learning Objective of the article:

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

When companies adopt four variance analysis 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 Variable overhead Efficiency Variance:

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

[Budgeted allowance based on actual hours worked* –  Budgeted allowance based on standard hours allowed**]

*Fixed expenses budgeted + (Actual hours worked × Standard variable rate)

**Fixed expenses budgeted + (Standard hours allowed × Standard variable 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 variable 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  variable overhead efficiency variance:

*850 × 4 = $3,400

This variance recognizes the difference between the 3,475 actual hours worked and the 3,400 standard (or allowed) hours for the work performed. Multiplying the difference of 75 hours times $1.20 (variable expense rate) results in $90. The sum of the spending variance  and variable efficiency variance equals the controllable variance, $104, of the two variance method.

When variable overhead efficiency variance and fixed overhead efficiency variance are combined, they equal the 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**

*See efficiency variance page

**See fixed overhead efficiency variance page

 

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