COST AND MANAGEMENT

UNIT 3 SECTION 5 OVERHEAD COST VARIANCES

ACCOUNTING Unit 3, section 5: Overhead cost variances

We have discussed price and efficiency variances in the previous section.

We hope you have enjoyed the discussion so far. In this session we are
going to look at Overhead cost variances.

As you have learnt in cost Accounting, overheads are either variable

overheads or fixed overheads. Variable overheads vary directly with the
volume of activity. This means that as production increases, variable
overheads also increase. However, the unit variable cost remains the same
as the level of production increases. Fixed overheads, however, remain the
same within certain activity level and therefore, the per unit fixed cost has
no meaning in the computation of fixed overhead variances. This makes the
fixed overhead variances very different from the variable overhead.

By the end of the session you should be able to:

 calculate the total variable and fixed overhead variances;
 compute variable and fixed overhead expenditure variance; and
 compute variable overhead efficiency variance
 calculate fixed overhead volume variance and analyse it into efficiency
and capacity variances

Now read on…

Total Variable Overhead Variance (TVOV)

The total variable overheads variance is the difference between the actual
variable overheads and the standard variable overheads.

The formula is AVO – SVO = TVOV

The overhead variances may be calculated in terms of labour hours or

production units so that

TVOV = (AH × AVOR) – (SH × SVOR)

Where AVO = Actual Variable Overhead
SVO = Standard Variable Overhead
AH = Actual Hours
AVOR = Actual Variable Overheads Absorption Rate
SH = Standard Hours
SVOR = Standard Variable Overheads Absorption Rate

Example 5.1
The following data is in respect of Yaw Mensah Ltd for one of its products.
Output 5000 units

Standard variable overheads per unit GHC2.50

Actual variable overheads incurred GHC13,000.00

110 UEW/IEDE
 COST AND MANAGEMENT
Unit 3, section 5: Overhead cost variances ACCOUNTING

You are required to compute the total variable overheads variance

Solution 5.1
TVOV = AVO – SVO
= 13000 – (5000 × 2.50)
= 13000 - 12500.00
= GH¢500.00 U

The actual variable overheads is greater than the standard variable

overheads, thus giving an unfavourable variance of GH¢500.00

The total variable overhead variance is made up of two variances. They are
variable overhead expenditure (spending) variance and variable overhead
efficiency variance and we are going to look at them one by one.

Variable Overhead Expenditure (Spending) Variance (VOSV)

The variable overhead expenditure variance which is also called variable
overhead spending variance is a price variance.

The variable overhead expenditure variance is the difference between the

standard variable overheads for the actual hours and the actual variable
overheads incurred.

The formula for computing the variable overhead expenditure variance is as

follows

VOSV = AVOR × AH – SVOR × AH

= (AVOR – SVOR) AH

Where VOSV = Variable overhead Spending Variance

AVOR = Actual Variable Overhead Absorption Rate
SVOR = Standard Variable Overhead Absorption Rate
AH = Actual Hours (usually labour hours)

Variable Overhead Efficiency Variance (VOEV)

The quantity or efficiency variance for variable overhead is the variable
overhead efficiency variance.

The variable overhead efficiency variance shows the extent of cost saved or
excess cost incurred due to efficient or inefficient performance. It is the
difference between the actual hours taken for the actual volume or output
and the standard hours allowed for the actual volume or output multiplied
by the standard variable overhead absorption rate.

The formula for the VOEV is

VOEV = (AH X SVOR) – (SH x SVOR)

UEW/IEDE 111
COST AND MANAGEMENT
ACCOUNTING Unit 3, section 5: Overhead cost variances

= (AH – SH) SVOR

Where
AH = Actual hours (usually labour hours)
SH = Standard hours allowed for the actual output
SVOR = Standard Variable Overhead absorption rate

Example 5.2
Osagyefo Ltd has developed the following variable overheads standard for
one of its products. Variable overhead: 5 hours at GHC3.50 per hour. The
following activity occurred during the month of July.

Units produced; 900 units

Direct labour: 5000 hours costing GH¢48000.00
Actual variable overheads: GH¢15000.00
You are required to compute the
a. total Variable Overheads Variance
b. variable overheads spending and
c. efficiency variances

Solution 5.2
Total Variable Overhead Variance
= AVO - SVO
= 15000.00 – (5 X 900 X 3.50)
= 15000.00 - 15750.00
= GHC750.00 F

Variable overhead Spending Variance

= (AVOR x AH) – (SVOR x AH)
= 15000.00 – (3.50 X 5000)
= GHC2,500 F

Variable Overhead Efficiency Variance

= (AH x SVOR) – (SH x SVOR)
= (5000 x 3.50) – (5 x 900 x 3.50)
= 17500.00 - 15750.00
= GHC1750.00 U

Variable overhead spending variance GH¢2500 F

Variable overhead efficiency variance GH¢1750 U
Total variable overhead variance GH¢750 F

112 UEW/IEDE
 COST AND MANAGEMENT
Unit 3, section 5: Overhead cost variances ACCOUNTING

Total Fixed Overheads Variance

Fixed overheads have to be applied or absorbed at a predetermined rate.
This predetermined rate is calculated by dividing the budgeted fixed
overheads by the budgeted, volume or activity level. The predetermined rate
is applied to cost absorption. If the actual fixed overheads incurred is
different from the fixed overhead absorbed, it results in an under or over
absorption of overheads. The fixed overhead variance is the sum of under or
over absorbed fixed overheads in the period.

The formula for finding the total fixed overheads variance is given by
TFOV = AFO – SFO
Where:
TFOV = Actual fixed overheads variance
AFO = Actual fixed overheads incurred
SFO = Standard fixed overheads absorbed.

Example 5.3
Kelvin Ltd makes a single production XYZ for which the fixed overhead
budget is GHC15000.00. The company plans to manufacture 2500 units of
XYZ which should take 3 hours each to manufacture.

The actual production in the month of August is 2600 units of XYZ and
fixed overheads incurred is GHC20,020.00

Calculate the total fixed overhead variance.

Solution 5.3
Standard fixed overhead absorption rate per hour

SFOR = Budgeted overhead

Standard hours allowed

= 15000.00
2500 ×3 hours

= GH¢ 2.00 per hour

Standard overhead cost per unit of XYZ will be 3 hours × GHC2.00 per
hour = GH¢ 6.00

This is the standard fixed cost that is used as the fixed overhead fixed cost
that will be used as the fixed overhead cost absorbed into every unit of XYZ
that is manufactured.

Actual fixed overhead incurred 20,020 .00

Standard fixed overhead absorbed (2600 ×6) 15,600.00
Total fixed overhead cost variance 4420.00(U)

UEW/IEDE 113
COST AND MANAGEMENT
ACCOUNTING Unit 3, section 5: Overhead cost variances

Note that Under-absorbed overhead is an unfavourable variance while Over-

absorbed overhead is a favourable variance.

Fixed Overhead Spending (Expenditure) Variance

The fixed overhead spending variance is variously known as expenditure,
expense or budget variance.

This variance is the difference between the fixed overhead cost which is
actually incurred and the fixed overhead cost which should have been
incurred. In other words is the difference between the actual fixed overhead
incurred and the budgeted fixed overhead expenditure
The formula for computing the budget is
FOSU = AFO – BFO
Where
FOSV = Fixed overhead spending variance
AFO = Actual fixed overhead incurred
BFC = Budgeted fixed overhead expenditure

Example 5.4
Using Example 5.3 above, Calculate the fixed overhead spending variance.

Solution 5.4
GH¢
Actual fixed overhead expenditure 20020.00
Budgeted fixed overhead expenditure 15000.00
Fixed overhead spending variance 5020.00(U)

The actual expenditure exceeded the budgeted expenditure, so the variance

is unfavourable.

Fixed Overhead Volume Variance

The fixed overhead volume variance is the difference between the actual
output and the budgeted output in units, multiplied by the standard fixed
overhead absorption rate.

The formula for calculating the fixed overhead volume variance is

FOUV = (SFOR × AQ) – (SFOR × BQ) = SFOR (AH – BH)

Where
FOUV = Fixed overhead volume variance
SFOR = standard fixed overhead volume variance
AQ = the actual production volume
BQ = the budgeted production volume.

114 UEW/IEDE
 COST AND MANAGEMENT
Unit 3, section 5: Overhead cost variances ACCOUNTING

Example 5.5
Using Example 5.3 above, calculate the fixed overhead volume variance.

Solution 5.5
FOUV = SFOR (AQ – BQ)
= GH¢ 600 (2600 – 2500)
= GH¢ 600.00(F)
The volume variance is favourable, because actual output volume is greater
than budgeted.

Summary
GH ¢
Fixed overhead spending variance 5,020(U)
Fixed overhead volume variance 600(F)
Total fixed overhead variance 4,420(U)

Note that the fixed overhead spending variance and the fixed overhead
volume variance equals the total fixed overhead cost variance.

Fixed Overhead Efficiency and Capacity Variance

The fixed overhead volume variance can be further sub-analysed into an
efficiency variance and a capacity variance. These explain why the
production volume was different from the budgeted volume. We can,
therefore, express the fixed overhead volume variance as equal to the sum of
the fixed overhead efficiency variance and the fixed overhead capacity
variance.

Fixed Overhead Efficiency Variance

The fixed overhead efficiency variance will be the same in hours as the
variable overhead efficiency variance, but is valued at the standard fixed
overhead absorption rate per hour.

The formula for computing fixed overhead efficiency variance is given by

FOEV = SFOR (AH-SH)
where
SFOR = the standard fixed overhead absorption rate.
AH = the standard labour hours to produce
SH = the actual cut put.

Fixed Overhead Capacity Variance

The fixed overhead capacity variance is the difference between the actual
hours worked and budgeted hours of work multiplied by the standard fixed
overhead absorption rate per hour.

The formula for computing the fixed overhead capacity variance is given by

UEW/IEDE 115
COST AND MANAGEMENT
ACCOUNTING Unit 3, section 5: Overhead cost variances

FOCV = SFOR (AH – BH)

where
FOCV = Fixed overhead capacity variance
SFOR = standard fixed overhead absorption rate
AH = Actual labour hours
BH = Budgeted labour hours.

Example 5.6
Kelvin Ltd makes a single production XYZ for which the fixed overhead
budget is GHC15000.00. The company plans to manufacture 2500 units of
XYZ which should take 3 hours each to manufacture.

The actual production in the month of August is 2600 units of XYZ and
fixed overheads incurred is GHC20,020.00

Calculate the fixed overhead efficiency and capacity variances and comment
on your results.

Solution 5.6
FOEV = SFOR (AH – SH)

= GHC2.00 (9100 – 7800)

= GHC2600 (U)

The variance is unfavourable because there was no efficiency in the use in

hours.
FOCV = SFOR (AH – BA)
= GHC2.00 (9100 – 7500)
= GHC 3200F

The variance is favourable because actual hours were more than budgeted,
which means that more units were produced than planned.

Summary
Total Fixed overhead variances
GH ¢
Spending Variance = 5,020(U)
Efficiency variance = 2,600(U)
Capacity variance = 3,200(F)
Volume variance = 600(F)
Total Fixed overhead variance 4,420(u)

Exercises
1.Koo Nsiah Ltd manufactures a product called Koi.
The standard variable overheads rate is GH¢2.40 per labour hour for 3 hours
per unit. During the month of September, the company produced 600 units
of Koosh in 2100 hours at a cost of GH¢4620.00.

116 UEW/IEDE
 COST AND MANAGEMENT
Unit 3, section 5: Overhead cost variances ACCOUNTING

You are required to compute

a. total variable overhead variance
b. variable overhead spending variance
c. variable overhead efficiency variance and comment on the results

2. Ameen Sangari Ltd makes a single product AMEEN soap for which the
fixed overhead budget is GHC60,000. The company plans to manufacture
60,000 units of AMEEN which should take 4 hours each to manufacture.

The actual production in the month of January is 6500 units of AMEEN

produced in 29250 hours. The actual fixed overheads incurred is GH
¢67275.00.

You are required to calculate

a. the total fixed overhead variance
b. the fixed overhead spending (expenditure) variance
c. the fixed overhead volume variance and analyse it into efficiency and
capacity variances.

UEW/IEDE 117