## **Learning Outcomes**

After reading this article, you will be able to calculate key overhead variances, interpret what they reveal about business performance, and explain the main causes behind these variances. You will evaluate which variances are worth investigating, describe relationships between different variance types, and recommend appropriate management action. You will also recognise how overhead variances interact with other cost variances and how to interpret variance patterns in an exam context.

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

For ACCA Management Accounting (MA), you are required to understand how overhead variances are calculated, interpreted, and used in business control. This article addresses:

- The calculation of fixed and variable overhead variances
- Interpretation of total, expenditure, efficiency, capacity, and volume variances
- Explanation of root causes of overhead variances
- Identification and investigation of significant variances
- Assessment of interrelationships between variance types
- Recommendation of control actions based on variance patterns

## **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. What does a favourable fixed overhead efficiency variance indicate about a company's operations?
2. Give two possible causes for an adverse variable overhead expenditure variance.
3. Explain the relationship between the fixed overhead efficiency variance and the labour efficiency variance.
4. When should management investigate a variance? Name two factors that influence this decision.

## **Introduction**

Overhead variances are used to analyse and control an organisation’s indirect costs by comparing what overheads should have been (standard overheads) versus what they actually were. By breaking variances into logical elements, management can focus on improving efficiency, controlling expenditure, and maximising resource use. Understanding the patterns, relationships, and causes behind overhead variances is critical for effective decision-making and strong ACCA exam answers.

> **Key Term: Overhead variance**
> The difference between actual overhead cost incurred and the standard (budgeted) overhead absorbed, analysed to highlight root causes for management attention.

## Types of Overhead Variances

Overhead variances are normally split into variable and fixed. Each has sub-variances, reflecting cost behaviour and performance measurement focus.

### Variable Overhead Variances

Variable overheads tend to change with activity levels (e.g., indirect materials, power costs). Main variances:

- **Variable overhead expenditure (spending) variance:** Did we spend more or less per input unit than budgeted?
- **Variable overhead efficiency variance:** Did we use inputs (often labour hours) more or less efficiently than standard allowed for actual output?

### Fixed Overhead Variances

Fixed overheads remain constant over a period, irrespective of output (e.g., rent, management salaries). Main variances:

- **Fixed overhead expenditure (spending) variance:** Did we spend more or less on fixed overheads overall versus budget?
- **Fixed overhead volume variance:** Did we produce more or fewer output units than planned, affecting absorbed fixed overhead?
- **Fixed overhead capacity and efficiency variances:** How much of the volume variance is due to the number of hours worked (capacity) versus how well those hours were used (efficiency)?

> **Key Term: Expenditure variance**
> The difference between actual overhead costs and budgeted overheads for a period.
>
> **Key Term: Efficiency variance**
> The variance arising when actual hours worked differ from standard hours allowed for actual output, valued at standard overhead absorption rate.
>
> **Key Term: Volume variance**
> The variance reflecting the difference between actual output and budgeted output, measured in absorption terms.
>
> **Key Term: Capacity variance**
> Portion of volume variance due to difference between actual and budgeted hours worked.
>
> **Key Term: Controllable variance**
> A variance arising from factors within a manager’s responsibility and influence.
>
> **Key Term: Interrelationship of variances**
> When changes in one variance affect or explain movements in others, due to common root factors.

## Calculating and Interpreting Overhead Variances

All variances follow a basic principle:

1. **Expenditure/spending**: Did actual cost differ from what should have been spent for the period?
2. **Efficiency**: Was input used more or less efficiently than expected?
3. **Capacity (fixed only)**: Was actual capacity (hours worked) above or below that allowed for output?
4. **Volume (fixed only)**: Did output volume reflect greater or lesser absorption of fixed costs?

### Structure of Overhead Variances

**Variable Overheads:**  
_Total Variable Overhead Variance_  
  → Expenditure variance  
  → Efficiency variance

\*\*Fixed Overheads (Absorption costing):\_  
_Total Fixed Overhead Variance_  
  → Expenditure variance  
  → Volume variance  
    → Capacity variance  
    → Efficiency variance\_

### **Worked Example 1.1**

A company budgets \$20,000 for fixed overheads based on expected output of 5,000 units (with a standard absorption rate of \$4 per unit). Actual fixed overheads are \$21,500, actual output is 4,750 units.

**Calculate:** Total fixed overhead variance, expenditure variance, and volume variance.

> **Answer:**
>
> - Expenditure variance = \$21,500 (actual) – \$20,000 (budget) = \$1,500 Adverse
> - Absorbed overhead = 4,750 × \$4 = \$19,000
> - Total fixed overhead variance = \$19,000 (absorbed) – \$21,500 (actual) = \$2,500 Adverse
> - Volume variance = \$19,000 (absorbed) – \$20,000 (budget) = \$1,000 Adverse  
>   Check: Expenditure variance + Volume variance = Total variance (\$1,500A + \$1,000A = \$2,500A).

### Investigating Overhead Variances

Not all variances require investigation. Factors influencing whether to investigate include:

- **Materiality:** Is the variance large enough to be important?
- **Controllability:** Can the manager influence the outcome?
- **Recurring trends:** Has the variance recurred in several periods?
- **Cost vs benefit:** Will corrective action save more than its cost?
- **Cause identified:** Is there an obvious reason (e.g., known strike, machinery fault)?
- **Potential knock-on effects:** Could the variance affect other areas, such as cash flow or customer satisfaction?

> **Key Term: Significance of variances**
> The process of determining whether a variance is important enough to warrant investigation and possible management action.

### Common Causes of Overhead Variances

**Variable Overhead Expenditure Variance:**

- Supplier price changes for indirect materials
- Utility price increases
- Poor control over minor spending (e.g., unplanned maintenance)

**Variable Overhead Efficiency Variance:**

- Labour inefficiencies (machine breakdown, absenteeism, training needs)
- Outdated processes

**Fixed Overhead Expenditure Variance:**

- Unexpected property rent rise
- Increase in management salaries
- Changes in fixed contract prices

**Fixed Overhead Volume/Capacity/Efficiency Variances:**

- Lower/higher production due to machine unavailability or excess demand
- Absenteeism affecting hours worked
- Production delays from supply chain problems

### **Worked Example 1.2**

XYZ Co. budgets 12,000 machine hours for the month to produce 3,000 units (4 hours each) and allocates \$60,000 fixed overhead (\$5 per machine hour). Actual figures: 11,200 machine hours worked, 2,800 units produced, fixed overheads incurred \$63,000.

**Calculate:** Fixed overhead capacity and efficiency variances.

> **Answer:**
>
> - Capacity variance: (11,200 – 12,000) × \$5 = –\$4,000 Adverse
> - Standard hours for actual output: 2,800 × 4 = 11,200 hours
> - Efficiency variance: (11,200 – 11,200) × \$5 = \$0  
>   All of the volume variance is due to lack of capacity (hours lost).

### Interrelationships Between Overhead and Other Variances

Overhead efficiency variances often mirror labour variances. When staff work faster (creating a favourable labour efficiency variance), fewer indirect resources are consumed, yielding a favourable overhead efficiency variance. Conversely, problems with poor-quality materials may increase both direct and overhead costs (adverse usage and fixed overhead volume variances).

> **Key Term: Linked variances**
> Two or more variances moving in the same direction due to the same root event or cause.

### **Worked Example 1.3**

A company experiences a favourable labour efficiency variance and a favourable variable overhead efficiency variance in the same period. What is a likely explanation?

> **Answer:**  
> Improved worker productivity means fewer hours are needed. As overheads are absorbed based on hours, both direct and overhead variances become favourable.

## Deciding When to Investigate Variances

Management should set tolerance limits for overhead variances (e.g., >5% of budget), and only investigate exceptional results. This approach allows efficient use of resources and focuses attention where improvement is most achievable.

### **Revision Tip**

Small or isolated adverse variances may not warrant investigation, but recurring, unexplained, or material adverse variances are exam favourites for discussion—know several possible causes for each type.

## Patterns and Interpretation of Variances

A variance must be interpreted in context. A single adverse variance, within a general pattern of favourable results, may not be cause for concern. However, multiple adverse variances, especially in capacity and efficiency, may indicate deeper operational difficulties, such as machinery failure or supply shortages. Always look at the set of variances together.

### **Exam Warning**

Do not assume every adverse variance is the manager’s fault or can be controlled. ACCA examiners expect you to distinguish between controllable and uncontrollable causes and recommend only practical corrective actions.

## Taking Corrective Action

After investigation, possible actions include:

- Tightening cost controls (e.g., stricter approval for maintenance)
- Revising standards to reflect new price levels or process changes
- Improving staff training or supervision to increase efficiency
- Upgrading equipment to reduce downtime and lost capacity
- Negotiating supplier contracts more effectively for variable items

Always link your recommended action to the type and cause of the variance.

## **Summary**

Overhead variances help management understand whether indirect costs have been controlled effectively. Analysis into expenditure, efficiency, capacity, and volume variances identifies where things went wrong and why. Investigating only significant and controllable variances ensures focus on actionable areas. Interrelationships between variances point to shared causes, allowing more targeted corrective action. Regular review and interpretation of overhead variances is essential for business control and essential exam success.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- The types and structure of overhead variances (variable and fixed, including sub-variances)
- How to calculate and interpret expenditure, efficiency, capacity, and volume variances
- Main causes of each overhead variance category
- Factors influencing whether to investigate specific variances
- The relationship between overhead and other cost variances
- Effective suggestions for management action based on variance patterns

## **Key Terms and Concepts**

- Overhead variance
- Expenditure variance
- Efficiency variance
- Volume variance
- Capacity variance
- Controllable variance
- Interrelationship of variances
- Significance of variances
- Linked variances

Overhead variances and interpretation - Investigating causes and interrelationships of variances