Unlike material and labor variances, overhead variances generally cannot be separated into price and quantity components. Instead, most companies separate into the portion controllable and the portion uncontrollable, as well as the variable and the fixed components.
Overhead Variance Analysis
While it is possible that most variable overhead costs can be analyzed separately using price and quantity variances (each cost with a different cost driver), most companies group all overhead amounts together due to the lack of materiality of each individual cost. If the variance analysis later indicates overhead variances are material, further analysis is usually performed to see which overhead cost(s) caused the variance.
The two components of manufacturing overhead variances are the overhead controllable variance and the overhead volume variance. As with direct cost variances, the late Dr. Charles Horngren developed a matrix format to simplify the calculation of overhead variances.
The matrix that follows displays three columns. Each column contains two rowsone row containing the variable costs and the second containing the fixed costs. The first column holds the actual variable and actual fixed costs incurred. The second column contains amounts that appear on the company's flexible budget for variable and fixed overhead costs. The last column contains overhead amounts that are applied to products during the year.
The two variances are differences between the totals of the two adjacent columns. The total of the Actual costs column is compared to the total of the Flexible Budget column. The difference is labeled Overhead Controllable Variance. The total of the Flexible Budget column is compared to the total of Applied column and the difference is labeled as Overhead Volume Variance. In each comparison, if the left total exceeds the right total, the variance will be unfavorable. If the left total is less than the right total, the variance is deemed favorable.
To determine the total overhead variance, combine the overhead controllable variance with the overhead volume variance.
Calculating Overhead Rates
Companies that implement standard costing systems use two separate overhead rates in variance analysis. Both rates are applied in a manner similar to the traditional method of assigning overhead costs, expect that there are two overhead ratesa variable overhead (VOH) rate and a fixed overhead (FOH) rate, and each is applied separately. The use of two overhead rates for overhead variances makes it easier to identify the cause of any overhead variance. Both rates are predetermined and are established at the beginning of the period, and as a result, are calculated using estimated overhead and estimated activity amounts. The two rates are calculated as:
Variable overhead rate  =  Estimated variable overhead 
Estimated units to be produced  
Fixed overhead rate  =  Estimated fixed overhead 
Estimated units to be produced 
While there are a number of other activity rates (used on the denominator) that can be used, the scope of this course is limited to using the number of units of product to be produced.
Calculating Applied Overhead and Flexible Budget Amounts
Each overhead rate is applied separately, in the same manner as overhead is applied in traditional costing, by multiplying the overhead rate times the actual activity. Because the activity is 'units to be produced,' each rate is multiplied by the actual units produced.
Applied Overhead = [FOH rate × Actual units produced] + [VOH rate × Actual units produced]
The variable overhead amount for the flexible budget column is the same as variable overhead applied because both are based on actual activity and the rate allowed in the flexible budget is the same as the rate used to apply overhead.
Fixed costs are the same in total no matter how many units are produced. As a result, the total fixed cost amount is the same total amount allowed no matter what level of units. The flexible budget amount typically differs from the applied fixed overhead amount because the rate used to apply overhead is based on preperiod estimates, while the applied is based on actual activity.
Determining if an Overhead Variance is Favorable and Unfavorable
Favorable variances occur when actual costs are less than expected. From a conceptual perspective, the following variances occur depending on the amounts allowed, amounts incurred, and amounts applied:
Type of Variance  Variance Occurs When 
Unfavorable overhead controllable variance 
Actual overhead costs exceed the flexible budget amount allowed 
Favorable overhead controllable variance 
Actual overhead costs are less than the flexible budget amount allowed 
Unfavorable overhead volume variance 
The company produced fewer units than the quantity planned 
Favorable overhead volume variance 
The company produced more units than the quantity planned 
From a mechanical perspective, when comparing the actual and flexible column totals, if the left column total is greater than the right total, the controllable variance is unfavorable. If the left is less than the right column, the controllable variance is favorable. Likewise, when comparing the flexible budget and the applied overhead column totals, if the left column total is greater than the right total, the volume variance is unfavorable. If the left column total is smaller, the volume variance is favorable.
Interpreting Variances
Once overhead variances are calculated, they must be interpreted. The controllable overhead variance exists because more or less overhead costs were incurred than the amount allowed. Assume a company has an unfavorable controllable variance of $200. This variance indicates that the company incurred $200 more overhead costs than allowed in the flexible budget. If the amount was favorable, it would indicate that the company saved $200 by spending less on overhead costs.
The volume variance exists because the volume level at which the company operated is different the amount budgeted. Suppose the company has a $450 unfavorable volume variance. This variance indicates that the company produced fewer units than initially estimated. Has this variance been favorable, it would indicate that the company produced more units than initially estimated. The variance is not due to over or under spending or the efficiency of how overhead costs are used. It is solely due to producing a different number of units than planned.
Responsibility for Overhead Variances
Overhead Controllable Variance
Who is responsible for the overhead controllable variance? The production supervisor is responsible for making sure that overhead costs are within budget guidelines, both fixed and variable.
Overhead Volume Variance
Who is responsible for the overhead volume variance? No one in particular has caused this variance. The estimated units in the budget differs from the actual units. This variance is never investigated because the company knows why it exists.
Walk Through Problem
Bateh Company produces hot sauce. It uses units as the cost driver for overhead. Bateh has a 1% materiality threshold. The following information was provided concerning its standard cost system for 2018:
Standard Data 

Actual Data 

Direct material 
1/8 lb. @ $7.50 per lb. 

Units of product produced 
4,400 

Direct labor 
24 mins. @ $12 per hr. 
Materials purchased 
600 lbs. for $4,440 

Budgeted fixed overhead 
$28,350 
Materials used 
556 pounds 

Budgeted variable overhead 
$4.50 per unit 
Direct labor worked 
1,610 hours totaling $19,481 

Budgeted production in units 
4,500 
Overhead incurred 
Fixed $20,000; Variable $28,400 







Solution
Step 1: Draw a matrix by setting up three columns and labeling them respectively as actual, flexible budget, and applied. Set up two rows labeled as VOH (variable overhead) and FOH (fixed overhead).
Step 2: Write the actual fixed and actual variable overhead costs on the respective lines under the Actual column. The problem gives these amounts as $28,400 and $20,000.
Actual 

Flexible 

Applied 

VOH 
28,400 

FOH 
20,000 

Step 3: Calculate the predetermined overhead rate for variable costs. The denominator contains the estimated 4,500 units the company plans to produce. However, the estimated variable overhead costs are not provided in the problem data. Instead the variable overhead rate is given at $4.50. You can plug the information you know into the formula and solve for the missing amountestimated variable overhead.
VOH rate =
$20,250
=
$4.50 per unit produced
4,500
Step 4: Calculate the predetermined overhead rate for fixed costs. The denominator contains the estimated 4,500 units the company plans to produce. The numerator contains the estimated (budgeted) fixed costs.
FOH rate = 
$28,350 
= 
$6.30 per unit produced 
4,500 
Applied FOH = [FOH rate X Actual units produced] = [$6.30 X 4,400] = $27,720
Applied VOH = [VOH rate X Actual units produced] = [$4.50 X 4,400] = $19,800
These amounts go into the last column on the fixed and variable cost rows, respectively.
Actual 

Flexible 

Applied 

VOH 
28,400 

19,800 

FOH 
20,000 



27,720 
Step 6: Calculate the flexible budget amounts. The flexible budget amount for variable costs is the same as the amount applied, which is always the case when units are the activity. Because fixed costs are the same in total regardless of how many units are produced, the fixed overhead allowed in the flexible budget column is $28,350. This is the fixed budget amount provided in the problem data.
Actual 

Flexible 

Applied 

VOH 
28,400 
19,800 
19,800 

FOH 
20,000 

28,350 

27,720 
Step 7: Add each column and write the total below the underline for each of the three columns.
Actual 

Flexible 

Applied 

VOH 
28,400 
19,800 
19,800 

FOH 
20,000 

28,350 

27,720 
48,400 
48,150 
47,520 
Step 8: Calculate the difference between the first and second columns to determine the overhead controllable variance. Since the left total is greater than the right total, the variance is unfavorable. Calculate the difference between the middle and last columns to determine the overhead volume variance. Since the left total is greater than the right total, the variance is unfavorable.
Actual 

Flexible 

Applied 

VOH 
28,400 
19,800 
19,800 

FOH 
20,000 

28,350 

27,720 
48,400 
48,150 
47,520 

OH Controllable 
OH Volume 

$250 U 

$630 U 

Total OH Variance  
$880 U 
Step 9: The total variance is determined by combining the two overhead variances together. Because both variances are unfavorable, the two amounts are added creating a total unfavorable variance of $880.
Step 10: Determine if the variances should be investigated. You first determine how much the threshold is. The center column is the total flexible budget amount allowed and is used as the budget amount for this calculation.
1% x $48,150 = $481.50
Step 10: Because the controllable variance does not exceed the $481.50 threshold, it should not be investigated. The volume variance is never investigated because its reason is known, i.e., it exists because the company produced 4,400 instead of 4,500 units of product. Who is responsible for these variances? The production supervisor is responsible for controllable overhead variable. Non one is responsible for the volume variance because we know why it exitsthe company operated at a different level of activity than budgeted.
This page was last edited on
Monday April 06, 2015 11:48 AM
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