When the variance is due to difference between actual and applied overhead it is called as?

What Is Variable Overhead Spending Variance?

A spending variance is the difference between the actual amount of a particular expense and the expected (or budgeted) amount of an expense. To understand what variable overhead spending variance is, it helps to know what a variable overhead is. Variable overhead is a cost associated with running a business that fluctuates with operational activity. As production output increases or decreases, variable overheads move in tandem. Overheads are typically a fixed cost, for example, administrative expenses. Variable overheads, on the other hand, are tied to production levels.

Variable overhead spending variance is the difference between actual variable overhead cost, which is based on the costs of indirect materials involved in manufacturing, and the budgeted costs called the standard variable overhead costs.

Key Takeaways

• Variable Overhead Spending Variance is the difference between what the variable production overheads actually cost and what they should have cost given the level of activity during a period.
• The standard variable overhead rate is typically expressed in terms of machine hours or labor hours.
• Variable overhead spending variance is favorable if the actual costs of indirect materials are lower than the standard or budgeted variable overheads.
• Variable overhead spending variance is unfavorable if the actual costs are higher than the budgeted costs.

Understanding Variable Overhead Spending Variance

Variable Overhead Spending Variance is essentially the difference between what the variable production overheads actually cost and what they should have cost given the level of activity during a period.

The standard variable overhead rate is typically expressed in terms of the number of machine hours or labor hours depending on whether the production process is predominantly carried out manually or by automation. A company may even use both machine and labor hours as a basis for the standard (budgeted) rate if the use both manual and automated processes in their operations.

Variable overhead spending variance is favorable if the actual costs of indirect materials — for example, paint and consumables such as oil and grease—are lower than the standard or budgeted variable overheads. It is unfavorable if the actual costs are higher than the budgeted costs.

Variable production overheads include costs that cannot be directly attributed to a specific unit of output. Costs such as direct material and direct labor, on the other hand, vary directly with each unit of output.

Example of Variable Overhead Spending Variance

Let's say that actual labor hours used are 140, the standard or budgeted variable overhead rate is $8.40 per direct labor hour and the actual variable overhead rate is $7.30 per direct labor hour. The variable overhead spending variance is calculated as below:

Standard variable overhead Rate $8.40 − Actual Variable Overhead Rate $7.30 =$1.10

Difference Per Hour = $ 1.10 × Actual Labor Hours 140 = $154

Variable Overhead Spending Variance = $154

In this case, the variance is favorable because the actual costs are lower than the standard costs.

A favorable variance may occur due to economies of scale, bulk discounts for materials, cheaper supplies, efficient cost controls, or errors in budgetary planning.

An unfavorable variance may occur if the cost of indirect labor increases, cost controls are ineffective, or there are errors in budgetary planning.

Limitations

Fast Fact

Variable overhead spending variance is essentially the difference between the actual cost of variable production overheads versus what they should have cost given the output during a period.

See Also:
Administration Expenses
Outsourcing
Predetermined Overhead Rate
Fixed Costs
Semi Variable Costs
Overhead Expense Reduction
Absorption Cost Accounting

Overhead Definition

The overhead definition is those ongoing expenses of running a business that do not directly relate to its core operations. It is ever present in the mind of accountants. The overhead definition includes the costs that are necessary for the business to continue operations, but that do not actually generate profits for the business.

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Overhead Explanation

Some examples include the following:

• Rent payments
• Utility bills
• Advertising expenses
• Insurance costs
• Interest payments
• Legal fees
• Taxes
• Other expenses

You can also call it overhead costs, overhead expenses, manufacturing overhead costs, factory overhead, or burden.

Overhead Variance

Overhead variance refers to the difference between actual overhead and applied overhead. You can only compute overhead variance after you know the actual overhead costs for the period. Overhead is applied based on a predetermined rate and a cost driver. This is essentially a way of estimating overhead costs before they actually incur. At the end of the fiscal period, it is possible to compare the actual overhead costs with the predetermined estimates. The difference between the actual overhead costs and the applied overhead costs are called the overhead variance.

Underapplied Overhead

When the actual amount of overhead expenses exceeds the applied amount of overhead expenses, the difference is called underapplied overhead. The predetermined rate underestimated the overhead costs for the period, and the applied overhead expenses were lower than the actual overhead expenses. The predetermined rate did not apply enough overhead expense for the period, so call the difference underapplied overhead.

Overapplied Overhead

When the applied amount of overhead expenses exceeds the actual amount of overhead expenses, call the difference overapplied overhead. The predetermined rate overestimated the overhead costs for the period, and the applied overhead expenses were higher than the actual overhead expenses. The predetermined rate applied too much overhead expense for the period, so call the difference between the two amounts overapplied overhead.

Overhead Formula

There is not set overhead formula due to the vast differences in overhead amounts based on business models. The overhead calculation is subject to many different approaches based on industry, the differences of overhead expenses, and more. This makes accounting for overhead costs more complicated than it may appear initially.

Overhead Accounting

Overhead Expense Allocation

One of the issues regarding overhead expenses is how to report them in the financial statements. They are not directly related to the core operations, however, ignoring overhead costs when determining the costs of production would not accurately reflect the full cost of production. Therefore, assign at least some portion of overhead costs to production activities and units of output.
Fixed overhead refers to the overhead not related to or applied to production. These costs do not fluctuate with production activity and are reported as period costs. Variable overhead refers to the overhead that is applied to production. These costs fluctuate with production activity. In addition, report them as product costs. Apply overhead to production activities. Also apply units of output using a cost driver and an overhead rate.
The cost driver is an activity that can be used to quantify and apply variable costs. For example, a certain amount of variable overhead expenses may be applied to production based on the number of direct labor hours involved in production, or based on the quantity of direct material used in production. The overhead rate is the rate at which you apply variable overhead to production and units of output based on the cost driver activity.

Reporting Overhead Variance

At the end of the fiscal period, the company must account for the amount of overhead variance. There are two ways to do this. First, transfer the overhead variance to the Cost of Goods sold account. Do this when the overhead variance is comparatively insignificant. The second alternative is to prorate the overhead variance to an inventory account, such as Work in Progress, Finished Goods, or Cost of Goods Sold. In this case, the apply overhead variance evenly across the units of inventory in the relevant account. Prorate overhead variance when the amount is comparatively substantial.
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