Managerial Accounting 10.5: Variable Overhead Variance Analysis - YouTube

This is Kurt Heisinger, accounting professor  at Sierra College and author of Managerial  

Accounting. This video describes how to calculate  the two variable manufacturing overhead variances.  

And we will start by talking about the flexible  budget and then continue that discussion by  

clarifying that we are going to be using the  flexible budget to calculate those two variances.  

So with the flexible budget, recall from a previous  video, that the flexible budget is calculated by  

taking the standard cost per unit, so for this  example it would be the standard cost per unit  

for variable manufacturing overhead, and multiply  that times the actual units produced. So remember  

that the flexible budget is prepared after the  year has gone by, the master budget is prepared  

before we start the year, but the flexible budget  is after the fact. And so we take the standard cost  

per unit that we established prior to beginning  the year and multiply that times the actual units  

produced that we know once the year has gone  by. So that gives us the flexible budget. And the  

idea then, in the second bullet point here, is to  compare the flexible budget with the actual cost  

that we incurred, that is in this example the  actual variable manufacturing overhead costs  

incurred. And then try to figure out why we had  a difference. And we have two different variances  

to help us to determine why we had a difference  between the flexible budget and actual costs. The  

first is the variable overhead spending variance,  and the second is the variable overhead efficiency  

variance. And so we will talk about both of those  next. The variable overhead spending variance  

is the difference between the actual costs for  variable overhead and the budgeted costs based  

on the standards. And so it is calculated here at  the very bottom of this slide, it is calculated by  

taking our actual costs, and subtracting from that  the budgeted cost based on standard. We figure that  

out by taking in this example, we are going to use  direct labor hours to allocate variable overhead,  

very common for companies to do that. So we are  going to take direct labor hours, we would just take  

the actual direct labor hours, times the standard  variable overhead rate per direct labor hour. So we  

are going to take the actual costs, minus the actual  hours, times the standard rate per hour. Next we will  

look at the variable overhead efficiency variance.  And the variable overhead efficiency variance is  

really the difference between the activity level  in the allocation base, and again we are in this  

series of slides going to use direct labor  hours as our activity or allocation base. So  

we are going to allocate overhead, variable overhead  cost based on direct labor hours. And there are  

many different ways to do it. So just in this  example we just happen to be using direct labor  

hours, because that tends to be pretty common.  We could use machine hours or some other form  

but we are going to use direct labor hours. So the  efficiency variance is really just the measuring  

the efficiency related to whatever the allocation  base is. And if we are using direct labor hours we  

are really measuring the difference between the  actual activity level in the allocation base, and  

the budgeted activity level in the allocation  base. So what were our actual direct labor hours  

and what were our budgeted direct labor hours and  will then attach a cost to each of those related  

to variable overhead and look at the difference. So  at the very bottom here, this is how we calculate  

the variable overhead efficiency variance. We  take the actual hours, here it is direct labor  

hours, times the standard rate per hour, and that  standard rate is not the direct labor rate it is  

the standard variable manufacturing overhead  rate per direct labor hour, and then we subtract  

from that the standard number of hours given  actual output, more on that later, times the again  

the same standard rate per direct labor hour,  standard variable manufacturing overhead rate  

per direct labor hour. So we take the difference  between the two of those and that gives us the  

variable overhead efficiency variance. So here is  an example of the calculations that are involved  

with those two variances that we just talked about  related to variable manufacturing overhead. And by  

the way variable manufacturing overhead, we are not  talking about fixed overhead here, we are talking  

about variable manufacturing overhead. That is a  separate lecture that I have created that relates to  

fixed manufacturing overhead variances. So the  two variances that you see here from left to  

right, are the variable overhead spending variance,  and the variable overhead efficiency variance. So  

going for again from left to right, we have actual  variable overhead costs of $100,000. So we will put  

that there upper left, and then we have to figure  out in the middle column the actual hours, here  

they happen to be direct labor hours. So you will  notice that this is the exact same number as a  

previous lecture that I created for direct labor  hour variance analysis. We are going to take actual  

direct labor hours of 18,900, and multiply it by  the standard rate of $5 per hour. And again that is  

the standard rate that is related to variable  manufacturing overhead not related to direct  

labor cost. That is a common confusion that students often have. So the $5 per hour is the  

variable overhead cost per direct labor hour. And  that then totals up to $94,500, and we take the  

difference between that and our actual costs and  that yields a 5,500 unfavorable variable overhead  

spending variance. So we essentially spent more  than we expected to spend here, given the actual  

number of direct labor hours worked. Now we go to  the far right and we are looking at the efficiency  

variance. And you will notice that we calculate  that by taking the standard hours allowed given  

actual production, and multiply that times that  $5 per hour per hour direct labor hour standard rate.  

The standard hours, make sure you look at the  footnote down below, that again is one of those  

trouble spots for students when they are  running these variances. The standard hours allowed  

give an actual output is shown right down here  at the bottom, this footnote right here, and the   

21,000 standard hours equates to the standard  of 0.1 direct labor hours per unit, and we had  

actual production and sales of 210,000 units, so  we simply take the 0.1 times 210,000 and that is  

where our standard hours of 21,000 comes from, and  that is right up here right up above. So we take  

that 21,000 in standard hours and multiply it by  the standard rate of $5 and that gives us $105,000.  

Then we take the difference between that and  the 94,500 and that yields a favorable variable  

overhead efficiency variance of $10,500. And that is  favorable strictly because our direct labor  

work force worked, actually worked less or fewer  hours than we expected them to work. They worked  

18,900 hours, when in fact we had expected them  to work 21,000 hours. So that is why we have a  

favorable variable overhead efficiency variance.  So one last item here. What we have done then to  

wrap this up is we have compared the flexible budget,  that is right here far right, the flexible budget to  

the actual costs. And we have two variances. You will  notice that the flexible budgets  

showed $105,000 in expected costs and the actual  costs for variable overhead totaled $100,000. So  

what we are doing here is we are explaining that  $5,000 difference through these two different  

variances. This slide describes some of the  possible causes for the variable overhead  

variances that you saw on the previous slide. And  again we would go out and research this being  

managerial accountants we would try to figure out  why we had these two different variances assuming  

that they are significant enough variances  to investigate. So we will start, just I will give  

you a couple of these. We will start with the  unfavorable variable overhead spending variance.  

And so why would our variable overhead spending  variance be unfavorable, why were those costs  

higher than we anticipated, is really what we are  getting at here. And one possibility is that  

we had a higher mix of indirect labor, we are  not talking about direct labor here. We had  

a higher mix of skilled indirect labor workers  and that could increase our hourly rates above  

the expected rates, and that then would mean that  our actual costs would be higher than expected.  

So that is one possible reason why that might  happen. Then let's take a look and you can look  

at the others here as well on your own, and  let's take a look at the right here at the  

efficiency variance. Remember we had a favorable  variable overhead efficiency variance and that  

our workers were efficient, were more efficient than we expected. So what might  

cause that. Now we are talking about direct labor  workers because remember our variable overhead  

costs are allocated based on direct labor hours.  So it can get a little confusing because over  

here we are talking about indirect labor, but  here we are talking about direct labor. Again  

because that is how our costs are allocated, and  because our direct labor workers worked fewer hours  

than expected we have this favorable variance.  So it could be that we had a higher mix of  

skilled direct labor workers than we initially  anticipated, and that would cause those workers  

to be more efficient, right if they are higher  skilled than expected, they would be perhaps more  

efficient than expected, and that would lead  to a favorable variable overhead efficiency  

variance. And again take a look there is some other  possibilities here as well. And we would have to go  

out to confirm these things, this is just to give  you an idea of what might cause these variances.