Importance and limitations of variable overhead spending variance

Variable Overhead Spending Variance:

Variable overheads are indirect variable expenses i.e. they can’t be traced back to one unit of production; depreciation expense of plant and machinery, for example.

Variable Overhead Spending Variance is the deviation in the expense incurred regarding variable overheads than what was expected.

It calculates the difference between actual variable overheads and applied variable overheads over the actual hours worked which helps us recognize how the costs could be reduced or minimized as the number of hours worked varies.

Formula for computation of variable overhead variance is as follows:

(Actual overhead rate – Standard overhead rate)  Actual hours worked

Analysis:

A favorable variable overhead spending variance is an indication of efficient management of costs causing the company’s profits to rise than what was forecasted.

It occurs when the actual variable overhead rate per hour is somehow less than the standard variable overhead rate signifying that the total expense incurred as variable overheads is less than the budgeted variable overhead expense.

An unfavorable or adverse variable overhead spending variance occurs due to a higher actual variable overhead rate than the standard variable overhead rate.

This has a negative impact on the financial statements since the actual manufacturing costs cross the line of the yearly budget.

Importance of variable overhead spending variance:

  • Variance overhead spending variance signifies various reasons that could have caused a variation in overheads. Some of the reasons are listed below:
  • An increase or decrease in the prices of indirect material due to inflation or discount on bulk orders.
  • An increase or decrease in minimum wage rate.
  • Overtime or bonus paid due extra work performed by indirect labor i.e. guards, factory supervisors, factory cleaners etc.
  • Planning and forecasting inaccuracies due to accounting errors.
  • An increase or decrease in depreciation expense.
  • Variable overhead spending variance assists in forecasting the amount of labor and the wage rate required for future needs.
  • It also helps in efficient use of resources due to better planning.
  • The variable overheads can be reduced to the minimum after identifying the reasons behind a variable overhead spending variance.
  • A variance analysis of variable overheads helps us recognize the future expenses that are to be incurred at a particular rate. These costs must be paid as soon as they are incurred or a current liability balance would increase on the balance sheet. The company must increase its liquidity as per the expenses budgeted.
See also  Importance and Limitation of Sales Volume Variances

Limitation of variable overhead spending variance:

  • A standard variable overhead rate is extremely likely to be incorrect and fictitious at a large level since it is a sum of various accounts. Human errors can be made while estimation of indirect labor/material rate, utility bills, consumables etc. A standard variable overhead rate is actually an average of a few correct and incorrect classifications of expenses.
  • It is too arduous to figure out the exact reason behind a variable overhead spending variance since you can’t put a finger on one specific overhead that was way more than the estimate.
  • Judgment by too many departments is involved in the total variable overhead calculation making it prone to error.
  • A variable overhead variance analysis can’t be applied to the service sector since most of their service cost includes overheads rather than direct costs or production costs.
  • Another major drawback is that it takes too much time to analyze the variances. This causes a time lag and the corrective measures are taken too late to be effective to the cause.
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