Last editedJan 20212 min read
Fixed overhead volume variance is the difference between the amount budgeted for fixed overhead costs based on production volume and the amount that is eventually absorbed. This variance is reviewed as part of the cost accounting reporting package at the end of a given period.
The fixed overhead costs included in this variance tend to be only those incurred during the production process, such as factory rent, equipment depreciation, staff salaries, insurance of facilities and utility fees.
Because they are fixed within a certain range of activity, these overhead costs are fairly easy to predict. This simplicity of prediction sees some businesses create a fixed overhead allocation rate that is used throughout the year. The allocation rate is the expected monthly amount of fixed overhead costs divided by the number of units produced.
However, if a company is experiencing rapid changes in its production systems, it may need to revise its overhead allocation rate more frequently, say monthly.
When can fixed overhead volume variance occur?
When the actual amount budgeted for fixed overhead costs based on production volume differs from the figure that is eventually absorbed, fixed overhead volume variance occurs.
There are a number of reasons why this can happen, aside from simply poor forecasting. If sales on a product are seasonal, production volumes on a monthly basis can fluctuate.
If production volume relies on the labor hours of workers and a company implements new efficient practices that reduce the number of hours needed to produce a product, more units will be made than budgeted.
Similarly, if the allocated volume is down to the number of machine hours and a company outsources some or all of its production, the budgeted amount of machine hours will be much less than expected.
Example of fixed overhead volume variance
Chuck is the manager of a company in New York selling tiles. In its New Jersey factory, the company budgets for the allocation of $75,000 of fixed overhead costs to produce the tiles at a rate of $25 per unit produced.
The expectation is that 3,000 units will be produced during a time period of two months. However, the actual number of units produced is only 2,000, resulting in a total of $50,000 fixed overhead costs. This creates an unfavorable fixed overhead volume variance of $25,000.
Fixed overhead volume variance is subdivided into:
Fixed overhead capacity variance
Fixed overhead efficiency variance
The sum of these two variances need to equal the fixed overhead volume variance.
Fixed overhead capacity variance is the difference between absorbed fixed production overheads attributable to the change in number of manufacturing hours, compared to what was budgeted.
It is calculated as (budgeted production hours minus actual production hours) x (fixed overhead absorption rate divided by time unit),
Fixed overhead efficiency variance is the difference between absorbed fixed production overheads attributable to the change in the manufacturing efficiency during a period.
It is calculated as (standard production hours minus actual production hours) x (fixed overhead absorption rate divided by time unit)
Fixed overhead volume variance limitations
Beside from its role as a balancing agent, fixed overhead volume variance does not offer more information from what can be ascertained from other variances such as sales quantity variance.
The calculation of the sub-variances also doesn’t provide a meaningful analysis of fixed production overheads. For example, if the workforce utilized fewer manufacturing hours during a period than the standard, it is hard to imagine a significant benefit of calculating a favorable fixed overhead efficiency variance.
We can help
If you’re interested in finding out more about fixed overhead volume variance, then get in touch with the financial experts at GoCardless. Find out how GoCardless can help you with ad hoc payments or recurring payments.