Management Accounting 101: Standard Costing and Variance Analysis - Variable and Fixed, Overhead Variances Spending Efficiency Volume

What This Is

Variable and fixed overhead variances are essential concepts in management accounting that help managers understand and control costs. These variances occur when actual overhead costs differ from budgeted or standard costs due to changes in volume, efficiency, or spending. For instance, Toyota, a renowned manufacturer of high-quality vehicles, uses variance analysis to optimize its production processes and reduce costs. By identifying and addressing variances, Toyota can improve its profitability and competitiveness in the market.

Key Frameworks & Metrics

• Variable Overhead (VOH) Variance = (Actual VOH - Budgeted VOH) + (Actual VOH - Budgeted VOH) × (Actual Units - Budgeted Units) – measures the difference between actual and budgeted variable overhead costs, considering changes in volume.
• Fixed Overhead (FOH) Variance = (Actual FOH - Budgeted FOH) + (Actual FOH - Budgeted FOH) × (Actual Units - Budgeted Units) – measures the difference between actual and budgeted fixed overhead costs, considering changes in volume.
• Spending Variance = (Actual VOH - Budgeted VOH) – measures the difference between actual and budgeted variable overhead costs, assuming no change in volume.
• Efficiency Variance = (Actual VOH - Budgeted VOH) × (Actual Units - Budgeted Units) – measures the difference between actual and budgeted variable overhead costs due to changes in volume.
• Volume Variance = (Actual VOH - Budgeted VOH) × (Actual Units - Budgeted Units) – measures the difference between actual and budgeted variable overhead costs due to changes in volume.
• Overhead Absorption Rate (OAR) = Total Fixed Overhead / Total Fixed Overhead Capacity – a rate used to assign fixed overhead costs to products or services.
• Variable Overhead Rate (VOR) = Total Variable Overhead / Total Direct Labor Hours – a rate used to assign variable overhead costs to products or services.
• Flexible Budget = Budgeted Amount × (Actual Units / Budgeted Units) – a budget that adjusts for changes in volume.
• Standard Cost = Budgeted Cost + Variance – a cost that includes the budgeted cost and any variance.

Step-by-Step Process

1. Identify the type of variance: Determine whether the variance is due to spending, efficiency, or volume.
2. Calculate the variance: Use the relevant formula to calculate the variance.
3. Analyze the cause of the variance: Identify the underlying reason for the variance, such as changes in volume, efficiency, or spending.
4. Take corrective action: Implement changes to address the underlying cause of the variance.
5. Monitor and review: Continuously monitor and review variances to ensure that corrective actions are effective.

Common Mistakes

• Mistake: Treating all costs as relevant when making decisions.
• Correction: Only consider costs that are directly affected by the decision.
• Mistake: Ignoring qualitative factors in make-or-buy decisions.
• Correction: Consider both quantitative and qualitative factors when making make-or-buy decisions.
• Mistake: Using ROI alone without considering residual income or EVA.
• Correction: Use a combination of metrics to evaluate investment opportunities.

Decision-Making Tips

• When faced with a make-or-buy decision, always isolate avoidable costs and consider strategic, not just quantitative, factors.
• When evaluating investment opportunities, use a combination of metrics, including ROI, residual income, and EVA.
• When analyzing variances, identify the underlying cause and take corrective action to address it.

Quick Practice Scenario

Scenario: A division rejects a project because its ROI would drop from 18% to 17%. By how much would residual income change if the project cost is $1M and the required rate of return is 12%?

Answer: Residual income would decrease by $20,000.

Explanation: Residual income is calculated as (Project Return - Required Rate of Return) × Project Investment. In this case, the project return would decrease from $180,000 to $170,000, resulting in a decrease in residual income of $20,000.

Last-Minute Cram Sheet

• 'Fixed costs' are only fixed in the short run within a relevant range – outside that range, they can change.
• Break-Even Point (units) = Fixed Costs / Contribution Margin per Unit – tells you how many units must be sold to cover all costs.
• Economic Value Added (EVA) = NOPAT - (Capital Invested × WACC) – measures true economic profit after charging for the cost of capital.
• Variable Overhead (VOH) Variance = (Actual VOH - Budgeted VOH) + (Actual VOH - Budgeted VOH) × (Actual Units - Budgeted Units) – measures the difference between actual and budgeted variable overhead costs, considering changes in volume.
• Fixed Overhead (FOH) Variance = (Actual FOH - Budgeted FOH) + (Actual FOH - Budgeted FOH) × (Actual Units - Budgeted Units) – measures the difference between actual and budgeted fixed overhead costs, considering changes in volume.
• Spending Variance = (Actual VOH - Budgeted VOH) – measures the difference between actual and budgeted variable overhead costs, assuming no change in volume.
• Efficiency Variance = (Actual VOH - Budgeted VOH) × (Actual Units - Budgeted Units) – measures the difference between actual and budgeted variable overhead costs due to changes in volume.
• Volume Variance = (Actual VOH - Budgeted VOH) × (Actual Units - Budgeted Units) – measures the difference between actual and budgeted variable overhead costs due to changes in volume.
• Overhead Absorption Rate (OAR) = Total Fixed Overhead / Total Fixed Overhead Capacity – a rate used to assign fixed overhead costs to products or services.
• Variable Overhead Rate (VOR) = Total Variable Overhead / Total Direct Labor Hours – a rate used to assign variable overhead costs to products or services.
• Flexible Budget = Budgeted Amount × (Actual Units / Budgeted Units) – a budget that adjusts for changes in volume.
• Standard Cost = Budgeted Cost + Variance – a cost that includes the budgeted cost and any variance.