Cost Accounting

This section will describe how the variable overhead total variance and the fixed overhead total variances calculated. You can recall the overheads refer to production costs that cannot be categorized as direct since they cannot be directly traced to an individual unit of production.

It is necessary to recall that overheads are absorbed into costs by means of Predetermined OverheadAbsorption Rates (OAR).

The activity level so budgeted could be expressed as units, weight, sales etc: but the most useful concept of the activity level is the standard hour. Thus, the total overhead absorbed = OAR x Standard hours of production.

Where the standard costing system uses Total absorption costing principles (where both fixed and variable overheads are absorbed into production costs), the total overheads absorbed can be sub-divided into Fixed Overhead Absorption Rates (FOAR) and Variable Overhead Absorption Rates (VOAR).

Thus,

Fixed Overhead Absorbed = FOAR x Standard hours of production

Variable Overhead Absorbed = VOAR x Standard hours of production.

Total Overheads Absorbed = (FOAR + VOAR) x Standard hours of production

But where the standard marginal costing principles are utilized by the standard costing system, only variable overheads are absorbed into production costs and thus only variances relating to variable overheads arise. This makes overhead variance analysis a bit easier in this case.

Start Note:

The total overhead variance can be broken down into its two constituent parts, namely:

• The variable overhead variance, and
• The fixed overhead variance

We will look at each of these individually.

1. Variable Overhead Variance

This is the difference between the actual variable overheads warned and the variable overheads absorbed. It can therefore be described as the underabsorbed or overabsorbed variable overheads.

The variable overhead expenditure variance is made up of two components, namely:

• The variable overhead expenditure variance,
• The variable overhead efficiency variance

The variable overhead expenditure variable is the difference between the actual variable overheads incurred and the allowed variable overheads based on the actual hours worked. This is calculated as follows:

Variable Overhead = Actual Variable - (Actual Labour Hours x V.O. A. R).

Expenditure variance Overheads

The variable overhead efficiency variance is the difference between the allowed variable overheads and the absorbed variable overheads and the absorbed variable overheads.

2. Fixed Overheads Variance

This is defined as the difference between the standard cost of fixed overheads absorbed in the production achieved (whether completed or not), and the fixed overheads attributed and charged to that period.

This is in fact the over or underabsorbed overheads for the period under consideration.

The fixed overhead volume variance has two main components namely:

• Fixed overhead expenditure variance, and
• Fixed overhead volume variance

The fixed overhead expenditure variance is the difference between the budget cost allowance for production for a specified control period and the actual fixed expenditure attributed to and charged to the period. It is therefore the difference between the actual and budgeted fixed overheads.

The fixed overhead volume variance is the difference between the standard cost absorbed in the production achieved and the budget cost allowed for the period. It arises due to the actual production volume differing from the planned: this is in turn caused by volume differing form the planned: This is in turn caused labour efficiency variance and or capacity variance (hours of working being less or more than planned). The fixed overhead efficiency variance, and

The fixed overhead capacity variance.

The fixed overhead efficiency variance is the portion of the fixed overhead volume variance which is the difference between the standard cost absorbed in the production achieved whether completed or not, and the actual labour hours worked. (valued at the standard hourly absorption rate).

Overhead Total Variance: Is the difference between the standard overhead cost specified for the production achieved and the actual cost incurred.

Overhead Expenditure Variance: Is the difference between the actual overheads expenditure and the budgeted overheads.

Overhead Efficiency Variance: Is the difference between the standard overhead rate for the production achieved and the standard overhead rate for the actual hours taken.

Overhead Volume Variance Is the difference between the standard overhead cost of the actual hours taken and the flexed budget allowance for the actual hours taken.

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