How to calculate variable Overhead Efficiency Variance?

Variable overhead efficiency variance is the difference between actual hours worked at standard rate/price and standard hours allowed on standard rate/price.

The standard hours are the total number of hours required to complete the production target during a particular period. For example, standard labor hours to produce an iPhone is 10 hours.

This is an important management tool used to compare the budgeted hours allowed on the standard rate with actual hours worked on the standard rate. For example, the actual hours to produce an iPhone is 15 hours.

It gives information about the efficiency of a certain department. The results that arise from variable overhead efficiency variance is can be termed as a favorable or unfavorable variance. For example, the company spends 5 more hours to produce an iPhone.

When the actual hours worked are less than the budgeted hours estimated by management, we called this difference as a favorable variance. In other words, it is the good performance.

While if the actual hours worked are higher than the budgeted hours estimated by management, we called it unfavorable variance. Or we can say the performance need to be review.

Formula:

The formula for variable overhead efficiency variance can be derived as,

Variable Overhead Efficiency Variance = (Actual hours worked × Standard/ estimated rate) – (Estimated hours × standard rate)

Talking the standard rate as common, we will get:

= Standard rate × (Actual hours worked – Budgeted hours allowed)

In short, we can describe the formula as

Variable Overhead variance = SR × (AH – SH)

Where,

  • Standard variable manufacturing overhead rate/price = SR
  • Total actual hours worked during the period = AH
  • Standard hours estimated for actual production = SH

Example:

The following information is extracted from the Indiana Company Pvt for the month of August.

  • Variable budgeted manufacturing overhead amounted to = $352,000
  • Estimated or budgeted hours allowed for production = 11,000hours
  • For standard manufacturing overhead rate = $32 (352,000/11,000)
  • Standard time estimated per unit = 3 hours
  • The actual hours worked during the period = 10500
  • Number of actual units produced = 5500

Required: Calculate the variable overhead efficiency variance for Indiana Company for the month of August.

Solution:

The formula for variable overhead efficiency variance = SR × (AH – SH)

Gather the required information from the question:

  • Standard rate (SR) = $30
  • Actual Hours = 10,500
  • Standard Hours = 11,000

Now put all the information in formula,

Variable overhead efficiency variance=

= 30 × (10500 – 11000)

= 30 × (-500)

Then we get,

Variable overhead efficiency variance

= $15,000 favorable

Explanation:

The result is favorable because our actual hours are less than our budgeted hours. It means that the company employees have completed their work earlier than expected.

And that’s why the efficiency graph goes higher and in the end, the result is a favorable one.

Causes of favorable variable efficiency variance:

The reasons for the favorable variable should be kept in mind so that the company can evaluate the best information from their calculation.

Because sometimes it’s not the hard work of the department which results in favorable variance, sometimes there are other factors also, which are not in control of the management.

  • Change of technology which increases the efficiency level automatically. It means that now the units will be produced at the much faster as compared to old machines.
  • Induction of highly skilled labor also decreases production.
  • The company may introduce any motivational plan to the employee, and the plan got popularity in the employees. In this way the company’s production graph increase without much change in hours required.
  • Change in type of material, which allows machines and labor to work faster.
  • The allocated budget may be high as compare to actual. That may be the reason for the difference.

Causes of unfavorable variance:

  • For unfavorable variance, there may be one of the following reasons
  • Change of material type, which is hard to handle and convert into finished goods
  • Employees get demotivated due to some reasons
  • Due to errors in setting up the standards and budgets

How to Calculate Direct Labor Efficiency Variance?

The direct labor variance is the difference between the actual labor hours used for actual production and standard labor hours allowed for actual production on standard labor hour rate.

From the definition, you can easily derive the formula:

Direct labor efficiency variance = (Actual labor hours – budgeted labor hours)

Labor efficiency variance compares the actual direct labor and estimated direct labor for units produced during the period.

It is a very important tool for management as it provides the management a very close look at the efficiency of labor work.

Example of direct labor efficiency variance

ABC Company is producing crystal glass in a very high tech company. Labor is used for packing the glass into cotton. The company is recently implemented the standard costing system.

The management estimate that 2000 hours should be used for packing 1000 kinds of cotton of glass.

The actual results show that the packing department worked 2200 hours while 1000 kinds of cotton are packed. The standard cost for labor hour is $40.

Required: Calculate the efficiency variance

Solution:

Write down the formula

Direct labor efficiency variance = (actual labor hours – budgeted labor hours) × standard labor rate

 Write down the important data from question

Actual labor hours used in 2200

Standard labor hour allowed 2000

Standard rate 40/hour

Now put the amounts in the formula

Direct labor efficiency variance = (2200-2000) × 40

= (200) × 40

Direct labor efficiency variance = 8000 unfavorable.

Example#2

MI is a leading manufacturing company in the field of making jeans. MI manufactured and sold 10,000 pairs during the period.

Following are information about company’s direct labor and their cost.

  Actual Hours/unit Standard hours/unit Actual rate/hour Standard rate/hour
Direct Labor 0.6 0.7 $14 $12

Labor variance can calculated in the following 5 steps

1) Calculation of Actual Hours

Actual hours = 10,000 × 0.6 = 6,000 hours

2) Calculation of standard cost on actual hours

Standard cost of actual hours = Actual hours × estimated rate

= 6,000 × 12 = 72,000

Step 3 Calculation of standard hours

Standard hours will be = 10,000 × 0.7

 = 7,000 hours

Step 4 Calculation of standard cost

Standard hour’s × standard rate

 = 7,000 × 12 = 84,000

Step 5 Calculation of variance

Labor Efficiency variance = estimated/standard cost of actual hours – standard cost

= 72,000 – 84,000

= 12,000 favorable.

Explanation:

Measuring efficiency of labor department is as important as any other task. Because labor cost is one of the major components of any product.

If the company fail to control the efficiency of labor, then it becomes very difficult for the company to survive in the market.  

Standard costing plays a very important role in controlling labor cost with maximize the efficiency of labor department. The result of efficiency variance be either favorable or unfavorable.

Favorable variance means that the actual labors hours’ usage is less than the actual labor hour usage for a specific certain amount of productions.

It also indicates that the management strategies are following by the labors. It is stated that there should be some motivation, if you apply standard costing in your organization.

Unfavorable efficiency variance means that the actual labor hours are higher than expected for a certain amount of unit’s production.

The unfavorable variance tells the management to look on the production process and identify where the loop holes are, and how to fix it.

How to calculation of Overhead Spending Variance?

The difference between actual variable manufacturing overhead incurred during the period and actual hours worked during the period on standard variable overhead rate is known as overhead spending variance.

From the calculation of overhead spending variance formula, you will get either favorable or unfavorable result.

Like if your company’s actual manufacturing overhead is higher than the actual hours worked at standard price, you will get a favorable variance. Which means that the company’s has achieved their targets sets for the period.

And if the company actual manufacturing overhead are less than actual hours worked on standard rate, the variance you will get would be an unfavorable one.

Calculation of Overhead spending variance:

The formula for overhead spending variance is as under

Variable overhead spending variance = (Actual hour × Actual variable overhead rate) – (Actual hours worked × standard variable overhead rate)

so,

Variable overhead spending variance = Actual hours worked (Actual variable overhead rate – Standard variable overhead rate)

For more detailed learning please read the example given below

Example:

The DJ Company has compiled the following data for the month of December 2018

Calculation shows that actual manufacturing overhead of the company are 80,000, the standard manufacturing rate set by company is 12 dollar per hour. And the actual hours worked during December are 7000 hours.

Required: calculate the variable overhead spending variance using the above information for the month of December.

Solution:

The given formula for variable manufacturing overhead is

Variable overhead spending variance = Actual hours worked (Actual variable overhead rate – Standard variable overhead rate)

Putting the values in formula

= 7000 × (11.5 (W-1) – 12

=7000 × -0.5

= 35, 00 fav

W-1

Actual overhead rate = Actual manufacturing / Actual hours worked

= 80,000/(7000)

= $11.4

Analysis:

Now analyze the calculation, you will find that the actual overhead rate is less than the standard rate which $12.

Example#2

ABC Company estimates that their variable overhead will be $20 per hour. In January the actual overhead rate identified as $23 per hour.  The actual labor hours worked are 20,000.

Required: Calculate the variable spending overhead variance

Solution:

Variable overhead spending variance = Actual hours worked (Actual variable overhead rate – Standard variable overhead rate)

=20,000 × ($23 – $20)

=20,000 × 3

Variable overhead spending variance = $60,000

Causes of Variable overhead spending variance

A favorable variance is always a good sign for company’s management. As it shows that the company has achieved what was planned at the start of period. The following are the reasons of creating variable manufacturing overhead:

  • The change in demand and supply of indirect material, which were not expected by the management at time of making budget.
  • Due to efficient approach by purchase department, company receives more purchase discount than normal.
  • Due to technological change inside the company, which results in lower the cost of fuel and power sources. For example, company installed a new plant which is more fuel efficient than the previous one.

Causes of Unfavorable Variance

Following are the reasons which results in unfavorable variable manufacturing overhead variance.

  • Due to demand of labor in the market, results in increase in per hour rate of labor. There may be shift of human resource from one area to another region.
  • The use of outdated and inefficient machinery also results in high manufacturing cost.
  • Used of unskilled indirect labor also increase the manufacturing overhead in total.

There may be some changes in the overhead supplies due to change in government rules and regulation.

How to Calculate Direct Labor Rate Variance?

The difference between the actual direct rate and standard labor rate is called direct labor rate variance.

Direct labor variance is a management tool to compare the budgeted rate set for direct labor at the start of production with the actual labor rate applicable during the production period.

Management can revise their budgeted rate if there is something extra ordinary happens in the normal course of business.

Standard should be real and based on the past experience, as the unreal standards may affect adversely.

How to Calculate Direct Labor Rate Variance:

The formula for direct labor may be derived as

(Standard rate × actual hours used) – (Actual rate × Actual Hours used)

So Actual Hours Used (Actual Rate – Standard Rate) = Direct Labor Rate Variance

The following example will help you to understand further

Example:

The Coporal Company is a larger manufacturer of handmade furniture. Management decides to apply standard costing in the labor department to analyze and control the labor cost.

Corporal Company manufactures and sold 10,000 units of furniture during the period.

Direct labor cost are as follows:

  Item   Actual Hours/Unit Standard Hours/Unit Actual Rate/Hour Standard Rate/Hour
Direct Labor 0.6 0.7 $13 11

Calculation of Labor Rate Variance

First we have to calculate actual labor hours used:

Actual Hours = Actual Units Manufactured × Actual Price

= 10,000 × 0.6

= 6,000 hours

Now calculate the actual cost

Actual Labor Cost = Actual Hours × Actual Rate

  = 6,000 × 13

  = $78,000

Now calculate the standard amount of actual number of hours

Standard cost of actual hours = Standard rate × Actual hours

 = 6000 × 11

= $66,000

Now you have calculate all the components of formula

Direct material rate variance = Actual Cost – Standard cost of actual hours

 =78,000 – 66,000

 = 12,000 Adverse

Analysis:

A favorable variance may arise due to one of the following reasons:

  • The phenomena of supply and demand also applies on the labor rate. Like if the availability of labor is more in the market while the demand is not really high. Then it is possible that labor decrease their rate to get some work. This decrease in rate also benefits the organization and gets a favorable variance at the end of period.
  • If the company due to some reasons go for relatively unskilled or semi-skilled labor. Then they have to pay on less rate as compare to highly skilled labors. 
  • There may be wrong estimations taken by the management about the labor rate. They may sets very high rates as compared to actual labor rates. It will give you favorable variance, at the end when you compare the two.

Causes for unfavorable variance:

  • If there is a boom in the labor rate throughout the market. Then organization have to increase their wage rate to retain their skilled labor.
  • Due to some reasons HR did not work efficiently and hired labor on much higher rate than expected.
  • If the labor union is strong enough to approve their demands.
  • Company may hire some highly skilled labor as compared to their needs.

Conclusion:

Labor rate variance is widely used in almost all manufacturing companies. Management are always want to find some new ways to control their product’s price.

And direct labor is one the essential part of cost of goods sold. So every company want to set some high standards in order to achieve the desired rates.

But as we discussed there are certain things, which are not in the control of management and there may arise some unfavorable variance.

How to calculate sales volume variance?

Introduction

Sales volume variance is used to measure the effect on the profit or contribution margin of the difference between the actual quantity sold and the budgeted sales quantity that is the quantity decided to be sold prior to actual sales.

In absorption costing the variance shows the impact on the profit whereas in marginal costing the impact is reflected on the contribution.

 Explanation

Since it is highly unlikely for the producers to achieve the budgeted sales quantity data, the actual quantity will mostly differ from the standard quantity.

The reasons behind this can be changes in the pattern of quantity demanded overtime, sales workforce efficiency and skills and changes in competition in the market.

The sales volume variance is calculated by taking the difference between actual quantity sold and the budgeted sales quantity and then multiplying it with the standard profit per unit or with standard contribution per unit depending upon the which type of costing is used that can be absorption or marginal. Following are the formulas illustrated using different costing.

Sales volume variance can be favorable or it can be adverse. In the case of a favorable sales volume variance the quantity actually sold is greater than the quantity which was budgeted.

This means that the producers were successful enough to sell more than they set a band for and earning more.

The reasons for this scenario can include effective skills of the sales department, extensive marketing campaigns or competitors leaving the market and the businesses attracting new customers.

Example:

A company has a budget to sell 350 combs at standard selling price of $8, the standard variable cost to produce a comb is $4 and the overhead absorption rate per comb is $2.

The actual quantity sold by the company is 360. The calculation of the variance is as follows.

The variance is adverse when the actual sales volume is less than the budgeted sales volume, this can be because of the decrease in the quantity demanded as compared to the expected demand, the products going out of fashion, poor quality of the product and rigid competition.

An adverse variance indicates that the company was not able to achieve its budgeted goal and ended up selling the quantity below the standard level, the result of this will be in the form of low profits and contributions.

Example:

The budgeted sales quantity to be sold is 200 cups and the standard contribution per unit is $6 and profit per unit is $4, whereas the actual quantity sold is 150 cups.

The variances can also occur due to wrong budgeting of data and poor research skills.

How to calculate sales price variance?

Sales Price Variance occurs when the actual selling price of a commodity or service differs from the standard selling price set by the management, which is an estimated selling price decided beforehand.

It is not possible that businesses will always attain the standard and budgeted sales data.

The actual price can vary due to market conditions and changes in the competition, changes in the profit margin or offering customer unplanned discounts.

Sales price variance is a helpful set of calculation for businesses to be aware of their products success in the market and how much they contribute in the overall sales revenue.

It helps them plan whether to provide discounts or to raise the prices of the product.

To calculate the variance, the actual revenue and the revenue generated from the actual quantity if sold at the standard price is compared, which means the sale price variance is the difference between the revenue actually generated with the actual selling price and the revenue that should have been generated with the standard selling price.

Formula:

Example:

Standard sales quantity of shirts is 500 units and the standard selling price is set at $50 whereas the actual quantity sold is 550 units at a selling price of $52, the sale price variance will be as follows

Analysis:

Variance can be favorable or it can be adverse; sales price variance is favorable when the actual sales price is greater than the standard sales price.

This can be because of high demands of the product, aggressive marketing campaigns leading to higher prices in the market, few competitors available in the market or the actual cost of the product of the item is greater and to cover the profit margin manufactures have raised the actual price of the item.

As shown in the example above the actual price is $52 whereas the standard price is $50, since the actual price is greater that is why the actual revenue generated is more than the standard revenue the variance of $1,100 is in the favor of the producers.

In conclusion, they have earned more than the expected, standard revenue which they decided before selling the items.

Sales price variance is adverse when the actual selling price is less than the standard selling price.

For instance, the standard quantity of mugs to be sold is 300 units at a standard selling price $20 but the actual quantity sold is 250 units at an actual selling price of $16, the calculation of the variance is below

Since the actual price $16 of the mug is below the standard price $20, the variance is adverse.

The reasons can be a decline in the demand of the certain mugs and the producers are trying to clear their stock of mugs by offering the consumers discounts on the prices or there are new entrants in the market of the mugs.

However, if the variances that occurred are huge this can be due to poor planning of budgeted data and unrealistic study about the market of the product and the competitors.