Variable overhead spending variance is defined as the difference between the actual rate and budgeted rate of spending on variable overheads.
Overheads are production expenditures that are indirect i.e. can’t be traced back to one unit of production like direct material or direct labor.
Variable overhead is an indirect expense that increases as production increases and decreases as production decreases for example diesel oil used in a production plant.
(Actual overhead rate – Standard overhead rate) * Actual hours worked
At the end of each year, a company must prepare a master budget. This preparation of a budget is a process that involves the estimation of prices, demand, and expenses for the following year.
Thus, a variable overhead budget is also prepared annually. On the basis of expected demand, the quantity and price of indirect materials and labor, utility bills, quality control, and others are forecasted.
All these lower budgeted expenses are then summed up and a standard cost of variable overheads is calculated.
However, the forecast is not always free of errors for several reasons, and the actual overheads incurred end up varying from the standard overheads.
Variance analysis is then performed for the purpose of pointing out flaws in the master budget to avoid such faults in the future.
The variance analysis helps a company scrutinize all the areas where costs can be reduced somehow to increase the overall profits of the company.
For example, 4ever Manufacturing ltd. is a company that produces tin cans. At the end of 2018 4ever Manufacturing had the following standard budgeted expenses for the year ended 2019:
Diesel oil 500
Utility bills 100
Indirect labor 30
Indirect material 20
The standard hours required for production were estimated to be 5000. Calculate the standard rate of variable overheads.
The standard rate of variable overhead or variable overhead per hour is calculated by dividing the total variable overheads by the standard hours of production.
In our example, the standard rate of variable overhead per hour would be $13 i.e. [(500,000+100,000+30,000+20,000)/5,000]
However at the end of 2019 due to an incorrect estimation of overheads the actual variable overhead per hour rate was $15 and the actual hours worked were 4500. Calculate the variable overhead spending variance.
(13 – 15) * 4,500 = -9,000
The negative ninety represents that 4ever Manufacturing had to pay $9000 more than they had expected to spend on variable overheads.
We apply the standard variable overheads over the actual hours worked by multiplying the standards rate of variable overheads by the actual hours worked.
The applied overhead value represents the amount of variable indirect expenses that would have been incurred if 4500 hours had been estimated instead of 5000 hours.
The company can then analyze how to reduce the extra ninety dollars spent to synchronize the actual profits with budgeted profits.
A variance can be favorable or unfavorable. A favorable variable overhead spending variance would be when the actual money spent on these expenses was less than the budgeted expense i.e. the actual variable overhead per hour rate would be less than the standard variable overhead per hour rate.
A favorable variance indicates an increase in profit.
On the contrary, however, an unfavorable variable overhead spending variance would be when the actual variable overhead rate per hour would be greater than the standard variable overhead per hour rate as shown in our example above.
An unfavorable variable overhead spending variance indicates a decrease in budgeted profit and is negatively affecting the company.