Learning Objective of the article:

1. Define and explain variable overhead efficiency variance.
2. How is variable overhead efficiency variance calculated?
3. What are the reasons / causes of unfavorable variable overhead efficiency variance.

When companies adopt four variance analysis approach they divide the overhead efficiency variance  (which is calculated when three variance approach is used) into its variable and fixed components. Variable component is called variable overhead efficiency variance and fixed component is called fixed overhead efficiency variance.

## Formula of Variable overhead Efficiency Variance:

Following formula is used for the calculation of variable overhead efficiency variance:

[Budgeted allowance based on actual hours worked* –  Budgeted allowance based on standard hours allowed**]

*Fixed expenses budgeted + (Actual hours worked × Standard variable rate)

**Fixed expenses budgeted + (Standard hours allowed × Standard variable rate)

## Example:

Following is the flexible budget of a department of a manufacturing company.

 Department 3 Monthly Flexible Budget Capacity 80% 90% 100% Standard production 800 1,000 1,200 Direct labor hours 3,200 4,000 4,800 Variable factory overhead: Indirect labor \$1,600 \$2,000 \$2,400 \$0.50 / dlh Indirect materials 960 1,200 1,440 \$0.30 Supplies 640 800 960 \$0.20 Repairs 480 600 720 \$0.15 Power and light 160 200 240 \$0.05 ———- ———- ———- ———- Total variable factory overhead \$3,840 \$4,800 \$5,760 \$1.20 per dlh ====== ====== ====== ====== Fixed factory overhead: Supervisor \$1,200 \$1,200 \$1,200 Depreciation on machinery 700 700 700 Insurance 250 250 250 Property tax 250 250 250 Power and light 400 400 400 Maintenance 400 400 400 ———- ———- ———- Total fixed factory overhead \$3,200 \$3,200 \$3,200 \$3,200 per month ———- ———- ———- ====== Total factory overhead \$7,040 \$8,000 \$8,960 \$3,200 per month + \$1.20 per dlh ====== ====== ====== ======

Following data is also provided:

Actual factory overhead is \$7,384. Actual production is 850 units of finished product. Actual hours used are 3,475 hours. 4 standard hours are allowed to complete a unit of finished product.

Required: Calculate variable overhead efficiency variance.

### Calculation of Standard Overhead Rate:

Assuming that 90% column represents normal capacity, the standard overhead rate is computed as follows:

Total factory overhead / Direct labor hours

= \$8,000 / 4,000

= \$2 per standard direct labor hour

At 90% capacity level, the rate consists of:

Total variable factory overhead / Direct labor hours

= \$4,800 / 4,000

= \$1.20 variable factory overhead rate

Total fixed factory overhead / Direct labor hours

= \$3,200 / 4,000

= \$0.80 fixed factory overhead rate

Total factory overhead rate at normal capacity:

(\$1.20 + \$0.80) = \$2.00

### Calculation of  variable overhead efficiency variance:

 Budgeted allowance based on actual hours worked: Fixed expenses budgeted \$3,200 Variable expenses (3,475 actual hours × 1.20 standard rate) \$4,170 ———- \$7,370 Budgeted allowance based on standard hours allowed: Fixed expenses budgeted \$3,200 Variable expenses (*3,400 standard hours × 1.20 standard rate) \$4,080 ———- \$7,280 ———- Variable overhead efficiency variance \$90 unfav. ======

*850 × 4 = \$3,400

This variance recognizes the difference between the 3,475 actual hours worked and the 3,400 standard (or allowed) hours for the work performed. Multiplying the difference of 75 hours times \$1.20 (variable expense rate) results in \$90. The sum of the spending variance  and variable efficiency variance equals the controllable variance, \$104, of the two variance method.

When variable overhead efficiency variance and fixed overhead efficiency variance are combined, they equal the efficiency variance of the three variance method. This concept is further explained by the following equation: