Learning Objective of the article:

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

## Definition:

Factory overhead efficiency variance is the difference between actual hours worked multiplied by standard overhead rate and standard hours allowed times the standard overhead rate.

Overhead efficiency variance is the responsibility of department management. The reasons / causes of unfavorable efficiency variance include inefficiencies, inexperienced labor, changes in operations, new tools, and different types of materials.

## Formula of efficiency Variance:

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

[(Actual hours worked × Standard overhead rate) – (Standard hours allowed for actual production × Standard overhead 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 factory 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 factory overhead efficiency variance:

 Actual hours worked × Standard overhead rate (3,475 actual hours × \$2 standard hours) \$6,950 Standard hours allowed × Standard overhead rate  ( 3,400* standards hours × \$4 standard overhead rate) \$6,800 ——— Overhead efficiency variance \$150 unfav.

*850 × 4 = \$3,400

This variance can also be computed as follows:

 Actual hours worked 3,475 Standard hours allowed 3,400 ——— Difference 75 ——— overhead efficiency variance (75 hours × 2 standard overhead rate) \$150 unfav. ======

This variance consists fixed and variable expenses and occurs when actual hours used are more or less than the standard hours allowed. When labor hours are the basis for applying factory overhead, this variance and its cause reflect the effect of the labor efficiency variance on factory overhead. When machine hours are the basis, the variance relates to efficiency of machine usage.