What is Variable Overhead Efficiency Variance? Definition, Formula, Explanation, And Analysis

Definition:

A variable overhead efficiency variance is one of the two contents of a total variable overhead variance. It is the difference between the actual hours worked and the standard hours required for budgeted production at the standard rate.

Variable overhead is an indirect production expense that varies based on production. It includes salaries and wages of factory supervisors and guards, utility bills, depreciation expenses, and others.

Formula:

You can calculate the variable overhead efficiency variance by the formula given below

(Standard hours – Actual hours)  * Standard Rate

where standard rate refers to the standard rate of variable overhead per hour.

Explanation:

When the master budget is prepared, many other small budgets are prepared by all the different departments in the company beforehand preparation of the master budget.

Thus, the production department does the same and provides an estimate of production costs that will be incurred in the following year.

One of the line items of a production budget is variable overheads.

The variable overheads are based on the previous production practices, estimated working hours that will be required in the coming year, and the capacity level of the company.

For example, the quantity of diesel oil utilized is estimated based on previous production units.

The total standard cost for diesel oil is then calculated by multiplying the quantity with the standard rate at which diesel oil will be bought.

The standard rate is adjusted per all price-increasing/decreasing factors (inflation rate, different suppliers, etc).

Similarly, indirect labor salaries and wages, including factory supervisors and guards, are estimated. Such an estimate is then incorporated into the total variable overhead expense.

See also  Sales Price Variance: Definition, Formula, Explanation, Analysis, and Example

To calculate the standard rate of variable overhead per hour the budgeted total variable overhead expense is divided by the budgeted hours necessary for production.

At the end of the forecasted year, the budgeted quantities are compared to the actual quantities. This process is called variance analysis.

In the calculation of variable overhead efficiency variance, standard hours i.e. the working hours that were required to produce the given quantity are compared against the actual hours taken by the employees to produce the number of demanded units.

A variance in variable overheads may typically arise due to a sudden increase in inflation rate or maybe due to a change in supplier of indirect materials at the eleventh hour.

If the variance is significant, the company must take appropriate measures to reduce such overheads to a minimum.

Let me illustrate how you should calculate the variable overhead efficiency variance. For example, a company’s standard card showed a standard variable overhead rate per hour at $5 and the standard hours for the required production were 4,000.

However, due to labor inefficiency, it took them 5,000 hours to meet the required production. Calculate the variable overhead efficiency variance.

(4000 – 5000) * 5 = -5000

Analysis:

A variance can be favorable and unfavorable. An unfavorable variable overhead efficiency variance is when the standard hours required for production are less than the actual hours worked.

As shown in the above example, a negative variance of $5,000 is shown. This means that the company had to pay $5,000 more than expected.

Similarly, a favorable variable overhead efficiency variance is when the employees do the required work in a lesser time than what was budgeted.

See also  What Are the Importance and Limitation of Sales Volume Variances?

A favorable variance occurs when the standard hours are more than the actual hours worked and signifies that the company incurred fewer variable overheads than expected.