Question

What does a positive and negative fixed overhead budget variance and fixed overhead volume variance mean? In the answer, ensure to go beyond stating that it is favourable or unfavourable.

Answer 1

Ans-

Fixed overhead budget variance:

Fixed overhead budget variance is the difference between total fixed overhead budgeted for a given accounting period and actual fixed overheads incurred during the period. This variance is favorable when actual fixed overhead incurred are less than the budgeted amount and it is unfavorable when actual fixed overheads exceed the budgeted amount. Fixed overhead budget variance is also known as fixed overhead spending/capacity/expenditure variance.

Even though fixed overheads are assumed to be fixed, their actual figure may differ from the amount estimated at the start of the period and this difference is represented by fixed overhead budget variance. When the total of fixed overhead expenses actually incurred during a given accounting period exceeds the budgeted amount, there is a favorable fixed overhead budget variance and this variance is unfavorable vice versa.

Causes of fixed overhead budget variance include:

• budgeted fixed overhead being inaccurate
• unplanned expansion of production capacity resulting in step costs
• unexpected changes in prices

Fixed overhead budget variance is one of the two main components of total fixed overhead variance, the other being fixed overhead volume variance. Fixed overhead budget variance is typically small compared to volume variance.

Formula:

Fixed Overhead Volume Variance = Actual Fixed Overhead - Budgeted Fixed Overhead

As per above formula, a positive figure indicates a favorable variance whereas a negative figure means an unfavorable variance.

Example:

Steptech Inc. manufactures fitness monitoring products. It estimated its fixed manufacturing overheads for the year 2013 to be $37 million. The actual fixed overhead expenses for the year 2013 were $40 million.

Fixed Overhead Budget Variance = $37 - $40 = $3 million (unfavorable)

Fixed Overhead Volume Variance:

Fixed overhead volume variance is the difference between fixed overhead applied to good units produced during a given accounting period and the total fixed overheads budgeted for the period. Fixed overhead volume variance occurs when the actual production volume differs from budgeted production. In this way it measures whether or not the fixed production resources have been efficiently utilized.

Fixed overhead volume variance is favorable when the applied fixed overhead exceeds the budgeted amount. This is because the units produced in such case are more than the quantity expected from current production capacity and this reflects efficient use of fixed resources. The standard fixed overhead applied to units exceeding the budgeted quantity is saved in the form of over-applied overhead. The result is lower actual unit costs and higher profitability than budgeted figures. An unfavorable fixed overhead volume variance occurs when the fixed overhead applied to good units produced falls short of the total budged fixed overhead for the period. This is because of inefficient use the fixed production capacity.

Fixed overheads may be applied to production using a predetermined overhead rate calculated by dividing estimated total fixed costs during the period by the budget units of a cost basis such as units produced, total machine hours etc.

Fixed overhead volume variance is one of the two components of total fixed overhead variance, the other being fixed overhead budget variance. There are two sub-components of fixed overhead volume variance:

• FOH volume capacity variance
• FOH volume efficiency variance

Formulas:

Here we will assume, number of units as the basis for applying fixed costs to production. The formula to calculate various different bases two of the most common being the number of units and machine hours.

Fixed Overhead Volume Variance = Applied Fixed Overhead – Budgeted Fixed Overhead

As per above formulas, a positive value of fixed overhead volume variance is favorable whereas a negative value is unfavorable. The figures required in the above formula can be calculated as follows:

Applied Fixed Overhead = Standard Fixed Overhead Rate × Standard Hours Allowed

Standard Fixed Overhead Rate =	Budgeted Fixed Overhead
Budgeted Units

Alternatively, fixed overhead volume variance may be calculated using the following formula:

Fixed Overhead Volume Variance = (Actual Activity – Normal Activity) × Fixed Overhead Application Rate

Example:

Calculate fixed overhead volume variance using the following data:

Budgeted Fixed Overheads	$50,000
Budgeted Units	10,000
Actual Units Produced	10,700

Solution:

Fixed Overhead Application Rate =	$50,000	= $5 per unit
10,000

Applied Fixed Overhead = 10,700 × $5 = $53,500

Fixed Overhead Volume Variance = $53,500 – $50,000 = $3,500 Favorable.