Variable Manufacturing Overhead Variances

What you'll learn to do: Discuss the variable manufacturing overhead variances

Remember back when we figured out our manufacturing overhead budget? It seems like a really long time ago, but here we are, back looking at that information again!! Just a reminder of how important the budgeting process is. We have used those pesky budgets during every step of the variance calculation process.

So guess what? One more standard cost variance analysis for variable manufacturing overhead!

Take a look at this video for a review of flexible budgeting, and calculating variances.

Learning OUtcomes

  • Analyze the variance between expected variable manufacturing overhead cost and actual variable manufacturing overhead costs
  • Analyze the variance between expected variable manufacturing overhead efficiency and actual variable manufacturing overhead efficiency
  • Discuss strategies to limit and reduce variable manufacturing overhead variances

Variable Manufacturing Rate Variances

As a manager in the accounting department, you have been tasked with determining the overhead rate for your manufacturing department. This information is important, as when you price your product or bid jobs, if you don’t include the cost of things like electricity and rent and depreciation on your equipment, you will be underpricing your stuff! Let’s take a look at an explanation of the why and how to calculate the variable manufacturing rate and understand why it is so important! Then we will talk about when this number varies from what we had originally calculated.

So we are again looking at two components: The manufacturing overhead rate variance and the manufacturing overhead efficiency variance. The rate variance happens when there is a change in the components of the variable hourly rate.

Spending Variance flows into Labor Rate Variance, Actual Hours of Input at Standard Rate, and Labor Efficiency Variance. Labor Rate Variance flows into Actual Hours of Input at Actual Rate. Labor Efficiency Variance flows into Standard Hours Allowed for Actual Output, at Standard Rate. A rate variance may occur if the cost of one of the components of this rate goes up. An example might be the cost of the needles for the machines that sew together the shoes, or a steep hike in the electricity rate.

A difference in the efficiency rate occurs when it takes more hours than budgeted to manufacture the budgeted number of pair of shoes.

We figured out our expected variable manufacturing overhead for Hupana Running Company back when we were working on our master budget. Here is a reminder for you!

Since we already figured out our variable rate in a previous unit (remember, it was way back when we were working on our master budget), we can use this number in our calculations.

So Mary, our production manager, has noticed an increase in the cost of some of the supplies that go into the manufacturing of our shoes. Apparently, there is a thread shortage, and our supplier has raised the price. That, along with more needles breaking in the machines, has raised our variable overhead cost from $3 per hour to $3.25 per hour.  Let’s take a look at how that may affect our variable overhead cost for Hupana:

Here is our budget:

Budgeted direct labor hours 1025
Variable manufacturing overhead rate $3
Variable manufacturing overhead $3,075
And here is what actually happened:

Budgeted direct labor hours 1025
Variable manufacturing overhead rate $3.25
Variable manufacturing overhead $3,331.25
So you can see, this change has caused an increase in our variable manufacturing overhead. This is a rate change, so let’s analyze it using what we know. (You can refer back to the diagram on 10.4 if needed)

  • Actual Quantity of Input at Actual Cost = 1025 × $3.25 = $3331.25
  • Actual Quantity of Input at Standard Cost= 1025 × $3.00 = $3075.00
  • Price Variance = $3331.25 − $3075.= $256.25 unfavorable variance. We spent more than anticipated.

So, if the direct labor hours remain the same, our spending variance will be $256.25—unfavorable. So, a reduction in the variable manufacturing overhead rate would create a favorable price variance.

So, a rise in the variable manufacturing overhead rate will cause an unfavorable variance in the price variance. But might that be a good thing? It could, if the increase in price causes a corresponding increase in efficiency!

Practice Questions

Variable Manufacturing Overhead Rate Variances

In our previous discussion, we talked about how even if the price of a component of our variable manufacturing overhead is higher, it might actually cause our spending variance to be favorable. Sometimes, higher quality of input creates such a time savings that it is a good thing. Of course the opposite could be true. Remember back when we talked about direct labor and direct materials, cheaper is not always better. If a savings on one component of our costs causes additional costs in another area, we need to examine what the best course of action would be. So let’s go back to Mary at Hupana and her new needles and thread!

So now, what happens if Mary notices that the needles and thread we are buying, even though they cost more, are actually creating better efficiency, thus lowering the time it takes to make our amazing shoes?  She has been doing a time tracking system, and noticed that rather than 1025 hours that were budgeted, it is now only taking 928 hours to make the same number of shoes! This is awesome news, so let’s see what the numbers look like.

Budgeted direct labor hours 928
Variable manufacturing overhead rate $3.25
Variable manufacturing overhead $3,016.00
So remember our budgeted amount of variable manufacturing overhead was 1025 hours at $3 per hour for a total cost of $3075. Let’s analyze the change.

  • Actual Hours of Input at Actual Rate = 928 × $3.25= $3016
  • Actual Hours of Input at Standard Rate = 928 × $3= $2784
  • Standard Hours of Input allowed for Actual Output at Standard Rate= 1025 × $3= $3075

So with that information the price variance can be calculated as follows:

  • Actual Hours of Input at Actual Rate=  $3016
  • Actual Hours of Input at Standard Rate= $2784
  • So we have a PRICE variance of $3016 − $2784= $232 unfavorable (we spent more per hour than budgeted)

But look at the efficiency variance:

  • Actual Hours of Input at Standard Rate = $2784
  • Standard Hours of Input Allowed for Actual Output at Standard Rate= $3075

So we have an efficiency variance of $3075 − $2784=  $291 favorable (We spent less total that we budgeted)

Our overall spending variance can then be calculated at $3075 − $3016= $59 favorable.

So the takeaway here is, the product may cost more, but if it increases efficiency the extra cost may be worth it! The cheapest product does not always bring us the best outcome!

Practice Questions

Reducing Variable Manufacturing Overhead

So how can Mary insure that the spending variance is minimized  for her variable manufacturing overhead? There are a few good ways to make this happen. You may notice some similarities here between reducing labor, materials and overhead variances. They all work together to create the best scenario for the business budget!

  1. Make sure to get high quality supplies! Spending more is not always a bad thing. If buying the good stuff reduces the time to produce the product, then it is worth the extra expense.
  2. Train your employees well and continue the training process. Less waste and higher efficiency will keep your variable manufacturing overhead low!
  3. Be a proactive manager. If you start to notice a “creep” in the time it is taking to manufacture your product, take notice! Talk with the employees involved in the process and get their input. The people actually working on the manufacturing process are invaluable resources! They may be able to offer valuable insight into why it may be taking longer or costing more to manufacture your product.

Managing costs is a big job! It takes the whole team, working together to make good decisions. Engage the team in the budgeting process and then keep them involved!

So, as you can see, the calculation of the variances is just step one in the process. Once we have determined our variances, we need to look at each one and see how we can minimize, reduce or eliminate those variances. Keeping the business profitable is the key! As a manager, you may be held responsible for part of this process. Let’s look at some potential problems, and how, as a manager, you may create solutions!

Remember when Mary was having materials issues? What happens when the cost of the materials rose, but the time to make the shoes stayed the same? What are some ways Mary may need to work to solve this variance?

  1. If the cost of materials increases due to market increases, it may be necessary to look at ways to streamline the production process to reduce production time.
  2. It may be possible that we, as a company, need to rethink pricing! If the cost of materials is rising, and we don’t see the pricing going back, raising the price we charge for our shoes might be the only option.
  3. Mary may need to talk with the purchasing department, and see if it is possible to find alternate sources for our raw materials.

So what about additional production time? Remember when Mary needed to hire a new employee? Jake had skills, but the process was still taking longer than budgeted to make each pair of shoes. What steps can she take to get back on budget?

  1. Train, Train, Train. Additional employee training, effective onboarding of new employees and practice are all necessary to get new employees up to speed. Make sure as well to have a good team environment, where existing employees are involved in the training and onboarding process.
  2. Listen to your employees. Are the raw materials of a quality to limit waste? Are the machines kept in good working order? Is there a cog in the wheel of production that isn’t working well? Maybe it is taking to much time to get materials from the warehouse to the production floor. Or perhaps one machine, in the middle of the process is slowing things down. It cannot be stressed enough, how important listening to the people who do the work is!
  3. Have you set unreasonable expectations? Sometimes, the budgeted amount of time isn’t reasonable. If your staff is trying to meet an expectation that isn’t reasonable, it could actually increase your costs by creating waste or even causing injuries!  Make sure the budgeted time aligns with historical data and again, that you have involved your staff in the budgeting process. Time studies (evaluating through tracking) may be needed here to really get a handle on preparing your time budget.

So, again, getting the numbers is the beginning. Evaluating the numbers  to improve costs, production time and profitability is the goal!

Practice Questions

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