A variable overhead efficiency variance is one of the two contents of a total variable overhead variance.
It is defined as the difference between the actual hours worked and the standard hours that were required for budgeted production at the standard rate.
Variable overhead is an indirect production expense that varies on the basis of production. It includes salaries and wages of factory supervisors and guards, utility bills, depreciation expenses, and others.
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.
When the master budget is prepared there are many other small budgets 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 are going to 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 are going to be required in the coming year, and the capacity level of the company.
For example, on the basis of previous production units, the quantity of diesel oil that is going to be utilized is estimated.
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 as per all price increasing/decreasing factors (inflation rate, different suppliers, etc).
Similarly, salaries and wages of indirect labor which includes factory supervisors and guards are estimated. Such estimate is then incorporated into the total variable overhead expense.
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 then the company must take appropriate measures to reduce such overheads to the minimum.
Let me illustrate how you should calculate the variable overhead efficiency variance. For example, a company’s standard card showed a standard rate of variable overhead per hour at $5 and the standard hours for the required production were 4000.
However, due to labor inefficiency, it took them 5000 hours to meet the required production. Calculate the variable overhead efficiency variance.
(4000 – 5000) * 5 = -5000
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 what was expected.
Similarly, a favorable variable overhead efficiency variance is when the employees do the required work in a lesser time than what was budgeted.
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.