## **Learning Outcomes**

After reading this article, you will be able to calculate and interpret fixed overhead expenditure, volume, capacity, and efficiency variances in an absorption costing system. You will learn to distinguish between each type, apply the correct formulas, explain common causes of variances, and connect your analysis to over- and under-absorption and management control. You will also understand how these variances inform performance measurement and guide corrective action.

## **ACCA Management Accounting (MA) Syllabus**

For ACCA Management Accounting (MA), you are required to understand fixed overhead variances within the context of standard costing and variance analysis under absorption costing systems. You should focus your revision on the following areas:

- Recognise when fixed overhead variances arise under absorption costing but not under marginal costing
- Calculate and explain the fixed overhead expenditure variance
- Calculate and explain the fixed overhead volume variance using both units and hours as the absorption basis
- Analyse the fixed overhead volume variance into capacity and efficiency variances where the absorption basis is hours
- Interpret the meaning and potential causes of each variance
- Understand the relationship between total overhead variance and over/under-absorption
- Apply fixed overhead variance analysis to assess and improve management control

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Which is the correct formula for the fixed overhead expenditure variance?
   a) Budgeted overhead − Actual overhead  
   b) (Actual hours worked × absorption rate) − Actual overhead  
   c) Actual production × absorption rate − Budgeted overhead  
   d) Budgeted overhead − Actual production × absorption rate

2. The fixed overhead volume variance, when based on hours, can be split into which two variances?
   a) Expenditure and price  
   b) Efficiency and capacity  
   c) Price and usage  
   d) Rate and allocation

3. True or false? The fixed overhead volume variance only arises in absorption costing, not marginal costing.

4. Name one situation that could cause a favourable fixed overhead capacity variance.

## **Introduction**

Fixed overhead variances are a key part of standard costing and management control in absorption costing systems. By analysing these variances, you gain detail about both cost control (what was actually spent compared to budget) and how efficiently resources were used to produce output.

Absorption costing includes fixed production overheads in product costs. Variances therefore show not just how spending differed from plans, but also how actual output levels and factory utilisation affected the absorption of these overheads.

> **Key Term: Fixed Overhead Expenditure Variance**
> The difference between the actual fixed overhead incurred and the amount budgeted for the period.
>
> **Key Term: Fixed Overhead Volume Variance**
> The difference between budgeted fixed overhead and the overhead absorbed by actual output or hours achieved.
>
> **Key Term: Fixed Overhead Capacity Variance**
> The portion of the fixed overhead volume variance arising from differences between actual hours worked and budgeted hours, valued at the absorption rate per hour.
>
> **Key Term: Fixed Overhead Efficiency Variance**
> The portion of the fixed overhead volume variance stemming from differences between standard hours for actual output and actual hours worked, valued at the absorption rate per hour.
>
> **Key Term: Fixed Overhead Absorption Rate (FOAR)**
> The rate used to charge fixed overheads to production, calculated by dividing budgeted fixed overheads by the budgeted activity level (units or hours).

## Calculating Fixed Overhead Variances

Fixed overhead variances arise only in absorption costing, as only this costing method attributes fixed production overhead to output using a predetermined rate. Variances help monitor both spending and resource usage.

### Fixed Overhead Expenditure Variance

The fixed overhead expenditure variance measures whether actual spending on fixed production overheads was higher or lower than budgeted.

**Formula:**
Fixed overhead expenditure variance = Budgeted fixed overhead − Actual fixed overhead incurred

- Favourable if spending was less than budget.
- Adverse if more was spent than budgeted.

### Fixed Overhead Volume Variance

The fixed overhead volume variance assesses the impact of actual activity (production units or hours) being greater or less than planned.

If overhead is absorbed per **unit**:

- Volume variance = (Actual units produced − Budgeted units) × FOAR per unit

If overhead is absorbed per **hour**:

- Volume variance = (Standard hours for actual output − Budgeted hours) × FOAR per hour

- Favourable if more output (or standard hours) achieved than planned, as more overhead is absorbed.
- Adverse if output (or standard hours) is below plan.

### Splitting the Volume Variance: Capacity and Efficiency

If overheads are absorbed based on hours, the volume variance is split for further control purposes:

- **Capacity variance:** (Actual hours worked − Budgeted hours) × FOAR per hour  
  Assesses whether the business used more or fewer hours than planned.
- **Efficiency variance:** (Standard hours for actual output − Actual hours worked) × FOAR per hour  
  Reflects whether workers operated efficiently compared to standard time allowed for the output.

The sum of capacity and efficiency variances equals the total volume variance.

### **Worked Example 1.1**

A business budgets for 12,000 direct labour hours and \$36,000 fixed overhead per month (giving FOAR \$3/hour).  
Actual: 13,000 hours worked, actual fixed overhead \$37,000, and actual output should have taken 12,500 standard hours.

**Required:** Calculate (a) the expenditure variance, (b) the volume variance, (c) the capacity variance, and (d) the efficiency variance.

> **Answer:**
> (a) Expenditure variance = \$36,000 − \$37,000 = \$1,000 Adverse  
> (b) Volume variance = (12,500 − 12,000) × \$3 = \$1,500 Favourable  
> (c) Capacity variance = (13,000 − 12,000) × \$3 = \$3,000 Favourable  
> (d) Efficiency variance = (12,500 − 13,000) × \$3 = \$1,500 Adverse  
> Capacity + Efficiency = \$3,000 F − \$1,500 A = \$1,500 F (matches the volume variance).

### **Worked Example 1.2**

Budgeted output is 3,000 units; budgeted fixed overhead is \$9,000 (so FOAR is \$3/unit). Actual output is 2,800 units; actual fixed overhead incurred is \$8,500.

**Required:** Calculate (a) the expenditure variance and (b) the volume variance.

> **Answer:**
> (a) Expenditure variance = \$9,000 − \$8,500 = \$500 Favourable  
> (b) Volume variance = (2,800 − 3,000) × \$3 = \$600 Adverse

### **Worked Example 1.3**

Budgeted working hours are 2,200 for the period. Actual hours worked are 2,050. FOAR is \$4 per hour.

**Required:** What is the capacity variance?

> **Answer:**
> Capacity variance = (2,050 − 2,200) × \$4 = (\$600) Adverse

## Interpreting Fixed Overhead Variances

Understanding the reasons behind each variance supports action to improve control:

- **Expenditure variance:** Arises from overspending or savings in rents, utilities, or salaries compared to plan.  
  Check for unexpected increases or unplanned expenses.
- **Volume variance:**
  - Favourable: Actual output or standard hours exceed budget, so more overhead was absorbed—possibly due to extra demand, fewer stoppages, or overtime.
  - Adverse: Output/standard hours were below budget—could result from machine breakdowns, material shortages, or unplanned idle time.
- **Capacity variance:** Favourable if more actual hours worked than budgeted (higher resource utilisation); adverse if hours worked were less—often because of idle time, absences, or production stoppages.
- **Efficiency variance:** Favourable if employees take less time than standard to do the job; adverse if more time is needed, which may point to lack of training, outdated equipment, or poor production planning.

Careful investigation is warranted for significant or recurring adverse variances—control action should be taken if the potential benefits exceed investigation and correction costs.

### **Exam Warning**

> Under marginal costing, only the expenditure variance is recognised as all fixed overhead is treated as a period cost. Volume, capacity, and efficiency variances are exclusive to absorption costing.

### **Revision Tip**

> Remember:
>
> - Use units for per-unit FOAR; use hours for per-hour FOAR.
> - Volume variance = capacity variance + efficiency variance (when based on hours).  
>   Consistently practice identifying which formula fits each variance.

## Link to Over- or Under-Absorption

The total fixed overhead variance is equal to the over- or under-absorbed overhead for the period:

- Total variance = Overhead absorbed (via FOAR) − Actual fixed overhead incurred
- Over-absorbed: Favourable—more overhead recovered than spent
- Under-absorbed: Adverse—less overhead recovered than actually spent

This reconciliation connects variance analysis to the management accounts and provides a control bridge to the financial statements.

## **Summary**

In absorption costing, fixed overhead variance analysis divides total overhead differences into expenditure and activity-related variances. Expenditure variances reflect cost control; volume, capacity, and efficiency variances reflect resource use and factory output levels. Understanding these allows managers to identify possible causes, recommend corrective action, and link operational performance with cost control.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Calculation and meaning of fixed overhead expenditure variance
- Calculation and meaning of fixed overhead volume variance (per unit or per hour)
- Splitting the volume variance into capacity and efficiency components (when absorption is by hour)
- Interpretation of each variance and its possible causes
- Link between the total fixed overhead variance and overall over/under-absorption
- Awareness that these variances are exclusive to absorption costing

## **Key Terms and Concepts**

- Fixed Overhead Expenditure Variance
- Fixed Overhead Volume Variance
- Fixed Overhead Capacity Variance
- Fixed Overhead Efficiency Variance
- Fixed Overhead Absorption Rate (FOAR)

Overhead variances and interpretation - Fixed overhead expenditure and volume (capacity/efficiency)