Fixed Production Overhead Volume Efficiency Variance
Represents the difference between the sum that a company has budgeted for its fixed overhead costs and the actual cost, depending on production volume.
Fixed Production Overhead Volume Efficiency Variance Details
Finding the fixed production overhead volume efficiency variance is actually a fairly simple principle. Just about every business has fixed costs that they need to account for. Here's an example of fixed costs that a company might be working with:
- Depreciation of equipment
- Rent on its buildings
- Utility bills
- Salaries or wages
But how can a company use revenue from their product sales to cover those fixed costs, especially if they aren't directly proportional to those products? Company accountants often use a technique called absorption costing. Essentially, they calculate the actual cost of producing one item of output. To find the actual or true cost, an accountant will look at a business's fixed overheads and assign a percentage of these fixed costs to every single item produced. This can help the company to determine the final price of the item.
In a well-run business, the accountant will have these costs readily available and should easily be able to calculate the fixed cost per unit of production and how these costs fall as the volume of production increases. If a company produces just two products a week, the fixed cost per unit would be very high. But if it produces twenty thousand products per week, the fixed costs per unit drops.
Example of Fixed Production Overhead Volume Efficiency Variance
KitchenHouse, a kitchen supply and appliance company, has decided to add to its existing range of kitchenware and produce a new line of microwave ovens. The accounting department studies the factory's fixed overhead costs and allocates $80,000 every month of its total fixed costs to microwave production. KitchenHouse expects to produce 4,000 microwaves a month, so each microwave it produces in a month will account for $20 of total fixed cost.
From the beginning, KitchenHouse has problems. Between a strike in its factory and machines breaking down, they're only able to produce 1,000 microwaves in the first month. As the factory has allocated $20 per microwave towards fixed overhead costs, the produced microwave units only account for $20,000 of the anticipated $80,000. As a result, the fixed overhead volume variance is an unhealthy $60,000. The percentage of actual production compared to the expected production, or the efficiency, is only 25%.
KitchenHouse has the capacity to produce 4,000 microwaves but isn't functioning efficiently. In this case, the efficiency variance of 75% can be improved once the staff is working full time and the machines are fixed. In an ideal world, there would be no variance. The efficiency would be 100%, and the microwaves would make their full contribution to fixed overhead costs.
Significance of Fixed Production Overhead Volume Efficiency Variance
Some companies calculate a rate of overhead costs that they use throughout the year. This doesn't usually cause problems to a company that produces a limited range of goods. But it's always a good idea to re-calculate the cost when producing a new item.
When a company reviews its allocated figures, which it should do regularly, it may find that there is a discrepancy or variance. This can occur because of several factors, including human error, seasonal sales, or because the company is producing more or less efficiently than the predicted rate.