by Dr Philip E Dunn
Various definitions and terminology appear in texts in management accounting
on the subject of the preparation and interpretation of fixed overhead
variances; but the fixed overhead variance and the sub-analysis of this
variance in standard absorption costing is shown as:
(1) Fixed Overhead Variance |
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(1.1) Fixed Overhead
Expenditure Variance |
(1.2) Fixed Overhead
Volume Variance |
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(1.3)
Fixed Overhead
Capacity Variance |
(1.4)
Fixed Overhead
Efficiency Variance |
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The variances have been defined as:
(1) Fixed Overhead Variance
The difference between the fixed overhead recovered in the activity
achieved and the actual fixed overhead incurred. It represents either
an under or over-recovery of fixed cost.
(1.1) Fixed Overhead Expenditure Variance
The difference between the budgeted and actual fixed cost for the period.
(1.2) Fixed Overhead Volume Variance
That part of the fixed overhead variance which is due to the difference
between the budgeted and actual level of activity and its effect on
the overhead recovered.
(1.3) Fixed Overhead Capacity Variance
That part of the volume variance which is due to the difference between
the budget or planned capacity in standard hours and the actual capacity
expressed as hours worked, and its effect on overhead recovered.
(1.4) Fixed Overhead Efficiency Variance
That part of the volume variance which is due to the efficiency of labour.
Before illustrating fully the preparation and analysis of the fixed
overhead variance, I wish to focus on the key control ratios. They form
an essential part of any variance analysis report to cost centre management
and are an aid to interpreting and analysing the fixed overhead variance.
These ratios include:
- Productivity – efficiency;
- Utilisation – capacity;
- Production Volume – activity.
These ratios use the concept of the standard hour, which allows management
to express budgeted and actual levels of activity in terms of the standard
hour.
The ratios are expressed as:
- Efficiency
Standard hours produced x 100/1
Actual hours worked
- Capacity
Actual hours worked x 100/1
Budget, standard hours
- Activity
Standard hours produced x 100/1
Budget, standard hours
The efficiency ratio is a measure of the effectiveness of the workforce,
capacity a measure of utilisation and activity a measure of production
volume.
I wish to use the model of ‘the control ratios’ to illustrate fully
the application and analysis of the fixed overhead variance and the
link with these measures.
The case study which follows focuses on these concepts.
Case study
Cuecraft manufactures snooker cues and the budget and actual
data for the quarter January–March 2001 was:
|
January |
February |
March |
Total |
Production and sales in units standard hours/ unit 4 |
2000 |
2500 |
3000 |
7500 |
Actual production and sales in units |
2300 |
2600 |
3100 |
8000 |
Actual hours worked |
9430 |
10140 |
12555 |
32125 |
Budgeted fixed overhead for quarter £84,000 |
Actual fixed overhead incurred £84,350 |
Firstly, I wish to consider the control ratios for the period:
Production and sales units budgeted |
7500 |
Standard hours/unit |
4 |
Budget standard hours |
30000 |
Actual production and sales in units |
8000 |
Standard hours produced |
32000 |
Actual hours worked |
32125 |
Efficiency Ratio
32000 x 100
32125 1
= 99.6%
Capacity Ratio
32125 x 100
30000 1
= 107.1%
Activity Ratio
32000 x 100
30000 1
= 106.7%
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We can clearly see that production volume is favourable and is
approximately 7 per cent greater than planned. As the efficiency
is only marginally adverse, the additional volume has been achieved
by management allowing more hours to be worked to meet the increased
demand.
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In order to prepare and present the fixed overhead variance and its
full analysis, a fixed overhead recovery rate needs to be calculated
for the period (FORR).
Budget fixed overhead
Budget standard hours
£84,000 = £2.80 per standard hour
30,000
If fixed costs remain in line with budget, and the volume planned
is achieved, the fixed costs will be fully recovered.
1 Fixed Overhead Variance
Fixed overhead recovered in the period less the fixed overhead incurred.
|
£ |
32,000 standard hours x £2.80 |
89,600 |
Actual incurred |
84,350 |
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5,250F |
This is favourable variance and represents an over-recovery of fixed
overhead during the period.
1.1 Fixed Overhead Expenditure Variance
Budget fixed overhead less actual incurred. £84,000 – £84,350
= £(350). This adverse variance indicates a marginal overspend
on fixed costs for the period.
1.2 Fixed Overhead Volume Variance
(Budget standard hours – standard hours produced) FORR
(30,000 – 32,000) £2.80 = £5,600 F.
As the level of production volume is favourable, i.e. the level of
activity is up, then an over-recovery results. There is a direct link
here with the activity ratio, which was 106.7 per cent for the period.
Volume = activity.
The favourable volume variance is highlighted by a favourable activity
ratio. Full recovery of fixed overhead being planned on an activity
of 7,500 units or 30,000 standard hours.
1.3 Fixed Overhead Efficiency Variance
As we have a marginally adverse efficiency ratio, then there will be
an adverse fixed overhead efficiency variance.
(Standard hours produced – actual hours worked) FORR
(32,000 – 32,125) £2.80 = (350)
This represents an under-recovery due to the inefficiency of the workforce.
1.4 Fixed Overhead Capacity Variance
As the management increased the hours available in the period, as shown
by the capacity ratio at 107.1 per cent, it is obvious that a favourable
variance will be highlighted here.
(Budget standard hours – actual hours worked) FORR
(30,000 – 32,125) £2.80 = £5,950 F
Summary of variances
F/(A)
Fixed overhead variance £5,250F
Fixed overhead expenditure variance (350)
Fixed overhead volume variance £5,600F
£5,250F
NB: The volume variance comprises fixed overhead efficiency variance
of (350) and fixed overhead capacity variance of £5,950 F.
This illustrates that under or over-recovery of fixed overhead in
the short run is influenced by either expenditure and/or volume. The
level of activity is directly affected by the efficiency of the workforce
or by management providing the capacity, or a combination of both.
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