Overhead variances analysis
FACTORY OVERHEAD VARIANCES: Remember that manufacturing costs consist of direct material,direct labor, and factory overhead. You have just seen how variances are computed for direct materialand direct labor. Similar variance analysis should be performed to evaluate spending and utilizationfor factory overhead. But, overhead variances are a bit more challenging to calculate and evaluate. As a result the techniques for factory overhead evaluation vary considerably from company tocompany (and textbook to textbook). If you progress to advanced managerial accounting courses, youwill likely learn about a variety of alternative techniques. For now, let's focus on one comprehensiveapproach.
VARIABLE VERSUS FIXED OVERHEAD: To begin, recall that overhead has both variable and fixedcomponents (unlike direct labor and direct material that are exclusively variable in nature). Thevariable components may consist of items like indirect material, indirect labor, and factory supplies.Fixed factory overhead might include rent, depreciation, insurance, maintenance, and so forth.Because variable and fixed costs behave in a completely different fashion, it stands to reason thatproper evaluation of variances between expected and actual overhead costs must take into accountthe intrinsic cost behavior. As a result, variance analysis for overhead is split between variancesrelated to variable overhead and variances related to fixed overhead.
VARIANCES RELATING TO VARIABLE FACTORY OVERHEAD: The cost behavior for variablefactory overhead is not unlike direct material and direct labor, and the variance analysis is quitesimilar. The goal will be to account for the total
variable overhead by applying: (1) the"
" amount to work in process, and (2) the "
" to appropriate variance accounts. Thisaccounting objective is no different than observed for direct material and direct labor!
On the left-hand side of the following graphic, notice that more is spent on actual variable factoryoverhead than is applied based on standard rates. This scenario produces unfavorable variances(also known as "underapplied overhead" since not all that is spent is applied to production). The right-hand side is the opposite scenario (favorable/overapplied overhead). Beneath the graphics are T-accounts intending to illustrate the cost flow. As monies are spent on overhead (wages, utilization of indirect materials, etc.), the cost (xxx) is transferred to the Factory Overhead account. As productionoccurs, overhead is applied/transferred to Work in Process (yyy). When more is spent than applied(as on the left scale), the balance (zz) is transferred to variance accounts representing the unfavorableoutcome. When less is spent than applied (as on the right scale), the balance (zz) represents thefavorable overall variances.