4.3 Overhead and Sales Variances

4.3 Overhead and Sales Variances

Overhead variances analyze indirect production expenses, while sales variances evaluate revenue deviations driven by price changes and market volume shifts. Analyzing overhead variances requires identifying whether the organization operates under Absorption Costing or Marginal Costing.

Variable Production Overhead Variances

Variable overheads vary in direct proportion to activity (measured in labour or machine hours). Variable overhead variances share the exact same efficiency hour differential as direct labour variances.

1. Total Variable Overhead Variance

$\text{Total VOH Variance} = \text{Flexed Variable Overhead} - \text{Actual Variable Overhead}$ $\text{Total VOH Variance} = (SH \times SVOR) - \text{Actual VOH Spent}$ Where $SVOR$ = Standard Variable Overhead Rate per hour.

2. Variable Overhead Expenditure Variance

Measures the difference between the actual variable overhead cost per hour and standard rate per hour. $\text{VOH Expenditure Variance} = (AH_{\text{worked}} \times SVOR) - \text{Actual VOH Spent} = AH_{\text{worked}} \times (SVOR - AVOR)$

3. Variable Overhead Efficiency Variance

Measures the overhead impact of working more or fewer hours than standard allowed for actual output. $\text{VOH Efficiency Variance} = (SH - AH_{\text{worked}}) \times SVOR$

Key Rule: If direct labour hours are used as the absorption base, the Variable Overhead Efficiency Variance will always move in the exact same direction (Favourable or Adverse) as the Labour Efficiency Variance!

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Fixed Production Overhead Variances: Absorption Costing

Under absorption costing, fixed production overheads are absorbed into products using a Predetermined Overhead Absorption Rate ($OAR$):

$OAR = \frac{\text{Budgeted Fixed Overhead}}{\text{Budgeted Output Units or Budgeted Labour/Machine Hours}}$

Total Fixed Overhead Variance is the difference between absorbed overhead and actual overhead incurred:

$\text{Total Fixed Overhead Variance} = \text{Absorbed Fixed Overhead} - \text{Actual Fixed Overhead}$ $\text{Absorbed Fixed Overhead} = \text{Actual Units Produced} \times OAR_{\text{unit}} \quad (\text{or } SH \times OAR_{\text{hour}})$

Fixed Overhead Variance Sub-Tree

1. Fixed Overhead Expenditure Variance:

   • Measures spending differences regardless of volume. $\text{FOH Expenditure Variance} = \text{Budgeted Fixed Overhead} - \text{Actual Fixed Overhead}$

2. Fixed Overhead Volume Variance:

   • Measures the over- or under-absorption of fixed costs resulting from producing more or fewer units than budgeted. $\text{FOH Volume Variance} = \text{Absorbed Fixed Overhead} - \text{Budgeted Fixed Overhead}$ $\text{FOH Volume Variance} = (\text{Actual Units Produced} - \text{Budgeted Units Produced}) \times OAR_{\text{unit}}$

3. Sub-dividing Volume Variance (Hours Base):

   • Fixed Overhead Capacity Variance: Measures whether factory facilities operated for more or fewer hours than budgeted. $\text{FOH Capacity Variance} = (AH_{\text{worked}} - \text{Budgeted Hours}) \times OAR_{\text{hour}}$
   • Fixed Overhead Efficiency Variance: Measures productivity during hours worked. $\text{FOH Efficiency Variance} = (SH - AH_{\text{worked}}) \times OAR_{\text{hour}}$

Check Formula Integrity: $\text{FOH Volume Variance} = \text{FOH Capacity Variance} + \text{FOH Efficiency Variance}$

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Fixed Overhead Variances: Marginal Costing Context

Under marginal costing, fixed overheads are not absorbed into product cost cards; they are treated entirely as period expenses. Consequently:

• No Fixed Overhead Volume Variance exists.
• No Capacity or Efficiency Fixed Overhead Variances exist.
• Only Fixed Overhead Expenditure Variance is calculated: $\text{Budgeted Fixed Overhead} - \text{Actual Fixed Overhead}$.

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Sales Variances

Sales variances evaluate revenue deviations. Unlike cost variances (where lower spending is Favourable), for sales variances, higher revenue or higher volume sold is Favourable.

1. Sales Price Variance

Measures the revenue impact of selling actual units at a price different from standard price.

$\text{Sales Price Variance} = \text{Actual Quantity Sold} \times (\text{Actual Selling Price} - \text{Standard Selling Price})$

• Favourable (F): Actual Selling Price > Standard Selling Price.
• Adverse (A): Actual Selling Price < Standard Selling Price.

2. Sales Volume Variance

Measures the profit or contribution impact of selling a different quantity than budgeted.

• Under Absorption Costing (Valued at Standard Profit Margin per Unit): $\text{Sales Volume Variance (Absorption)} = (\text{Actual Quantity Sold} - \text{Budgeted Quantity Sold}) \times \text{Standard Profit per Unit}$

• Under Marginal Costing (Valued at Standard Contribution per Unit): $\text{Sales Volume Variance (Marginal)} = (\text{Actual Quantity Sold} - \text{Budgeted Quantity Sold}) \times \text{Standard Contribution per Unit}$

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Worked Comprehensive Example

Budgeted Data for Beta Ltd:

• Budgeted Production & Sales: 4,000 units
• Budgeted Labour Hours: 8,000 hours (2 hours/unit)
• Budgeted Fixed Overhead: £40,000 (OAR = £10.00 per unit or £5.00 per hour)
• Standard Selling Price: £50 per unit
• Standard Variable Cost: £30 per unit (Standard Contribution = £20/unit; Standard Profit = £10/unit)

Actual Results:

• Actual Production & Sales: 4,200 units
• Actual Labour Hours Worked: 8,100 hours
• Actual Fixed Overhead Incurred: £41,500
• Actual Selling Price: £52 per unit

Variance Calculations

1. Sales Price Variance:

   • $4,200 \text{ actual units} \times (£52 - £50) = £8,400 \text{ Favourable (F)}$

2. Sales Volume Variance (Absorption Costing):

   • $(4,200 - 4,000) \times £10 \text{ standard profit} = £2,000 \text{ Favourable (F)}$

3. Sales Volume Variance (Marginal Costing):

   • $(4,200 - 4,000) \times £20 \text{ standard contribution} = £4,000 \text{ Favourable (F)}$

4. Fixed Overhead Expenditure Variance:

   • $£40,000 \text{ budgeted} - £41,500 \text{ actual} = £1,500 \text{ Adverse (A)}$

5. Fixed Overhead Volume Variance (Absorption Costing):

   • $(4,200 \text{ actual units} - 4,000 \text{ budgeted units}) \times £10.00 = £2,000 \text{ Favourable (F)}$

6. FOH Volume Sub-variances (Hours Base):

   • $SH = 4,200 \text{ units} \times 2 \text{ hrs} = 8,400 \text{ SH}$
   • $OAR_{\text{hour}} = £5.00/\text{hr}$
   • Capacity Variance: $(8,100 \text{ AH} - 8,000 \text{ BH}) \times £5.00 = £500 \text{ Favourable (F)}$
   • Efficiency Variance: $(8,400 \text{ SH} - 8,100 \text{ AH}) \times £5.00 = £1,500 \text{ Favourable (F)}$
   • Check: $£500 \text{ (F)} + £1,500 \text{ (F)} = £2,000 \text{ Favourable Volume Variance}$

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AAT Exam Traps

Exam Trap — Fixed Overhead Volume Variance Sign: When actual output exceeds budgeted output, the Fixed Overhead Volume Variance is FAVOURABLE because the factory produced more units and absorbed extra fixed overheads. Do not confuse this with cost expenditure!