Which of the following is a reason for an unfavorable fixed factory overhead volume variance?

Fixed overhead volume variance is the difference between the amount budgeted for fixed overhead costs based on production volume and the amount that is eventually absorbed. This variance is reviewed as part of the cost accounting reporting package at the end of a given period.

The fixed overhead costs included in this variance tend to be only those incurred during the production process, such as factory rent, equipment depreciation, staff salaries, insurance of facilities and utility fees.

Because they are fixed within a certain range of activity, these overhead costs are fairly easy to predict. This simplicity of prediction sees some businesses create a fixed overhead allocation rate that is used throughout the year. The allocation rate is the expected monthly amount of fixed overhead costs divided by the number of units produced.

However, if a company is experiencing rapid changes in its production systems, it may need to revise its overhead allocation rate more frequently, say monthly.

When can fixed overhead volume variance occur?

When the actual amount budgeted for fixed overhead costs based on production volume differs from the figure that is eventually absorbed, fixed overhead volume variance occurs.

There are a number of reasons why this can happen, aside from simply poor forecasting. If sales on a product are seasonal, production volumes on a monthly basis can fluctuate.

If production volume relies on the labor hours of workers and a company implements new efficient practices that reduce the number of hours needed to produce a product, more units will be made than budgeted.

Similarly, if the allocated volume is down to the number of machine hours and a company outsources some or all of its production, the budgeted amount of machine hours will be much less than expected.

Example of fixed overhead volume variance

Chuck is the manager of a company in New York selling tiles. In its New Jersey factory, the company budgets for the allocation of $75,000 of fixed overhead costs to produce the tiles at a rate of $25 per unit produced.

The expectation is that 3,000 units will be produced during a time period of two months. However, the actual number of units produced is only 2,000, resulting in a total of $50,000 fixed overhead costs. This creates an unfavorable fixed overhead volume variance of $25,000.

Fixed overhead volume variance is subdivided into:

• Fixed overhead capacity variance

• Fixed overhead efficiency variance 

The sum of these two variances need to equal the fixed overhead volume variance.

Fixed overhead capacity variance is the difference between absorbed fixed production overheads attributable to the change in number of manufacturing hours, compared to what was budgeted.

It is calculated as (budgeted production hours minus actual production hours) x (fixed overhead absorption rate divided by time unit),

Fixed overhead efficiency variance is the difference between absorbed fixed production overheads attributable to the change in the manufacturing efficiency during a period.

It is calculated as (standard production hours minus actual production hours) x (fixed overhead absorption rate divided by time unit)

Fixed overhead volume variance limitations

Beside from its role as a balancing agent, fixed overhead volume variance does not offer more information from what can be ascertained from other variances such as sales quantity variance.

The calculation of the sub-variances also doesn’t provide a meaningful analysis of fixed production overheads. For example, if the workforce utilized fewer manufacturing hours during a period than the standard, it is hard to imagine a significant benefit of calculating a favorable fixed overhead efficiency variance.

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Learning Objective

1. Calculate and analyze fixed manufacturing overhead variances.

Question: Many organizations also analyze fixed manufacturing overhead variances. Recall from earlier chapters that manufacturing companies are required to assign fixed manufacturing overhead costs to products for financial reporting purposes (this is called absorption costing). It is common for companies such as Jerry’s Ice Cream to apply fixed manufacturing overhead costs to products based on direct labor hours, machine hours, or some other activity. Companies using a standard costing system apply fixed overhead based on a standard dollar amount per unit produced (this calculation is shown in the footnote to Figure 10.12 "Fixed Manufacturing Overhead Information for Jerry’s Ice Cream"). Assume Jerry’s uses direct labor hours to assign fixed overhead costs to products shown in Figure 10.12 "Fixed Manufacturing Overhead Information for Jerry’s Ice Cream". How is this information used to perform fixed overhead cost variance analysis?

Answer: It is important to start by noting that fixed overhead in the master budget is the same as fixed overhead in the flexible budget because, by definition, fixed costs do not change with changes in units produced. Thus budgeted fixed overhead costs of $140,280 shown in Figure 10.12 "Fixed Manufacturing Overhead Information for Jerry’s Ice Cream" will remain the same even though Jerry’s actually produced 210,000 units instead of the master budget expectation of 200,400 units.

Figure 10.12 Fixed Manufacturing Overhead Information for Jerry’s Ice Cream

Fixed manufacturing overhead variance analysis involves two separate variances: the spending variance and the production volume variance. We show both variances in Figure 10.13 "Fixed Manufacturing Overhead Variance Analysis for Jerry’s Ice Cream", and provide further detail following the figure.

Figure 10.13 Fixed Manufacturing Overhead Variance Analysis for Jerry’s Ice Cream

*From Chapter 9 "How Are Operating Budgets Created?", the direct labor budget is 20,040 budgeted direct labor hours = 200,400 units budgeted to be produced × 0.10 direct labor hours per unit.

**Standard hours of 21,000 = 210,000 actual units produced and sold × Standard of 0.10 hours per unit.

† $140,280 is the original budget presented in the manufacturing overhead budget shown in Chapter 9 "How Are Operating Budgets Created?". The flexible budget amount for fixed overhead does not change with changes in production, so this amount remains the same regardless of actual production.

‡ $(4,280) favorable fixed overhead spending variance = $136,000 – $140,280. Variance is favorable because the actual fixed overhead costs are lower than the budgeted costs.

§ $(6,720) favorable fixed overhead volume variance = $140,280 – $147,000. Variance is favorable because the volume of goods produced and sold was higher than expected.

Fixed Overhead Spending Variance Calculation

Question: How is the fixed overhead spending variance calculated?

Answer: The fixed overhead spending varianceThe difference between actual and budgeted fixed overhead costs. is the difference between actual and budgeted fixed overhead costs. As shown in Figure 10.13 "Fixed Manufacturing Overhead Variance Analysis for Jerry’s Ice Cream", Jerry’s Ice Cream incurred $136,000 in fixed overhead costs for the year. Budgeted fixed overhead costs totaled $140,280. Thus the spending variance is calculated as follows:

Key Equation

Fixed overhead spending variance = Actual costs − Budgeted costs

Fixed overhead spending variance=Actual costs − Budgeted costs= $136,000−$140,280=($4,280) favorable

Because fixed overhead costs are not typically driven by activity, Jerry’s cannot attribute any part of this variance to the efficient (or inefficient) use of labor. In fact, there is no efficiency variance for fixed overhead. Instead, Jerry’s must review the detail of actual and budgeted costs to determine why the favorable variance occurred. For example, factory rent, supervisor salaries, or factory insurance may have been lower than anticipated. Further investigation of detailed costs is necessary to determine the exact cause of the fixed overhead spending variance.

Fixed Overhead Production Volume Variance Calculation

Question: How is the fixed overhead production volume variance calculated?

Answer: Before discussing the production volume variance, a word of caution: do not equate the fixed overhead production volume variance with the variable overhead efficiency variance. There is no efficiency variance for fixed manufacturing overhead because, by definition, fixed costs do not change with changes in the activity base. The fixed overhead volume variance is solely a result of the difference in budgeted production and actual production. The fixed overhead production volume varianceThe difference between the budgeted and applied fixed overhead costs. is the difference between the budgeted and applied fixed overhead costs. As shown in Figure 10.13 "Fixed Manufacturing Overhead Variance Analysis for Jerry’s Ice Cream", Jerry’s Ice Cream budgeted $140,280 in fixed overhead costs for the year. Fixed overhead costs applied totaled $147,000. Thus the production volume variance is calculated as follows:

Key Equation

Fixed overhead production volume variance = Budgeted costs − Applied costs

Fixed overhead production volume variance=Budgeted costs  − Applied costs=$140,280−$147,000=($6,720) favorable

The fixed overhead production volume variance is a direct result of the difference in volume (units) between budgeted production and actual production. All other variables are held constant including standard direct labor hours per unit (0.10) and standard rate per direct labor hour ($7). Thus an alternative approach to this calculation can be used assuming the standard fixed overhead cost per unit is $0.70 (= 0.10 direct labor hours per unit × $7 per direct labor hour):

Key Equation

Fixed overhead productionvolume variance =Std. fixed overheadcost per unit×(Budgeted unitsproduced−Actual unitsproduced)

Fixed overhead prod.volume variance=Std. fixed overheadcost per unit×(Budgeted unitsproduced−Actual units produced)($6,720) favorable=$0.70 ×(200,400budgeted units−210,000actual units)

The fixed overhead production volume variance is favorable because the company produced and sold more units than anticipated.

Comparison of Fixed and Variable Overhead Variances

Question: What are the similarities and differences between the fixed and variable overhead variances?

Answer: Figure 10.14 "Comparison of Variable and Fixed Manufacturing Overhead Variance Analysis for Jerry’s Ice Cream" summarizes the similarities and differences between variable and fixed overhead variances. Notice that the efficiency variance is not applicable to the fixed overhead variance analysis.

Key Takeaway

• Two variances are calculated and analyzed when evaluating fixed manufacturing overhead. The fixed overhead spending variance is the difference between actual and budgeted fixed overhead costs. The fixed overhead production volume variance is the difference between budgeted and applied fixed overhead costs. There is no efficiency variance for fixed manufacturing overhead.