Production Volume Variance

What is Production Volume Variance?

Production volume variance is defined as the variance in production cost as observed by the business with respect to the budgeted or anticipated value and its actual value. It is a statistical metric employed by the business to perform comparative analysis between actual and anticipated or expected overheads related to the production process.

Explanation

Production volume variance is a variance between actual cost and budgeted cost of the production process and also referred to as the variance on volume. One of the critical aspects of any business is to determine the overall costs of overheadsCosts Of OverheadsOverhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc.read more. The determination of overhead expenses is necessary as such costs are of a fixed nature.

Irrespective of the levels of volumes received by the business or the number of units manufactured by the business, the metric on overhead costs remains to be fixed. The overhead costs generally comprise of purchases of equipment, rent on factories and warehouses, and cost of insurance. Additionally, there is the presence of other costs that generally changes as per the volume managed or handled by the business.

Such costs comprise of expenditures on raw materials, goods and services transportation as well as storage costs of finished goods. Such costs may vary with respect to the higher levels of volume.  The variance on the production volume is generally static and is stale.

The production variance tends to happen because the business may have determined an expected valueExpected ValueExpected value refers to the anticipation of an investment's for a future period considering the various probabilities. It is evaluated as the product of probability distribution and outcomes.read more that could be older in value, and even before the beginning of the production process. Hence it is regarded as a stale metric, and the business may choose other available statistics. The other metrics could be the production of the number of units per day at the pre-defined cost.

Formula

Production Volume Variance = (Value of Units Produced on Actual Level – Budgeted or Anticipated Levels of Production Units) x Overhead Rate Per Unit on Budgeted Levels

Production-Volume-Variance

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Source: Production Volume Variance (wallstreetmojo.com)

Examples

Below are some examples to understand the concept in a better way –

Example #1

Let us take the example of ABC company. The ABC company anticipated that it could produce 8,000 units for the coming year at the overhead rate per unit of $20. However, later that year, the business produced 9,400 units. Help the management determine production volume variance.

Solution

Production Volume Variance Example 1
  • = (9,400 – 8,000) x $20
  • = $28,000

Therefore, the business observed a production variance of $28,000. This is regarded as favorable as the business utilized a greater number of units corresponding to the fixed costsFixed CostsFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more the business has to bear, thereby driving operational efficiency.

Example #2

Let us take the example of the PQR company. The PQR company anticipated that it could produce 10,000 units for the coming year at the overhead rate per unit of $20. However, later that year, the business produced 7,400 units. Help the management determine production volume variance.

Solution

Production Volume Variance Example 2
  • = (7400 – 10000) x $20
  • = -$52,000

Therefore, the business observed a production variance of -$52,000. This is regarded as unfavorable as the business utilized a lesser number of units corresponding to the fixed costs the business has to bear, thereby driving operational efficiency.

Importance

The production volume variance is an important statistical metric that helps the business on making a comparison of actual overhead costs incurred by the business with the anticipated value of the overhead costs. The production variance analysis, therefore, forms a part of the standard costingStandard CostingStandard cost is an estimated cost determined by the company for the production of the goods and services or for performing an operation under normal circumstances and are derived by the company from the historical analysis of the data or from the time and the motion studies.read more process of the business. Whenever a business generates unfavorable levels of production variance analysis, it means that the overall fixed costs that the business utilized for generating the output were less than what was anticipated or expected values of the budgeted values. This further indicates that for the overall total number of units, it results in higher production costsProduction CostsProduction Cost is the total capital amount that a Company spends in producing finished goods or offering specific services. You can calculate it by adding Direct Material cost, Direct Labor Cost, & Manufacturing Overhead Cost. read more per unit.

Whenever the actual overall fixed costs exceed the budgeted value, then the production 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.read more is regarded as favorable. This signifies that the overall cost of production covered a greater number of finished goods or outputs. Therefore, it indicates how well the business is performing on operational levels.

Advantages

The production volume variance is a useful metric as it helps the business determine the volume of the production process that the business could focus on to drive business operations at low costs, with maximum volume, and at higher profits. The metric helps the business to achieve operational excellence as it helps businesses focus more on the achievement of more than the budgeted values. It as a metric helps businesses understand whether or not it could produce or manufacture enough finished goods in order to drive profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more and sustain business operations.

The main focus remains on the overhead costs per unit basis and not on the total cost of production. Since many of the production costs tend to be fixed, such higher values drive the higher value of profits.

Conclusion

The production volume variance is termed as the variance between actual overhead costs and budgeted overhead values. It is basically a statistical measure that helps the business plan its operational capacity, which then helps the business to drive efficient business operations and, in turn, reap out maximum profitability.

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