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 by the company’s standard hours of the specific product to complete the production target during a particular period. For example, the 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 a favorable variance. In other words, it is a 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 needs to be reviewed.
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)
- Standard variable manufacturing overhead rate/price = SR
- Total actual hours worked during the period = AH
- Standard hours estimated for actual production = SH
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.
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 the formula,
Variable overhead efficiency variance=
= 30 × (10500 – 11000)
= 30 × (-500)
Then we get,
Variable overhead efficiency variance
= $15,000 favorable
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