Fixed Overhead Cost Variance

Check this fact:

 

Fixed overhead variance is an extension of fixed overheads.

 

Did you nod in the affirmative?

 

Well, let’s proceed.

 

Fixed overhead cost refers to costs that are incurred even when the production level is zero. It includes insurance, rent, utility, office administrative expenses, and other expenses of the same nature.

 

Fixed overhead cost variance helps to determine if there is over or under absorption of overhead for the actual production. In simple terms, FOH cost variance measures the difference between the standard fixed overheads for actual output and actual fixed overheads incurred. 

 

There are two types of fixed overhead variance analysis. They are:

1. Fixed overhead expenditure variance.
2. Fixed overhead volume variance.

 

Fixed overhead expenditure variance is the difference between the actual fixed overheads incurred and the fixed overheads budgeted for the period.

 

Fixed overhead volume variance measures the differences between the budgeted amount of fixed overhead costs based on production levels and the amount that is absorbed. The FOH volume variance is further analyzed into fixed overhead volume efficiency variance and fixed overhead volume capacity variance.

 

For businesses that adopt the marginal costing approach the fixed overhead cost variance will be equal to the fixed overhead expenditure variance.

 

The Formula For Fixed Overhead Variance

• Fixed overhead cost variance = (Actual Output x Fixed Overhead Absorption Rate – Actual Fixed Overheads)

 

Where:

Fixed Overhead Absorption Rate (FOAR) =  Budgeted fixed overhead

                                                                                    Budgeted labor hours

 

1. Fixed overhead expenditure variance = Budgeted Fixed Overhead – Actual fixed Overhead cost

 

2. Fixed overhead volume variance = (Budgeted hours – Actual Hours) x FOAR

 

3. Fixed overhead capacity variance = (Budgeted Hours – Actual Hours spent on production) x FOAR per standard time.

 

4. Fixed overhead efficiency variance = (Standard Hours –  Actual Hours) x FOAR per standard time.

 

Tip:

FOAR per standard time means FOAR per unit of hour i.e. FOAR ÷ Standard hour per unit of production.

 

Comprehensive Example On Fixed Overhead Cost Variance

The management of Adio PLC, a fast-growing company in the consumer goods industry, charged its chief accountant to prepare a budget on the fixed overheads to be incurred next year.

Budgeted Fixed Overheads	$90,000
Budgeted Units	9,000
Actual Units Produced	11,000
Standard hour per unit	2 hours
Actual hours of production	50, 000 hours
Actual Fixed Overheads	$120,000

Use the information provided to compute FOH cost variance, FOH expenditure, and volume variance.

 

Solution:

 

1. Fixed Overhead Expenditure Variance = Budgeted Fixed Overhead – Actual fixed Overhead cost

 

= $90,000 – $120,000 = $30,000 Adverse.

 

Interpretation: Adio Plc spent more than its budgeted expenses.

 

2. Fixed overhead volume variance = (Budgeted hours – Actual Hours) x FOAR

 

FOAR = Budgeted Fixed Costs ÷ Budgeted units.

 

FOAR = $90,000 ÷ 9,000 = $10/unit.

 

(Since budgeted units were not provided, we’ll replace the formula with Budgeted FOH – Absorbed FOH)

 

Absorbed Fixed Overheads = Actual Output x Fixed Overhead Absorption Rate = 14,000 x $10 = $140,000.

 

Then, the Fixed Overhead Volume Variance = $90,000 – $140,000 = $50,000 Favourable.

 

Interpretation: The FOH volume variance is favorable because the company achieved a higher output than anticipated in the budget.

 

3. Fixed overhead cost variance = (Actual Fixed Overheads – Absorbed Fixed Overheads)

 

FOH cost variance = ($120,000 – $140,000) = $20,000 Favourable

 

The addition of both volume and expenditure variance must give the same answer as FOH cost variance.

Therefore, $30,000A + $50,000F = $20,00 F.

 

The Advantages Of Fixed Overhead Cost Variance

1. It helps in assessing and improving operational performance.
2. It aids the decision-making of management.
3. It is a basis for assessing budgeting.

Limitations

1. FOH variance gives a shallow analysis of differences in fixed overheads.
2. Since Fixed overheads are made of components costs like depreciation, provisions, etc, a mistake in the estimate of such costs would result in the wrong variance analysis.
3. It is a complex concept for managers who are not in the line of finance or accounting.
4. It may be unnecessary and wasteful to monitor fixed overhead variances since its cost does not change regularly.