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Variable Overhead Efficiency Variance

A measure that can arise from a difference in productive efficiency

What is Variable Overhead Efficiency Variance?

Variable overhead efficiency variance is a measure of the impact of the difference between the real time it takes in the manufacturing of a product and the time that the business entity budgeted for it. Thus, it can arise from a difference in productive efficiency.

 

Variable Overhead Efficiency Variance

 

The productivity efficiency variance is the difference between the number of labor hours required to manufacture a certain number of a product and the budgeted number of hours. The difference can be significant and needs to be accounted for.

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 trick 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:

 

Variable Overhead Efficiency Variance – Formula

 

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 the application of 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 that was 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 the actual performance of an entity due to a margin of error. The error can be a direct result of 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 the investigation of the variable overhead efficiency variance.

 

Example

Assume that the cost accounting staff of Company X has calculated that the production staff of the company must work 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:

 

Given information:

Standard Hours = 10,000

Hours Worked = 9,000

 

Calculation:

Standard Overhead Rate per Hour = Cost Incurred / Standard Hours

= $100,000 / 10,000

= $10

 

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)

 

Related Readings

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Variance Analysis Template
  • Philosophy of Accounting
  • Variance Formula
  • Budgeting and Forecasting Course

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