Variable overhead efficiency variance is a measure of the difference between the actual costs to manufacture a product and the costs that the business entity budgeted for it. Thus, it can arise from a difference in productive efficiency.
The productivity efficiency variance is the difference between the actual number of labor hours required to manufacture a certain number of a product and the budgeted or standard number of hours. The difference can be significant and needs to be monitored and managed.
Variable overhead efficiency variance is one of the factors that impact the total variable overhead variance. The other important factor is the variable overhead spending variance.
Variable Overhead Efficiency Variance – Formula
Variable overhead efficiency variance is essentially an accounting measure that is calculated by multiplying the difference between the actual and budgeted hours worked with the standard variable overhead rate per hour. The formula for calculating the variable overhead efficiency variance is:
When a favorable variance is achieved, it implies that the actual hours worked during the given period were less than the budgeted hours. It results in applying the standard overhead rate across fewer hours, which means that the total expenses being incurred are reduced by a factor of the decrease in hours worked. It does not necessarily mean that, in actual terms, the company incurred a lower overhead. It simply implies that an improvement was seen in the total allocation base used to apply overhead.
Risk of Error
The variable overhead efficiency variance uses inputs provided by different departments within the organization. The production expense information is submitted by the production department of the enterprise. The estimated labor hours to meet output requirements are estimated by the staff responsible for industrial engineering and production scheduling.
Projections are based on two things: the historical and estimated employee efficiency, or labor productivity, and the capacity levels of the equipment, with depreciation being accounted for.
There is an inherent risk of arriving at a variance that does not represent an entity’s actual performance due to a margin of error. The error can directly result from an incorrect estimation or record of the standard number of labor hours. Therefore, the validity of the underlying standard, or lack thereof, must be accounted for in investigating the variable overhead efficiency variance.
Assume that the cost accounting staff of Company X has calculated that the company’s production staff works 10,000 hours per month. The company also incurs a cost of $100,000 per month as its variable overhead costs. The information given is largely based on historical and projected labor patterns.
A few months later, Company X decided to install a new materials handling system. It is supposed to have a significant impact on production efficiency. The overall efficiency improves, and the total hours worked during the month drops to 9,000 from the previous 10,000. In this case, the variable overhead efficiency variance is as follows:
Standard Hours = 10,000
Hours Worked = 9,000
Standard Overhead Rate per Hour = Cost Incurred / Standard Hours
= $100,000 / 10,000
Therefore, the company established a variable overhead rate of $10 per hour.
$10 Standard Overhead Rate / Hour x (9,000 Hours Worked – 10,000 Standard Hours)
= $10,000(Variable Overhead Efficiency Variance)
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