Variance Analysis: Overhead Costs
For direct materials and direct labor, total variance are broken down into price and efficiency variances. The total overhead variance the difference between applied and actual overhead is also broken down into component variance. The number of component variances computed depends on the method of variance analysis used. Common methods are the two, three, and four-variance methods. The four-variance method provides the most detail, and its component variances can be combined to form the variances for the two and three-variance methods which are described later.
In analyzing overhead variances, a traditional approach is assumed. Standard overhead rates are computed in basically the same way that was described in Chapter 4. Traditional overhead rate computations rely on unit-level drivers such as direct labor hours and machine hours. The overhead analysis in this chapter assumes that direct labor hours is the only driver used to assign overhead costs to products. Thus, when we speak of variable and fixed overhead, we are assuming that it is fixed or variable with respect to direct labor hours, a unit-level driver. In Chapter 12, variance analysis is extended to a more general setting where both unit-and non-unit-level drivers are allowed.
Four-Variance Method for Calculating Overhead Variances
The four – variance method calculates two variance for variable overhead and two variance for fixed overhead. We first divide overhead into categories: variable and fixed. Next, we look at component variances for each category. The total variance overhead variance is divided into two components: the variable overhead spending variance and the variable overhead efficiency variance. Similarly, the total fixed overhead variance is divided into two components: the fixed overhead spending variance and the fixed overhead volume variance.
Cornerstone 9-6 shows the how and why of calculating the total variable overhead variance. To illustrate the variable overhead variances, we will continue to use the Helado Company example. Variance will be constructed for the month of May.