Overhead Variances :: Overview

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Interpretation of Variance  
 

• Mathematical Interpretation

The variances that we calculate are all value variances i.e. any Variance that we calculate is the difference between two values.
Variance = Value1 − Value2
Variance = (Quantity1 × Price1) − (Quantity2 × Price2)   [Since Value = Quantity × Price.]

• Classification

» Adverse/Negative/Unfavourable Variance

The variance is said to be either negative (−) or Adverse (Adv) or Unfavourable (Unf) if it indicates a loss.

  • In relation to costs, we would incur a loss if the actual cost is greater than the standard cost.
  • In relation to profits or incomes, we would incur a loss if the actual profit or income is less than the standard.

This type of variance is indicated by either a negative sign (−) placed before the value of the variance or by writing the letters UF or Unf or Adv after the value.

» Positive/Favourable Variance

The variance is said to be either Positive (+/Pos) or Favourable (Fav) if it indicates a gain position or beneficial position.
  • In relation to costs, we would gain if the actual cost is less than the standard cost.
  • In relation to profits or incomes, we would gain if the actual profit or income is greater than the standard.

This type of variance is indicated by either a positive sign (+) placed before the value of the variance or by writing the letters Fav or F or Pos after the value.

Variance Formulae » Standard − Actual (Or) Actual − Standard ??  
 
Many a times students would get struck up with deciding whether the standard data comes first or the actual data. The basic idea behind all variances being Variance = Value 1 − Value 2, the standard value should come first in case of cost variances and the actual value should come first in case of sales variances.

To have a clear understanding assume an example and spend a few seconds to think over and decide every time you are in doubt. Never mug it up. The below explanation is given as an aid.

» When measuring Variance in Expenses/Costs

Standard cost is Rs. 2,000 and the actual cost is Rs. 2,400.
This should indicate a negative variance.
How do you get a negative sign? 2,400 − 2,000 or 2,000 − 2,400.
Surely, it would be 2,000 − 2,400
Thus it should be Standard Cost − Actual Cost.

» When measuring Variance in Incomes

Standard income is Rs. 2,500 and the actual income is Rs. 3,000.
This should indicate a positive variance.
How do you get a positive sign? 2,500 − 3,000 or 3,000 − 2,500.
Surely, it would be 3,000 − 2,500
Thus it should be Actual Income − Standard Income.

Overhead Variances  
 
The difference between the absorbed overhead and incurred overhead is what we call the under/over absorbed overhead. Overhead variance is nothing but this. We call this the Total Overhead Cost Variance.

This would give an idea of how much more or less cost had been incurred when the actions are compared to plans. However, it does not give a scope for pin pointing the responsibility for the variance and thereby take corrective actions.

We cannot identify whether the difference is on account of the labourers/laborers working inefficiently (in which case, the people who manage work should be held responsible) or on account of more or less expenditure being incurred (in which case the people responsible for incurrence of expenses are to be held responsible).

Therefore, the Total Overhead Cost Variance is further analysed into its constituent parts to give an idea of the overhead variances in various other angles.

Total Overhead Variance as a Synthesis of its Constituent Variances  
 
The analysis of the total overhead cost variance into its constituent parts gives an idea of the overhead variances in various other angles.

The possibility for this arises on account of the fact that there are three types of costs involved with regard to overhead variances. The Budgeted overhead cost, the incurred overhead cost and the absorbed overhead cost. The concept of absorption brings in a different angle in analysing variances, more so in case of fixed overhead variances.

All the variances involving overheads which are collectively called "Overhead variances" and their inter relationships are depicted in the illustration below:
TOHCV
Total Overhead Cost Variance
 
 
VOHCV
Variable Overhead
Cost Variance
FOHCV
Fixed Overhead
Cost Variance
 
     
VOHEfV
Variable Overhead
Efficiency Variance
VOHExV
Variable Overhead
Expenditure Variance
FOHVV
Fixed Overhead
Volume Variance
FOHEV
Fixed Overhead
Expenditure Variance
 
   
FOHCapV
Fixed Overhead
Capacity Variance
FOHCalV
Fixed Overhead
Calendar Variance
FOHEfV
Fixed Overhead
Efficiency Variance

This can be understood as the "Total Overhead Cost Variance" broken down into its constituent parts and the constituent parts further broken down wherever possible.

• Inter-relationships

The inter-relationships as can be interpreted from the above illustration are

• TOHCV = VOHCV + FOHCV   → (1)
• VOHCV = VOHExV + VOHEfV   → (2)
• FOHCV = FOHExV + FOHVV   → (3)
• TOHCV = VOHExV + VOHEfV + FOHExV + FOHVV   → (4) [From (1), (2) and (3)]
• FOHVV = FOHCapV + FOHCalV + FOHEfV   → (5)
• TOHCV = VOHExV + VOHEfV + FOHExV + FOHCapV + FOHCalV + FOHEfV   → (6) [From (4) and (5) ]

These inter-relationships can be useful in problem solving for deriving the required answers as well as in checking for the correctness of answers.

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