Fixed overhead spending variance, also known as fixed overhead expenditure variance, measures the difference between actual fixed costs incurred and the budgeted fixed costs.
It is one of the two parts of fixed overhead total variance; the other is fixed overhead volume variance.
Budgeted fixed overheads – Actual fixed overheads = Fixed overhead spending variance
Fixed overhead variances are particularly important when it comes to variance analysis. A variance analysis compares all the budgeted figures with the actual figures and analyzes the reasons behind such differences.
After the reasons have been highlighted the company takes measures to deal with any material variances throughout the year to minimize costs.
Fixed overheads are a line item in our variance analysis because a fixed overhead is not supposed to vary, as the name suggests.
These are production costs incurred whether the output is produced or not.
They do not vary as the output varies unless a specific point is crossed and it becomes stepped costs instead of fixed costs.
Hence, any significant increase or decrease in fixed cost is a critical point for an entity and shall be dealt with immediately since an unexpected material expense would hurt the company’s financial statements.
A fixed overhead spending variance could arise due to various reasons. Some of them are mentioned below:
- Any unexpected expansion of business or investment may result in higher actual fixed overheads and lower budgeted overheads. On the contrary, an expected expansion of business not taking place would result in a lower actual fixed overhead and higher budgeted fixed overhead.
- Planning errors and inefficient overhead management may cause deviation in actual fixed overheads than budgeted.
- Unexpected over-time of indirect labor may be the reason behind higher actual fixed overheads and lower budgeted fixed overheads of the company.
For example, the production department of Tahkila Industrials expects that the annual fixed overheads of the company will be $500,000 for the year ended 2019.
However, during the period cost rationalization measures were carried out and fixed overheads were reduced by minimizing inefficiencies resulting in an annual fixed overhead expense of $420,000. Calculate the fixed overhead spending variance.
We must calculate the difference between budgeted and fixed overheads per the formula.
Fixed overhead spending variance = $500,000 – $420,000 = $80,000
The company realized a decrease of $80,000 in fixed overheads, resulting in a higher actual profit earned by the Tahkila Industrials than the budgeted profit.
There are two types of variances i.e. favorable and unfavorable/adverse. A favorable variance occurs when the costs incurred are lower than the budgeted costs.
Similarly, an adverse or unfavorable variance arises when the actual costs incurred are higher than the budgeted costs.
A favorable fixed overhead spending variance arises when the actual fixed overheads incurred by the company are lower than the budgeted fixed overheads.
As shown in the example above, Tahkila Industrial had a favorable variance for the year ended 2019 since they had to pay $80,000 less than expected.
This means that they must have had an unexpected earning of $80,000 positively affecting the financial statements.
An unfavorable or adverse fixed overhead spending variance would arise when the actual fixed overheads exceed the budgeted fixed overheads.
In such a case, the company incurs an entirely new expense that the production department didn’t anticipate. This results in an adverse effect on the financial statements of a company.