What is Fixed Overhead Volume Variance?
Fixed overhead volume variance refers to the difference arising between the budgeted fixed overheads and the actual overheads applied to the units produced during an accounting period. The value of variance reflects the over or under absorption of fixed overheads and it arises due to change in the quantum of production against the budgeted quantum of production.
Companies arrive at a figure of budgeted fixed overheads based on their expected level of production. Based on budgeted fixed overheads, an absorption rate is calculated for applying the same to the actual production. Recovery of fixed overheads can be made by including the same in cost per unit. The absorption rate per unit is calculated by dividing the budgeted fixed overheads by the budgeted production units. The same is termed as “Standard Fixed Overhead Rate.”
The actual product might be different, and therefore, it leads to a difference in the total fixed overheads absorbed or applied to the actual production and the budgeted fixed overheads. Thus, the variance is created due to variance in the actual production against the budgeted production.
It can be calculated using the following formula:
Fixed Overhead Volume Variance = Applied Fixed Overheads – Budgeted Fixed Overhead
- Applied Fixed Overheads = Standard Fixed Overheads × Actual Production
- Standard Fixed Overheads = Budgeted Fixed Overheads ÷ Budgeted Production
The formula suggests that the difference between budgeted fixed overheads and applied fixed overheads reflects fixed overhead volume variance. Also, there can be other bases for the allocation of fixed overheads apart from production units. These allocation bases can include direct labor hours, machine hours, and so on. The standard fixed overhead and the applied fixed overheads with be calculated based on such allocation base.
Fixed overhead volume varianceVolume VarianceVolume Variance is an assessment tool that checks if there is a difference in actual quantity consumed or sold and its budgeted quantities. It is usually expressed in monetary terms by multiplying the difference between the two with the standard price per unit. is calculated as follows:
It can either be positive or negative. When the same is positive, it reflects favorable variance, and when the variance is negative, it reflects unfavorable variance.
In the example that we took, the variance was a negative figure, i.e. ($10,000). This means that the budgeted fixed overheads exceeded the applied fixed overheads. This reflects that the actual production has been less than the budgeted production, suggesting that the company is underutilizing its production facilities. This gives rise to unfavorable variance.
Fixed overhead volume variance is positive when the applied fixed overheads exceed budgeted fixed overheads. This indicates that the company has over-utilized its production facilities by producing many units with the available resources. This represents a favorable condition for the company.
There can be various causes, which are as follows:
|Allocation Base||Cause of Fixed Overhead Volume Variance|
|Units Produced||Production capacity is either underutilized or overutilized either due to less demand for the product or otherwise due to a change in efficiency levels.|
|Units Sold||Units sold differ from the budgeted salesBudgeted SalesThe sales budget forecasts the quantity that the entity expects to sell and the amount of revenue generated from the sale of such amount expected in the future, based on the management’s judgment related to the competition, economic conditions, market demands, and market demands past trends. units either because of less demand or due to less production.|
|Number of Direct Labor Hours||Variance can arise if the organization introduces a new technique that helps the workers to increase their efficiency. Alternatively, the variance can arise if the labor tends to be ineffective, and idle hours are more than expected.|
|Number of Machine Hours||Variance can arise if some better machinery is introduced, which reduces the machine hours to be used for production or when some process is outsourced to third parties, and machine hours are reduced.|
- It helps to determine the efficiency of the company in respect of production capacity.
- It is an important variance as it helps the management balance the books in the operating statement prepared as a part of absorption costingAbsorption CostingAbsorption costing is one of approach which is used for the purpose of valuation of inventory or calculation of the cost of the product in the company where all the expenses incurred by the company are taken into the consideration i.e., it includes all the direct and indirect expenses incurred by the company during the specific period..
- The variance doesn’t give much useful information provided by other variances calculated under cost accountingCost AccountingCost accounting is a defined stream of managerial accounting used for ascertaining the overall cost of production. It measures, records and analyzes both fixed and variable costs for this purpose..
- Calculating other variances is beneficial in many cases, such as when labor hours are used as an allocation base. In this case, calculating labor variance will give better results.
This has been a guide to what is Fixed Overhead Volume Variance. Here we discuss formula, example, interpretations, and causes along with advantages and disadvantages. You may learn more about financing from the following articles –