8.4 Compute and Evaluate Overhead Variances
3 min read•june 18, 2024
are crucial for understanding in manufacturing. These variances measure differences between actual and standard variable overhead rates and efficiency. By analyzing rate and efficiency variances, managers can pinpoint areas of overspending or inefficiency.
Interpreting provides insights into pricing fluctuations, productivity changes, and overall cost management. Favorable variances indicate cost savings and improved efficiency, while unfavorable variances signal potential issues. This analysis is key for optimizing operations and enhancing profitability.
Variable Overhead Variances
Variable overhead rate calculation
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- quantifies the difference between incurred and predetermined
- Calculated using the formula
- arises when actual rate is lower than standard rate (spending less per hour than expected)
- occurs when actual rate exceeds standard rate (spending more per hour than anticipated)
- measures the difference between actual hours worked and allowed for the actual output produced
- Determined using the formula
- happens when actual hours are fewer than standard hours allowed (working more efficiently than planned)
- results when actual hours surpass standard hours allowed (working less efficiently than expected)
Interpretation of overhead variances
- can be caused by:
- Fluctuations in the prices of variable overhead items (supplies, utilities)
- Alterations in the mix of variable overhead items used (switching to higher or lower cost items)
- may stem from:
- Variations in worker or machine productivity (faster or slower than normal)
- Differences in the quality of materials used (higher or lower grade than usual)
- Changes in the efficiency of production processes (streamlined or bottlenecked)
- Fluctuations in affecting overhead consumption
- Favorable variances lead to:
- Reduced actual costs compared to standard costs (spending less than budgeted)
- Enhanced profitability (increasing margins)
- Potential indicators of improved efficiency or cost control (optimizing operations)
- Unfavorable variances result in:
- Elevated actual costs relative to standard costs (spending more than planned)
- Diminished profitability (shrinking margins)
- Possible signs of inefficiencies or inadequate cost control (wasting resources)
Total variable overhead variance
- is the sum of the variance and variable overhead efficiency variance
- Calculated as
- Measures the overall difference between actual variable overhead costs incurred and standard variable overhead costs allowed
- Favorable variance occurs when total actual variable overhead costs are less than total standard variable overhead costs (spending less overall than budgeted)
- Unfavorable variance arises when total actual variable overhead costs exceed total standard variable overhead costs (spending more overall than planned)
- Rate and efficiency variances can be combined to determine the total impact on variable overhead costs
- Favorable and unfavorable variances may offset each other, resulting in a smaller net variance (pluses and minuses evening out)
- Examining individual variances helps pinpoint specific areas of concern or success in managing variable overhead costs (drilling down to root causes)
Overhead Management and Analysis
- involves distributing indirect costs to products or cost centers
- is used to estimate overhead costs before production begins
- adjusts for changes in activity levels, allowing for more accurate
- helps in cost control by identifying deviations from expected performance
- Regular review of variances supports continuous improvement in overhead management
Key Terms to Review (29)
Actual Hours: Actual hours refer to the total number of hours worked by employees in a given period, as recorded and documented by the organization. This term is particularly relevant in the context of computing and evaluating overhead variances, as it is a crucial component in determining the actual costs incurred by a business.
Actual Variable Overhead Rate: The actual variable overhead rate is a metric used to measure the variable overhead costs incurred per unit of production. It is calculated by dividing the actual variable overhead costs by the actual production volume, and it is used to evaluate the efficiency of overhead cost management in the context of overhead variance analysis.
Cost Control: Cost control is the process of managing and regulating the costs incurred by an organization in order to maximize profitability and efficiency. It involves monitoring, analyzing, and taking corrective actions to ensure that costs are kept within predetermined budgets or targets. Cost control is a critical responsibility of management across various business functions and is particularly important in the context of managerial accounting.
Cost Drivers: Cost drivers are the factors that directly influence the incurrence of costs within an organization. They are the underlying causes that determine the level of resources consumed and the resulting costs associated with business activities or operations. Cost drivers play a crucial role in various managerial accounting concepts, including the estimation of variable and fixed costs, the application of job order and process costing methods, the calculation of activity-based product costs, and the analysis of overhead variances.
Favorable variance: A favorable variance occurs when actual costs are less than standard costs or actual revenues exceed standard revenues. It indicates better performance than expected and can result from cost savings, higher efficiency, or increased sales.
Favorable Variance: A favorable variance refers to a situation where the actual cost or performance is less than the standard or budgeted amount, indicating that the organization has spent less or performed better than expected. This term is particularly relevant in the context of materials variances, overhead variances, and overall variance analysis within a company's operations.
Flexible budget: A flexible budget adjusts for changes in the level of activity, such as sales volume or production levels. It provides a more accurate comparison of actual results to budgeted amounts by accommodating fluctuations in operational conditions.
Flexible Budget: A flexible budget is a type of budget that adjusts to changes in activity or volume levels, allowing for more accurate planning and control of costs. It is a crucial tool for managing and evaluating a company's performance, particularly in the context of operating budgets, flexible budgets, and overhead variance analysis.
Overhead Allocation: Overhead allocation is the process of assigning indirect costs, or overhead, to the products or services produced by a business. It is a critical component in determining the full cost of a product or service and is essential for both activity-based costing and the analysis of overhead variances.
Overhead variances: Overhead variances are the differences between actual overhead costs and standard overhead costs allocated to production. They help in assessing cost control and efficiency in manufacturing processes.
Overhead Variances: Overhead variances refer to the differences between the actual overhead costs incurred by a business and the overhead costs that were budgeted or applied to production. These variances provide insights into the efficiency and effectiveness of a company's overhead management and can help identify areas for improvement.
Predetermined overhead allocation rate: A predetermined overhead allocation rate is a method used to assign indirect costs to products based on a consistent formula. It is calculated before the period begins and involves estimating total overhead costs and selecting an allocation base.
Predetermined overhead rate: The predetermined overhead rate is a calculation used to allocate estimated manufacturing overhead costs to products or job orders, based on a specific activity base, such as direct labor hours or machine hours. It is determined before the period begins and helps in budgeting and costing processes.
Predetermined Overhead Rate: The predetermined overhead rate is a method used in job order costing to apply overhead costs to individual jobs or products. It is calculated by dividing the estimated total overhead costs for a period by the estimated activity base, such as direct labor hours or machine hours, for that same period. This rate is then used to apply overhead to each job based on the job's actual usage of the activity base.
Standard Hours: Standard hours refer to the predetermined, expected level of production or labor hours required to complete a specific task or activity within an organization. They are used as a benchmark to evaluate and analyze overhead variances in the context of managerial accounting practices.
Standard Variable Overhead Rate: The standard variable overhead rate is a predetermined rate used to apply variable overhead costs to production. It represents the expected variable overhead cost per unit of the cost driver, such as direct labor hours or machine hours, and is used to allocate variable overhead costs to products or services during the production process.
Total variable overhead cost variance: Total variable overhead cost variance is the difference between the actual variable overhead costs incurred and the standard variable overhead costs allocated based on actual production levels. It helps managers understand whether they are spending more or less on variable overheads than planned.
Total Variable Overhead Cost Variance: The total variable overhead cost variance is the difference between the actual variable overhead costs incurred and the variable overhead costs that should have been incurred based on the actual level of activity. This variance is an important metric in evaluating the efficiency and performance of a company's overhead cost management within the context of 8.4 Compute and Evaluate Overhead Variances.
Total Variable Overhead Variance: The total variable overhead variance is the difference between the actual variable overhead costs incurred and the variable overhead costs that should have been incurred based on the actual level of activity. It measures the efficiency with which variable overhead resources were utilized compared to the expected level of utilization.
Unfavorable variance: Unfavorable variance occurs when actual costs exceed standard costs, indicating higher expenses than planned. It signals inefficiencies or higher resource consumption in production or operations.
Unfavorable Variance: An unfavorable variance is a type of variance that occurs when the actual cost or performance of a business activity exceeds the expected or budgeted cost or performance. It indicates that the actual outcome is less favorable than the planned outcome, signaling potential inefficiencies or issues that need to be addressed.
Variable overhead efficiency variance: Variable overhead efficiency variance measures the difference between the standard variable overhead cost allocated for the actual hours worked and the standard variable overhead cost allowed for the actual production achieved. It helps in assessing the efficiency in utilizing labor hours related to variable overheads.
Variable Overhead Efficiency Variance: The variable overhead efficiency variance is a measure of the difference between the actual variable overhead costs incurred and the variable overhead costs that should have been incurred based on the actual level of activity. It reflects the efficiency with which a company utilizes its variable overhead resources in the production process.
Variable Overhead Rate: The variable overhead rate is a measure used to allocate variable overhead costs to products or services based on a selected activity or cost driver. It represents the variable overhead cost per unit of the selected activity, such as direct labor hours or machine hours, and is a crucial component in the computation and evaluation of overhead variances.
Variable overhead rate variance: Variable overhead rate variance is the difference between the actual variable overhead costs incurred and the standard variable overhead costs based on the actual hours worked. It helps in evaluating the efficiency of a company's cost control related to variable overheads.
Variable Overhead Rate Variance: The variable overhead rate variance is a measure of the difference between the actual variable overhead incurred and the expected variable overhead based on the actual activity level. It is an important metric in evaluating the efficiency of overhead cost management within the context of 8.4 Compute and Evaluate Overhead Variances.
Variable Overhead Variances: Variable overhead variances refer to the differences between the actual variable overhead costs incurred and the variable overhead costs that were budgeted or expected for the level of activity during a given period. These variances provide insights into the efficiency and performance of a company's variable overhead spending.
Variance analysis: Variance analysis is the process of comparing budgeted financial performance to actual financial performance to identify discrepancies. It helps managers understand why variances occur and how to address them for better future planning.
Variance Analysis: Variance analysis is a management accounting technique used to identify and evaluate the differences between actual and expected or budgeted performance. It provides insights into the causes of these variances, enabling managers to make informed decisions and take corrective actions to improve operational efficiency and financial performance.