Introduction
In this article, we will cover in detail about the fixed overhead spending variance. We commonly call The fixed overhead spending variance as fixed overhead expenditure variance or fixed production overhead expenditure variance. Before going further detail, let’s have a look at overview and the basic definition.
Business operations require ongoing expenses to produce products or services. Operating expenses can be direct or indirect costs. Manufacturing or factory overheads are indirect costs associated with production and can be fixed or variable. Fixed overhead costs can change due to a change in the volume or cost. Fixed overhead total variance has two integral parts:
Under normal circumstances, factory fixed overheads such as Electricity, Insurance, Indirect labor, and material should remain fixed. However, significant changes in production do require even fixed overheads to be adjusted.
Definition
Fixed Overhead expenditure or spending variance in simple terms is:
“The difference between the budgeted fixed production overhead expenditure and actual fixed production overhead expenditure.”
Fixed Overhead Spending Variance Formula
We can calculate the Fixed Overhead Spending or expenditure variance as per the formula below:
Fixed Overhead Spending Variance = Actual Cost – (Budgeted Hours × Standard Rate)
Or Simply, Fixed Overhead Spending Variance = AHAR – SHSR.
Either way, it is simply the difference in spending from budgeted and actual fixed overhead costs.
Examples of Fixed Overhead Spending Variance
In this section, we will illustrate the calculation of fixed overhead spending variance or fixed overhead expenditure variance into 3 examples as follow:
Simple Example 01:
Suppose a factory has 03 production supervisors totaling monthly wages of $ 15,000. If one of the full time supervisors is on vacation, the slot may remain empty or fulfilled by a part-timer. That will reduce the monthly supervisors’ wages to let’s say $ 12,500. In this case, although the supervisor wages are a fixed overhead expenditure, yet the company sees a Favorable spending variance of $ 2,500 for one month.
Working Example 02:
Blue Waters Co. provides us with the Following information for their production facility:
| Budgeted Costs | In $ |
| Fixed Production Overheads | 25,600 |
| Units production | 6,300 |
| Standard or budgeted Time for each unit | 2 hours per unit |
| ACTUAL COSTS | |
| Fixed Overheads | 27,200 |
| Units produced | 6,180 |
| Labor hours taken | 12,300 |
Budgeted Factory Overhead Rate = Fixed Overhead Costs ÷ total labor hours
Budgeted Factory Overhead Rate = 25,600 ÷ 12,600 = $ 2.03 per unit
Actual Factory Overhead Rate = 27,200 ÷ 12,300 = $ 2.21 per unit
Fixed Overhead Spending Variance = (AH×AR – SR×SH) = (12,300 × 2.211 – 12,600 × 2.0322)
= 27,200 – 25,600 = $ 1,600 ADVERSE
Alternatively, we can calculate by using one line formula as follow:
Fixed Overhead Spending Variance = Actual Fixed Overhead Spending – Budgeted Fixed Overhead Spending
= 27,200 – 25,600 = $ 1,600 ADVERSE
Example 03:
Fixed overhead spending variance and fixed overhead volume are often linked. Suppose a company uses a standard absorption rate of $ 15 per unit, for an estimated production of 1,500 units. They planned a budget for fixed overhead spending for $ 30,000. If the production output is exactly the same as planned with no abnormal fixed overhead changes then there will be no fixed overhead variances.
Let’s assume the production falters to only 1,200 units and fixed overheads rise to $ 35,000 for the production period. Then,
Fixed Overhead Spending Variance = Actual Fixed Overhead Spending – Budgeted Fixed Overhead Spending
= 35,000 – 30,000 = ($ 5,000) ADVERSE
Fixed Overhead Volume Variance = (Actual Units – Budgeted units) × Standard Rate
= (1,200 – 1,500) × 15 = ($ 4,500) ADVERSE
TOTAL FIXED OVERHEAD VARIANCE = ($ 9,500) ADVERSE
Analysis and Interpretation
As in the marginal costing method, overheads are written off to the income statement, so the only variance occurring will be the overheads expenditure variance. Variance for fixed overhead spending is simple to calculate and understand. The only confusion is to differentiate between variable and fixed overheads.
All variable overheads changing with production volume are variable; other associated indirect costs are fixed overhead costs. Production planning is done well in advance, and we typically assume that the fixed overheads would not change much with production.
Fixed overheads spending variance will be the same for both marginal and absorption costing methods. Businesses often give more importance to ADVERSE variances than FAVORABLE variances. However, it is important to know the real reasons behind the adverse variances. Fixed overhead variance can change due to several factors.
Reasons for Favorable Fixed overhead Variance:
- Inaccurate planned budget costs estimated for fixed overheads
- An unexpected rise in indirect labor or material costs
- Operational efficiency reducing costs or increasing production
- Reconciliation in past budgeting or operation patterns
Reasons for ADVERSE Fixed overhead Variance:
- Hiring additional labor on a temporary basis to expand production volumes
- Inefficient production process causing less produced units
- Production facility expansion costing extra during the ongoing budget period
- Inaccurate past patterns carried over
Responsibility of Fixed Overhead Spending Variance
Unlike other operating variances such as variable overhead efficiency variances, we typically assume the fixed overheads to remain unchanged. So if there is any change in fixed overheads, it will be a significant one. Changes in fixed overheads require approvals from top management, so they become top level management responsibility. In this rare scenario, we can assume that production department cannot be held responsible for fixed overhead variances.
For example, a non-cash item such as depreciation calculations depend on the costing method adopted by the management. During production, any relevant fixed overhead expenditure changes can be indirect labor, additional insurance charges, additional safety contracts, additional rental or land leases, etc.
Benefits and Limitations
Fixed overhead spending variance often arises due to change in long-term planning, so any analysis of this will offer top level management valuable reasoning. A line-by-line costing approach can help management to identify the reason for fluctuations and planning gaps.
- Provides insights into top level management for long-term planning
- Production and operational managers are not held responsible for any deviations
- Can help identify discrepancies in non-cash item valuations such as plant and machinery depreciation methods
Few of the fixed overhead spending variance limitations include:
- Fixed overheads cannot be controlled by production managers
- Production and operational managers should not be appraised on fixed overhead variances
- Often considered less valuable as fixed overhead changes require prior planning and top level management approvals, so variances in budgets are small
Conclusion
Although the fixed overheads do not change often, however, whenever there is a change in fixed overheads it is ought to be significant. As fixed overheads can be easily pre-planned analyzing past patterns, so a change in fixed overheads would normally require approval from higher management. Sometimes, a non-cash item such as depreciation and amortization also causes a change in fixed overheads on reconciliation.
Business expansion often creates fixed overheads expenditure variances (also other variances change), that would need adequate justification before approval from top management. As with any variance control, such analysis will provide valuable information, if the actual reasons for deviation are analyzed.
