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.
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 overheads. 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 value 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.
Below are some examples to understand the concept in a better way –
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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.
- = (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 costs the business has to bear, thereby driving operational efficiency.
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.
- = (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.
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 costing 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 costs per unit.
Whenever the actual overall fixed costs exceed the budgeted value, then the production volume variance 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.
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 profitability 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.
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.
This has been a guide to what is Production Volume Variance. Here we discuss how to calculate production volume variance along with advantages and importance. You may learn more about financing from the following articles –