Accounting Articles for Students
Variance analysis - fixed overhead variances
by Philip Dunn | Published on 4/29/2003
Various definitions and terminology appear in texts in management accounting
on the subject of the preparation and interpretation of fixed overhead
variances; but the fixed overhead variance and the sub-analysis of this variance
in standard absorption costing is shown as:
The variances have been defined as:
(1) Fixed Overhead Variance
The difference between the fixed overhead recovered in the activity achieved and the actual fixed overhead incurred. It represents either an under or over-recovery of fixed cost.
(1.1) Fixed Overhead Expenditure Variance
The difference between the budgeted and actual fixed cost for the period.
(1.2) Fixed Overhead Volume Variance
That part of the fixed overhead variance which is due to the difference between the budgeted and actual level of activity and its effect on the overhead recovered.
(1.3) Fixed Overhead Capacity Variance
That part of the volume variance which is due to the difference between the budget or planned capacity in standard hours and the actual capacity expressed as hours worked, and its effect on overhead recovered.
(1.4) Fixed Overhead Efficiency Variance
That part of the volume variance which is due to the efficiency of labour.
Before illustrating fully the preparation and analysis of the fixed overhead variance, I wish to focus on the key control ratios. They form an essential part of any variance analysis report to cost centre management and are an aid to interpreting and analysing the fixed overhead variance.
These ratios include:
- Productivity - efficiency;
- Utilisation - capacity;
- Production Volume - activity.
These ratios use the concept of the standard hour, which allows management to express budgeted and actual levels of activity in terms of the standard hour.
The ratios are expressed as:
Standard hours produced x 100/1
Actual hours worked
Actual hours worked x 100/1
Budget, standard hours
Standard hours produced x 100/1
Budget, standard hours
The efficiency ratio is a measure of the effectiveness of the workforce, capacity a measure of utilisation and activity a measure of production volume.
I wish to use the model of the control ratios to illustrate fully the application and analysis of the fixed overhead variance and the link with these measures.
The case study which follows focuses on these concepts.
Cuecraft manufactures snooker cues and the budget and actual data for the quarter January-March 2001 was:
We can clearly see that production volume is favourable and is approximately 7 per cent greater than planned. As the efficiency is only marginally adverse, the additional volume has been achieved by management allowing more hours to be worked to meet the increased demand.
In order to prepare and present the fixed overhead variance and its full analysis, a fixed overhead recovery rate needs to be calculated for the period (FORR).
Budget fixed overhead
Budget standard hours
$84,000 = $2.80 per standard hour
If fixed costs remain in line with budget, and the volume planned is achieved, the fixed costs will be fully recovered.
1 Fixed Overhead Variance
Fixed overhead recovered in the period less the fixed overhead incurred.
|32,000 standard hours x $2.80||89,600|
This is favourable variance and represents an over-recovery of fixed overhead during the period.
1.1 Fixed Overhead Expenditure Variance
Budget fixed overhead less actual incurred. $84,000 ¿ $84,350 = $(350). This adverse variance indicates a marginal overspend on fixed costs for the period.
1.2 Fixed Overhead Volume Variance
(Budget standard hours - standard hours produced) FORR
(30,000 ¿ 32,000) $2.80 = $5,600 F.
As the level of production volume is favourable, i.e. the level of activity is up, then an over-recovery results. There is a direct link here with the activity ratio, which was 106.7 per cent for the period. Volume = activity.
The favourable volume variance is highlighted by a favourable activity ratio. Full recovery of fixed overhead being planned on an activity of 7,500 units or 30,000 standard hours.
1.3 Fixed Overhead Efficiency Variance
As we have a marginally adverse efficiency ratio, then there will be an adverse fixed overhead efficiency variance.
(Standard hours produced ¿ actual hours worked) FORR
(32,000 ¿ 32,125) $2.80 = (350)
This represents an under-recovery due to the inefficiency of the workforce.
1.4 Fixed Overhead Capacity Variance
As the management increased the hours available in the period, as shown by the capacity ratio at 107.1 per cent, it is obvious that a favourable variance will be highlighted here.
(Budget standard hours ¿ actual hours worked) FORR
(30,000 - 32,125) $2.80 = $5,950 F
Summary of variances
Fixed overhead variance $5,250F
Fixed overhead expenditure variance (350)
Fixed overhead volume variance $5,600F
NB: The volume variance comprises fixed overhead efficiency variance of (350) and fixed overhead capacity variance of $5,950 F.
This illustrates that under or over-recovery of fixed overhead in the short run is influenced by either expenditure and/or volume. The level of activity is directly affected by the efficiency of the workforce or by management providing the capacity, or a combination of both.
About the author: Dr Philip E Dunn has been involved in the training of
Accountants and Accounting Technicians for over 30 years.
He is an international author of accounting and managerial finance papers and has published over 575 articles, papers and case studies in journals in the UK, US, Canada, South Africa, Russia, Latvia, China and India.
He is a former editor of Accountingweb's Business Management Zone, the editor of Financier, a journal for accountancy students in Russia and Latvia and the editor of the International Journal of Applied Finance for Non-Financial Managers.
Dunn has a keen interest in a Conceptual Framework for Accounting with a Global focus and looks with enthusiasm to the revision and development of International Accounting Standards and their impact on Global Financial Reporting. He also has a firm commitment to developing CPD programmes in Managerial Finance for the Non-Financial Manager.
Article courtesy of ACCA Accountant
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