To illustrate the variable overhead variances, we will examine activity for Helado Company during the month of May. The following data were gathered for this time period:
The total variable overhead variance is the difference between the actual and the applied variable overhead. For our example, the total variable overhead variance is computed as follows
A graphical, 3-pronged approach for dividing this total variance into spending and efficiency variances is illustrated in Exhibit 9-7.
Variable Overhead Spending Variance
The variable overhead spending variance measures the aggregate effect of differences in the actual variable overhead rate (AVOR) and the standard variable overhead rate (SVOR). The actual variable overhead rate is simply actual variable overhead divided by actual hours. For our example, this rate is $5.80 ($7,540/1,300 hrs.). The formula for computing the variable overhead spending variance is as follows:
The variable overhead spending variance measures the aggregate effect of differences in the actual variable overhead rate (AVOR) and the standard variable overhead rate (SVOR). The actual variable overhead rate is simply actual variable overhead divided by actual hours. For our example, this rate is $5.80 ($7,540/1,300 hrs.). The formula for computing the variable overhead spending variance is as follows:
The variable overhead spending variance is similar to the price variances of direct materials and direct labor, although there are some conceptual differences. Variable overhead is not a homogeneous input it is made up of a large number of individual items such as indirect materials, indirect labor, electricity, maintenance, and so on. The standard variable overhead rate represents the weighted cost per direct labor hour that should be incurred for all variable overhead items. The difference between what should have been spent per hour and what actually was spent per hour is a type of price variance. A variable overhead spending variance can arise because prices for individual variable overhead items have increased or decreased. Assume, for the moment, that the price changes of individual overhead items are the only cause of the spending variance. If the spending variance is unfavorable, then price increases for individual variable overhead items are the cause; if the spending variance is favorable, then price decreases are dominating.
If the only source of the variable overhead spending variance were price changes, then it would be completely analogous to the price variances of direct materials and direct labor. Unfortunately, the spending variance also is affected by how efficiently overhead is used. Waste or inefficiency in the use of variable overhead increases the actual variable overhead cost. This increased cost, in turn, is reflected in an increased actual variable overhead rate. Thus, even if the actual prices of the individual overhead items were equal to the budgeted or standard prices, an unfavorable variable overhead spending variance could still take place. Similarly, efficiency can decrease the actual variable overhead cost and decrease the actual variable overhead rate. Efficient use of variable overhead items contributes to a favorable spending variance. If the waste effect dominates, then the net contribution will be unfavorable; if efficiency dominates, then the net contribution is favorable. Thus, the variable overhead spending variance is the result of both price and efficiency.
Many variable overhead items are affected by several responsibility centers. For example, utilities are a joint cost. Assigning the cost to a specific area of responsibility requires that cost be traced not allocated to the area. To the extent that consumption of variable overhead can be traced to a responsibility center, responsibility can be assigned. Consumption of indirect materials is an example of a traceable variable overhead cost. Controllability is a prerequisite for assigning responsibility. Price changes of variable overhead items are essentially beyond the control of supervisors. If price changes are small (as they often are), the spending variance is primarily a matter of the efficient use of overhead in production, which is controllable by production supervisors. Accordingly, responsibility for the variable overhead spending variance is generally assigned to production departments.
The $260 favorable spending variance simply reveals that, in the aggregate, Helado Company spent less on variable overhead than expected. Even if the variance was insignificant, it reveals nothing about how well costs of individual variable overhead items were controlled. Control of variable overhead requires line-by-line analysis for each individual item. Exhibit 9-8 presents a performance report that supplies the line-by-line information essential for proper control of variable overhead. Assuming that Helado investigates any item that deviates more than 10 percent from budget, the cost of gas would be the only item that would be investigated. The investigation reveals that the utility company lowered the price of natural gas as a result of a state regulatory hear-
If the only source of the variable overhead spending variance were price changes, then it would be completely analogous to the price variances of direct materials and direct labor. Unfortunately, the spending variance also is affected by how efficiently overhead is used. Waste or inefficiency in the use of variable overhead increases the actual variable overhead cost. This increased cost, in turn, is reflected in an increased actual variable overhead rate. Thus, even if the actual prices of the individual overhead items were equal to the budgeted or standard prices, an unfavorable variable overhead spending variance could still take place. Similarly, efficiency can decrease the actual variable overhead cost and decrease the actual variable overhead rate. Efficient use of variable overhead items contributes to a favorable spending variance. If the waste effect dominates, then the net contribution will be unfavorable; if efficiency dominates, then the net contribution is favorable. Thus, the variable overhead spending variance is the result of both price and efficiency.
Many variable overhead items are affected by several responsibility centers. For example, utilities are a joint cost. Assigning the cost to a specific area of responsibility requires that cost be traced not allocated to the area. To the extent that consumption of variable overhead can be traced to a responsibility center, responsibility can be assigned. Consumption of indirect materials is an example of a traceable variable overhead cost. Controllability is a prerequisite for assigning responsibility. Price changes of variable overhead items are essentially beyond the control of supervisors. If price changes are small (as they often are), the spending variance is primarily a matter of the efficient use of overhead in production, which is controllable by production supervisors. Accordingly, responsibility for the variable overhead spending variance is generally assigned to production departments.
The $260 favorable spending variance simply reveals that, in the aggregate, Helado Company spent less on variable overhead than expected. Even if the variance was insignificant, it reveals nothing about how well costs of individual variable overhead items were controlled. Control of variable overhead requires line-by-line analysis for each individual item. Exhibit 9-8 presents a performance report that supplies the line-by-line information essential for proper control of variable overhead. Assuming that Helado investigates any item that deviates more than 10 percent from budget, the cost of gas would be the only item that would be investigated. The investigation reveals that the utility company lowered the price of natural gas as a result of a state regulatory hear-
Read variable overhead efficiency variance.
ing. The reduction is expected to be permanent. In this case, the cause of the favorable variance is beyond the control of the company. The correct response is to revise the budget formula to reflect the decreased cost of natural gas.
ing. The reduction is expected to be permanent. In this case, the cause of the favorable variance is beyond the control of the company. The correct response is to revise the budget formula to reflect the decreased cost of natural gas.
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