Importance and limitation of variable overhead efficiency variance

Variable overhead efficiency variance:

A variable overhead efficiency variance exhibits the difference between budgeted variable overheads and applied variable overheads.

In other words, it is the difference between standard hours and actual hours worked at the standard variable overhead rate.

It helps identify the cost saved or incurred by the company due to efficiency or inefficiency of labor.

An efficient labor produces one unit in less than the standard time of production whereas an inefficient labor takes more time than the standard time of production of one unit.

Variable overheads are indirect production costs incurred by the company that vary as the output varies.

Variable overhead efficiency variance can be calculated through the following formula:

(Actual hours – Standard hours)  Standard variable overhead rate per hour

Analysis:

A variable overhead efficiency variance is favorable when the actual hours worked by the labor are less than the standard hours required for the same quantity of production.

It means that instead of having to pay the labor a full rate for each hour saved, the company can give bonus to the employees instead and reduce its manufacturing cost while increasing the revenue as well.

This is having a positive impact on the financial statement hence, a favorable variance.

An unfavorable or adverse variable overhead efficiency variance occurs when the actual hours worked by the labor are more than the standard hours required to produce the same number of production.

It means that the labor has worked inefficiently, the productivity has reduced and more wages will be paid per hour while the revenue decreases as well due to lesser production.

See also  Importance and limitation of fixed overhead total variance

Importance of variable overhead efficiency variance:

  • A difference between actual hours worked and standard hours can be caused due to numerous reasons and variable overhead efficiency variance helps identify the reason behind it. Some of them are as follows.
  • The quality of raw material can affect the efficiency of labor since a good quality material is easy to manage whereas a poor quality material takes more time to work with.
  • Purchase of new advance machinery that consumes lesser time for production of single unit resulting in a favorable variance.
  • The hiring of labor is another factor. A skilled labor is more efficient than an unskilled labor, having major impacts on productivity and efficiency of the company.
  • Introduction of bonus or overtime pay.
  • Miscalculation and under- or over-estimation of budgeted costs.
  • A significant unfavorable efficiency variance would assist in identifying the need of change in working environment and an increase in salaries and wages so that productivity could be increased.
  • It would help us minimize the cost by managing the staff as needed. Efficiency variance helps in figuring out the lazy or inefficient workers that could be replace with skilled labor.
  • Better management of input resources (labor) can be done if a proper and well-researched variance analysis of variable overheads is done.

Limitations of variable overhead efficiency variance:

  • Total variable overhead account is a sum of all the small variable indirect expenses that are incurred during production or manufacturing. During the budgeting process all the expenses are estimated by the production department meaning there could be estimation errors in several of the small accounts resulting in an extremely fictitious standard variable overhead rate per hour.
  • Finding the reason behind a variable overhead efficiency variance could be a tiresome task since all the accounts must be checked for the reason behind such deviation.
  • It is difficult to analyze whether the variance is material or not since no materiality threshold is defined.
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