Importance and limitation of fixed overhead spending variance

Definition:

Fixed overhead spending or expenditure variance is the difference between actual fixed overheads incurred by the company and the budgeted fixed overheads that were estimated by the company before the year started. It can be calculated as follows:

Actual overheads – budgeted overheads = Fixed overhead spending variance

Analysis:

A favorable fixed overhead spending variance occurs when the actual fixed costs incurred by the company are less than actually incurred costs.

It means that the company managed to use its resources efficiently and minimized its overheads having a positive impact on the financial statements.

An unfavorable or adverse fixed overhead spending variance means that the company’s actual fixed costs exceeded the fixed costs the company had budgeted beforehand.

A higher actual fixed cost means that the targeted profit wasn’t achieved and the actual profit is lower than the budgeted profit. This has an adverse impact on the overall financial position of the company.

Importance of fixed overhead spending variance:

• Fixed overhead spending variance is an important component of the variance analysis. It assists in recognizing any major expenses that were incurred by the company unexpectedly. A fixed overhead spending variance may arise due to the following situations:
i. In order to increase the production capacity to meet the unexpected demand in market an investment in a plant or machinery for the factory may result in a fixed overhead spending variance due to increase in depreciation expense.
ii. Crossing the utility bill usage limit may cause this fixed cost to become a stepped cost resulting in a sudden huge increase in utility expense.
iii. Machine break-down or labor strike.
iv. Increase in national wage rate resulting in an increase in indirect labor cost.
v. Cost reduction measures taken during the year to minimize company’s production costs resulting in a decrease in fixed overheads and a favourable variance.
• A major chunk of production costs is attributed to fixed overheads. If these costs aren’t paid in the year they were accrued the current liability balance would increase significantly indicating that the company has liquidity issues. In order to avoid such problems a variance analysis of fixed overhead spending variance would give an idea of how much to increase our liquidity in order to circumvent a low current ratio.
• Performing a variance analysis on the fixed overheads would assist in identifying areas where costs could be reduced and inefficiencies could be eliminated i.e. cost rationalization.
• A fixed overhead spending variance analysis would help us plan future investments in plant or machinery and expansion of business.
• Analysis of fixed overhead variances would also assist in managing our resources in the most efficient manner by pointing out the reasons behind inefficiencies.

See also  Fixed Overhead Total Variance: Definition, Formula, Explanation, And Illustration

Limitations of fixed overhead spending variance:

• The fixed overhead spending variance only measures the difference between total overheads. No explanation is given as to which particular expense is the reason behind such variance.
• The above point is why fixed overhead variance analysis is time consuming. By the time the reasons are found out and cost-reduction measures are decided, newer fixed costs are incurred and the previous analysis becomes irrelevant.
• A lot of resources and costs are spent on a comprehensive analysis. This means that instead of improving our resource-management we are utilizing a lot of our resources in performing variance analysis on our costs resulting in internal inefficiencies.
• Total fixed overheads consist of all the indirect production costs such as depreciation, indirect material, indirect labor etc. An inaccurate estimate in any of these would result in a deviation between budgeted fixed overheads and actual fixed overheads.

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