Variable Overhead Efficiency Variance Definition, Formula, Example, Calculation, Explanation

Generally, the production department is considered responsible for any unfavorable variable overhead efficiency variance. Similarly, a favorable variable overhead efficiency variance is when the employees do the required work in a lesser time than what was budgeted. Before we go on to explore the variances variable overhead efficiency variance formula related to fixed indirect costs (fixed manufacturing overhead), check your understanding of the variable overhead efficiency variance. Think of VOEV as a way to measure how efficiently you’re using your resources, specifically the variable overhead costs. It’s like a report card, but instead of grades, it shows you how well you’re managing things like electricity, supplies, and other costs that change with production levels. However, due to labor inefficiency, it took them 5,000 hours to meet the required production.

How Labor Hours and VOEV Cuddle (or Clash!)

Variable overhead efficiency is not just a calculation of standard and actual time rate; an entity should interpret with the total inputs utilization ratio to achieve higher outputs. As the variable overheads are an integral part of the production and often change with the number of units produced, we should also consider other factors such as machine hours, labor hours, and raw material for a clear analysis. For example, the company ABC, which is a manufacturing company spends 480 direct labor hours during September. However, the standard hours that are budgeted for the company to spend in the production process for September is 500 hours with the standard variable overhead rate of $20 per direct labor hour. Variable Overhead Efficiency Variance is traditionally calculated on the assumption that the overheads could be expected to vary in proportion to the number of manufacturing hours. Using Activity based costing in the calculation of variable overhead variances might therefore provide more relevant information for management control purposes.

• However, the management should make sure to set the realistic standard or budget benchmarks taking into confidence the operations’ managers and the skilled labor.
• The Marginal costing approach takes into account variable overhead costs that can directly be linked with variable overhead efficiency.
• Actual hours are the hours that the company’s workforce actually spends during the period or actually spends to complete a certain number of units of production.
• Likewise, the company can calculate variable overhead efficiency with the formula of the difference between standard and actual hours multiplying with the standard variable overhead rate.
• Variable overheads are indirect production costs incurred by the company as the output varies.

Standard Cost for Actual Input (Variable Overhead)

For example, if the manufacturing process depends more on manual work, labor hours may be more suitable. On the other hand, if the work is mostly automation in the production process, the machine hours may be used instead as it is more suitable in this case. Boulevard Blanks has decided to allocate overhead based on direct labor hours (DLH).

If an entity provide incentive to the operational managers and skilled labor for favorable variance it may motivate them to improve on the processes and low idle hours. Unavailability of raw materials, old machinery, and disruptions in the power supply are some of the uncontrollable factors that can still cause adverse variance in variable overhead rate analysis. The management should analyze in-depth for the production causing more machine-hours than expected.

Thetotal standard cost for diesel oil is then calculated by multiplying thequantity with the standard rate at which diesel oil will be bought. Avariable overhead efficiency variance exhibits the difference between budgetedvariable overheads and applied variable overheads. The formula basically looks at the difference between the hours you actually worked versus the hours you should have worked, all multiplied by the standard variable overhead rate. We’ll break that down into bite-sized pieces later, so don’t worry if it sounds like gibberish right now. Hours refers to the number of machine hours or labor hours incurred in the production of output during a period.

Variable Overhead: A Key Player in the Cost Structure

In simple terms, variable overhead variance showed adverse results as the production took more machine hours than the standard rate of 0.25 machine hours per unit. Conversely, we can say that standard machine hours per unit production were set lower that resulted in adverse variance. As in any case, we should consider the quantitative numbers from any ratio or variance analysis as a starting point only. As the name suggests, variable overhead efficiency variance measure the efficiency of production department in converting inputs to outputs.

Budgeting: Setting the Stage for VOEV

The Marginal costing method accounts for the variable overheads to calculate the contribution margin. Variances in planned overhead expenses can affect the contribution margins significantly especially if the sale prices are small and competition is severe. In this article, we will cover in detail about the variable overhead efficiency variance.

Direct Labor’s Influence: Linking Labor Hours to VOEV

Most of the variable overheads correlate to the production changes, so the overhead variance should follow the same pattern. However, an entity can set the variable overhead rate and expenditure variances as basis for benchmarking in production processes and such entity can motivate its labor to achieve favorable results with incentives. Variable overhead efficiency variance formula calculates the difference between actual hours worked and standard hours allowed. Standard hours allowed represents the efficient level of labor for the actual output. An unfavorable variance indicates inefficiency in labor usage, while a favorable variance suggests efficient use of labor, impacting overall cost control within the company.

It means that instead of paying the labor a full rate for each hour saved, the company can give bonuses to the employees instead and reduce its manufacturing cost while increasing the revenue. This means you spent $1,000 more on variable overhead than you should have, because you took longer than expected. The importance of setting realistic and achievable standards cannot be overstated. The standard rate is adjusted per all price-increasing/decreasing factors (inflation rate, different suppliers, etc). Itmeans that the labor has worked inefficiently, the productivity has reduced andmore wages will be paid per hour while the revenue decreases as well due tolesser production. Ultimately, the decision of which structure to use is up to the management team of the company.

What’s the Good News? Decoding Favorable Variances

• Variable overhead variance can be an important performance measurement tool especially for the firms using marginal costing approach.
• If the result of the calculation is positive, the variance is favorable; on the other hand, if the result is negative, the variance is unfavorable.
• In other words, the company is more efficient than expected in completing the task.
• A balanced approach encourages continuous improvement while promoting ethical behavior.

The variable overhead efficiency variance is used to assess how well a company has controlled its variable overhead costs. It is calculated by comparing the actual variable overhead costs incurred to the standard variable overhead costs that should have been incurred. An unfavorable variable overheadefficiency variance is when the standard hours required for production are lessthan the actual hours worked. The standard direct labor hours allowed (SH) in the above formula is calculated by multiplying standard direct labor hours per unit and actual units produced. A favorable variance occurs when the standard hours are more than the actual hours worked and signifies that the company incurred fewer variable overheads than expected. With careful monitoring, the management may be able to find out idle work hours causing adverse variance to both labor rate and variable overhead rates.

Analysis

Skilled labor, new machinery, and efficient workflow can all contribute towards a favorable OH rate variance. An unfavorable OH variance indicates inefficiencies in the production processes, unavailability of raw material or skilled labor may also cause longer hours for production. However, this result of $400 of favorable variable overhead efficiency variance doesn’t mean that the company ABC’s total variable overhead variance is favorable. The company ABC needs to also calculate variable overhead spending variance in order to determine the total variable overhead variance as it is the result of the combination of the two variances. In other words, the variable overhead variance is broken down into the variable overhead efficiency variance and the variable overhead spending variance. Let me illustrate how you should calculate the variable overhead efficiency variance.

Standard hours are the number of hours that the company’s workforce is expected to spend during the period or to spend in completing a certain number of units of production. Remember that both the cost and efficiency variances, in this case, were negative showing that we were under budget, making the variance favorable. Even though the answer is a negative number, the variance is favorable because we used less indirect materials than we budgeted. However, be careful not to create perverse incentives that lead to unintended consequences. For instance, if employees are incentivized to cut corners to reduce labor hours, they may compromise product quality or safety.