8.4 Compute and Evaluate Overhead Variances

Variable overhead variances are crucial for understanding cost control in manufacturing. These variances measure differences between actual and standard variable overhead rates and efficiency. By analyzing rate and efficiency variances, managers can pinpoint areas of overspending or inefficiency.

Interpreting overhead variances provides insights into pricing fluctuations, productivity changes, and overall cost management. Favorable variances indicate cost savings and improved efficiency, while unfavorable variances signal potential issues. This analysis is key for optimizing operations and enhancing profitability.

Variable Overhead Variances

Variable overhead rate calculation

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• Variable overhead rate variance quantifies the difference between actual variable overhead rate incurred and standard variable overhead rate predetermined
  • Calculated using the formula $([Actual hours](https://www.fiveableKeyTerm:Actual_Hours) \times (Actual rate - Standard rate))$
  • Favorable variance arises when actual rate is lower than standard rate (spending less per hour than expected)
  • Unfavorable variance occurs when actual rate exceeds standard rate (spending more per hour than anticipated)
• Variable overhead efficiency variance measures the difference between actual hours worked and standard hours allowed for the actual output produced
  • Determined using the formula $(Standard rate \times (Actual hours - Standard hours))$
  • Favorable variance happens when actual hours are fewer than standard hours allowed (working more efficiently than planned)
  • Unfavorable variance results when actual hours surpass standard hours allowed (working less efficiently than expected)

Interpretation of overhead variances

• Variable overhead rate variance can be caused by:
  • Fluctuations in the prices of variable overhead items (supplies, utilities)
  • Alterations in the mix of variable overhead items used (switching to higher or lower cost items)
• Variable overhead efficiency variance may stem from:
  • Variations in worker or machine productivity (faster or slower than normal)
  • Differences in the quality of materials used (higher or lower grade than usual)
  • Changes in the efficiency of production processes (streamlined or bottlenecked)
  • Fluctuations in cost drivers affecting overhead consumption
• Favorable variances lead to:
  • Reduced actual costs compared to standard costs (spending less than budgeted)
  • Enhanced profitability (increasing margins)
  • Potential indicators of improved efficiency or cost control (optimizing operations)
• Unfavorable variances result in:
  • Elevated actual costs relative to standard costs (spending more than planned)
  • Diminished profitability (shrinking margins)
  • Possible signs of inefficiencies or inadequate cost control (wasting resources)

Total variable overhead variance

• Total variable overhead cost variance is the sum of the variable overhead rate variance and variable overhead efficiency variance
  • Calculated as $(Variable overhead rate variance + Variable overhead efficiency variance)$
  • Measures the overall difference between actual variable overhead costs incurred and standard variable overhead costs allowed
  • Favorable variance occurs when total actual variable overhead costs are less than total standard variable overhead costs (spending less overall than budgeted)
  • Unfavorable variance arises when total actual variable overhead costs exceed total standard variable overhead costs (spending more overall than planned)
• Rate and efficiency variances can be combined to determine the total impact on variable overhead costs
  • Favorable and unfavorable variances may offset each other, resulting in a smaller net variance (pluses and minuses evening out)
  • Examining individual variances helps pinpoint specific areas of concern or success in managing variable overhead costs (drilling down to root causes)

Overhead Management and Analysis

• Overhead allocation involves distributing indirect costs to products or cost centers
• Predetermined overhead rate is used to estimate overhead costs before production begins
• Flexible budget adjusts for changes in activity levels, allowing for more accurate variance analysis
• Variance analysis helps in cost control by identifying deviations from expected performance
• Regular review of variances supports continuous improvement in overhead management