What Is Variable Overhead Rate Variance?
The difference between the budgeted and actual rates of spending for variable overhead is called a variance. This variance is the variable overhead rate variance. As an accountant, you need to be aware of the changing costs that can affect your bottom line.
The difference between what you budgeted for and how much was spent on variable overhead can be accounted as favorable or unfavorable.
Variances are used to determine how much more or less efficient your factory is at producing items. These calculations include information from the production department as well as proposed labor hours worked by industrial engineers based on historical data and predicted efficiency levels for each piece of equipment in use. It will result in a finalized figure that reflects any possible changes before it’s submitted back down through these same channels later this week.
Importance of Variable Overhead Rate Variance Calculation
With the importance of overhead rate variance calculation, it’s important to understand why these numbers are so crucial.
- When the local governments decide to change their minimum wage rates.
- The cost of materials used to produce goods will rise or fall and it will lead to variance.
- The overtime is paid for extra work done by security guards, factory supervisors, and other staff members.
- It’s important to be able to forecast how much labor and wages will change in the future. This is where variable overhead rate variance comes into play.
- There are many reasons why overhead rates may vary, but it can be narrowed down to one factor in particular with careful examination.
- Variance analysis is a great way to see what your company’s expenses will be in the future and how much they might increase or decrease from month to date. You can use this information when preparing financial statements so that you’re not surprised by an expense incurred outside of normal parameters.
How To Calculate Variable Overhead Rate Variance?
Variable Overhead Rate Variance = Actual Manufacturing Variable Overheads Expenditure – (Actual Hours × Standard Variable Overhead Rate per Hour)
Example
ABC is a manufacturer that produces two types of products which L and M.
Following is given a break-up of standard variable manufacturing overhead cost:
| L | M | |
|---|---|---|
| Number of Hours | 3 (Labor) | 2 (Machine) |
| Overheads: | ||
| Indirect Labor | $ 20 | $ 10 |
| Machine lubricants | $ 5 | $ 5 |
| Electricity | $ 5 | $ 25 |
| Total | $ 30 | $ 40 |
| Overhead/h | $ 10 | 20 |
Following information belongs to the actual data from the last month:
| Variable Manufacturing Overheads | $ 900,000 |
|---|---|
| Direct Labor Hours | 30,000 |
| Machine Hours | 20,000 |
Variable overhead rate variance shall be calculated as follows:
| L | M | Total $ | |
|---|---|---|---|
| Actual variable overhead expense | $ 900,000 | ||
| Less: | |||
| Actual hours | 30,000 | 20,000 | |
| Standard variable overhead rate | × 10 | × 20 | |
| Standard overhead expense | = 300,000 | = 400,000 | (700,000) |
| Variable overhead rate variance | 200,000 ADVERSE |
Favorable variable manufacturing overhead rate variance shows that an entity incurred lower expenses than the budgeted cost.
Possible Causes For Favorable Variance
The following are some possible reasons for the overhead rate variance:
- More effective cost control: Optimizing electricity consumption by installing energy-efficient equipment.
- Planning errors resulting in ignoring the learning curve effect which could have reasonably been expected would result in more efficient use of indirect materials used next period.
- The efficiency of a company increases: This is because it takes less time and resources to produce goods at larger volumes, which results in lower costs for the business overall.
- A decline in the general price level of indirect supplies can lead to a decrease or loss for companies that rely on these items as they make up an important part of their business strategy.
The company incurred a higher cost than the budgeted expense. This is an adverse variable manufacturing overhead rate variance, which indicates that there was unexpectedly more work done on their end of things this quarter rather than originally expected for some reason or another.
Potential Causes For Adverse Variance
The following are some of the most common causes for adverse variance in overhead rate:
- Ineffective cost control, such as not maximizing batch production quantities leads to increased setup costs. Ineffective inventory management can also lead to an increase in 24/7 emergency stocks needed due to fluctuations within your industry environment and competition from other suppliers on price point
- With the rise in the minimum wage, companies will be forced to find ways of cutting back on labor costs.
- Decrease in production output but the overhead remains the same due to the nature of expenses.
- The increasing of electricity’s price.
Limitation of Variable Overhead Rate Variance
Though the concept of variable overhead rate variance is important to accounting and budgeting, it does have some limitations that an organization cannot ignore.
- Variable production overhead costs are those that change with any variation in another variable. These can include things like rent, electricity bills, and employee wages whether they’re directly related or not for each individual unit of output produced by a business enterprise since these will vary depending on how much stuff gets made overall- even though there’s no one specific thing changing here per se ‘behind’ the scenes.
- The conventional management of costs often obscures the real variables that should be considered. Variable blanket terms like machine hours or laborious work can provide a confusing basis for controlling expenses, while overhead variance calculations based on activity provide an important use case in highlighting where savings could come from if these issues were looked at more closely.
- The average variable overhead rate which is calculated while finding the variance in this estimation process may not be correct and could even contain large errors since it’s made up of various accounts. There’s also a chance that human mistakes can happen during estimating indirect labor/material rates, utility bills consumables, etc., so actual standard verses would always depend on how many good estimates were combined with bad ones to come out at one end
- When it comes to figuring out the cause of an overhead rate variance, there are too many variables that cannot be pinpointed into one specific thing.
- Each department manager has their own judgment while making calculations which can lead to errors if there is too much involved.
- The concept of variable overhead variance cannot be applied to the service sector as most services have overheads instead and not direct costs or production.
- The system has a lot of limitations that cause it to take too much time for the computer program to examine all possibilities, resulting in an error being made and corrective measures being taken late.
Conclusion
Another approach is analyzing the fixed and variable cost components in order to clearly identify what cost-drivers are at play in the cost behavior for factory variable overhead. By determining which costs respond to changes in production volume, management can implement efficiencies and/or optimize resources to better manage cost as it pertains to factory variable overhead. Additionally, with accurate data from a prior period, there can be predictive analysis conducted on future costs associated with periods of high or low production volume.
When a professional manager is faced with the challenge of analyzing variances related to overhead expenses, they should do more than simply conclude that there was less money spent than expected. The reality may be much different; variations of indirect labor and material costs could mean deviations from planned prices paid for underlying components which leads them into an even wilder goose chase after information about what happened during any given period.
Variable overhead rate and efficiency variances are often combined to create a total variable overhead variance. These can be influenced by a company’s productive efficiency, which means that it might not actually reflect the amount of work being done but rather how well you perform in terms of managing your resources like labor or materials per hour spent on an activity (which would lead towards less profitability).
Variable overhead rates can be a pain in the butt for any business, but it’s especially frustrating when they change drastically. That is why variable overheads often adjust with changes to production output levels and other factors that affect how much work needs to be done at one time versus another – which means you might see your costs go up or down without warning depending on what kind of workload comes into town.