Is the difference between budgeted fixed overhead and applied fixed overhead?

Overhead variances arise when the actual overhead costs incurred differ from the expected amounts. Managers want to understand the reasons for these differences, and so should consider computing one or more of the overhead variances described below. Each of these variances applies to a different aspect of overhead expenditures. It is not necessary to calculate these variances when a manager cannot influence their outcome.

Fixed Overhead Spending Variance

The fixed overhead spending variance is the difference between the actual fixed overhead expense incurred and the budgeted fixed overhead expense. An unfavorable variance means that actual fixed overhead expenses were greater than anticipated. The formula for this variance is:

Actual fixed overhead - Budgeted fixed overhead = Fixed overhead spending variance

The amount of expense related to fixed overhead should (as the name implies) be relatively fixed, and so the fixed overhead spending variance should not theoretically vary much from the budget.

Fixed Overhead Volume Variance

The fixed overhead volume variance is the difference between the amount of fixed overhead actually applied to produced goods based on production volume, and the amount that was budgeted to be applied to produced goods. For example, a company budgets for the allocation of $25,000 of fixed overhead costs to produced goods at the rate of $50 per unit produced, with the expectation that 500 units will be produced. However, the actual number of units produced is 600, so a total of $30,000 of fixed overhead costs are allocated. This creates a fixed overhead volume variance of $5,000.

Variable Overhead Efficiency Variance

The variable overhead efficiency variance is the difference between the actual and budgeted hours worked, which are then applied to the standard variable overhead rate per hour. The formula is:

Standard overhead rate x (Actual hours - Standard hours)
= Variable overhead efficiency variance

 A favorable variance means that the actual variable overhead expenses incurred per labor hour were less than expected.

Manufacturing overhead is an accounting term that refers to all indirect expenses incurred to build a product. For example, if your company uses a warehouse or production facility to produce a product, the electricity in that building is a manufacturing overhead expense. Applied manufacturing overhead applied to production and budgeted manufacturing overhead are both useful in manufacturing overhead accounting to ensure a product is profitable, or measure the profitability of manufacturing operations. They are also useful for inventory purposes in helping determine how much product to produce and how valuable inventory surplus is. These two figures help business decision makers determine how much product to produce, or whether to shut down the product manufacturing operations altogether.

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 ). Assume Jerry’s uses direct labor hours to assign fixed overhead costs to products shown in . 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 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 , and provide further detail following the figure.

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

*From , 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 . 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 , 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

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 , 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

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

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: 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.

Which is called difference between budgeted fixed overhead and actual fixed overhead?

What is a budgeted fixed overhead?

What are the two fixed overhead variances?

Which of the following is the difference between actual and budgeted amounts of fixed overhead costs?