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.
Explanation
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.
Formula
It can be calculated using the following formula:
Here,
- 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.
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Examples
Fixed overhead volume variance is calculated as follows:
Interpretation
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.
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.
Favorable 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.
Causes
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 sales 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. |
Advantages
- 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 costing.
Disadvantages
- The variance doesn’t give much useful information provided by other variances calculated under cost accounting.
- 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.
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