## Learning Outcomes

After studying this article, you will be able to calculate, explain, and interpret variable and fixed overhead variances. You will understand the purpose and calculation of expenditure, efficiency, capacity, and volume variances, and be able to use them for performance management and profit reconciliation in the ACCA PM exam context.

## ACCA Performance Management (PM) Syllabus

For ACCA Performance Management (PM), you are required to understand the use of standard costs for controlling overheads and assessing performance. In particular, this article addresses:

- How to calculate variable overhead expenditure and efficiency variances
- How to calculate fixed overhead expenditure, volume, capacity, and efficiency variances
- How to interpret overhead variances for cost control and managerial appraisal
- How to reconcile budgeted and actual profits using these variances
- How to distinguish between controllable and uncontrollable overhead costs in performance analysis

## Test Your Knowledge

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

1. What does the variable overhead efficiency variance measure?
2. How is the fixed overhead volume variance further divided under absorption costing?
3. True or false? A favourable variable overhead expenditure variance indicates that less was spent per hour than budgeted.
4. Why must overhead variances be linked to controllability when assessing manager performance?

## Introduction

Overheads, including both variable and fixed overheads, comprise a significant portion of total costs in many organisations. Standard costing allows these overheads to be planned, controlled, and analysed through a system of variance calculations. Understanding these variances enables you to pinpoint areas of operational efficiency or inefficiency and supports meaningful performance assessment.

> **Key Term: overhead variance**
> The difference between budgeted (standard) overhead and actual overhead cost for a period, used to analyse cost control and performance.

### VARIABLE OVERHEAD VARIANCES

Variable overheads, such as indirect materials or utilities that fluctuate with activity, are typically analysed into two variances:

- Variable overhead expenditure variance
- Variable overhead efficiency variance

### Variable Overhead Expenditure Variance

This variance compares the amount that should have been spent on variable overhead for the actual activity (hours worked), at the standard rate, against the amount actually spent.

> **Key Term: variable overhead expenditure variance**
> The difference between actual variable overhead incurred and the expected variable overhead for actual hours worked, valued at the standard rate.

### Variable Overhead Efficiency Variance

This variance measures whether more or fewer hours were used than expected for the level of output, valued at the standard variable overhead rate.

> **Key Term: variable overhead efficiency variance**
> The difference between standard hours allowed for actual output and actual hours worked, valued at the standard variable overhead rate.

### Worked Example 1.1

A company budgets for 6,000 machine hours at a standard variable overhead rate of \$2 per hour (\$12,000 budgeted cost). Actual output required 6,400 machine hours, and the variable overhead incurred was \$13,120. The standard hours allowed for actual production were 6,200.

**Required:** Calculate the variable overhead expenditure and efficiency variances.

> **Answer:**
>
> - Expenditure variance:
>   - Expected overhead for 6,400 hours: 6,400 × \$2 = \$12,800
>   - Expenditure variance = \$12,800 – \$13,120 = \$320 Adverse
>
> - Efficiency variance:
>   - (Standard hours allowed – Actual hours) × Standard rate = (6,200 – 6,400) × \$2 = \$400 Adverse
>
> - Total variance: \$320 A + \$400 A = \$720 Adverse

### FIXED OVERHEAD VARIANCES

Fixed overheads remain stable across normal levels of activity. In standard costing, fixed overheads are analysed using absorption costing principles.

![Variable overhead variance calculation linking actual hours, standard rate, standard hours, expected overhead, expenditure variance, efficiency variance, and total variance.](https://static.pastpaperhero.com/images/acca-pm-basic-variances-variable-and-fixed-overhead-variances_00.png)

_Variable overhead analysis derives expected overhead, expenditure variance, efficiency variance, and total variance using actual hours, standard hours, and standard rate._

The key variances are:

- Fixed overhead expenditure variance
- Fixed overhead volume variance (which can be split further)

### Fixed Overhead Expenditure Variance

This measures whether actual fixed overhead incurred matches the budgeted amount for the period.

> **Key Term: fixed overhead expenditure variance**
> The difference between budgeted fixed overheads and actual fixed overheads incurred in the period.

### Fixed Overhead Volume Variance

This variance compares the budgeted fixed overheads (for planned output) with the amount of overhead absorbed based on actual output.

> **Key Term: fixed overhead volume variance**
> The difference between overhead absorbed for actual output (in standard hours) and budgeted fixed overhead.

The volume variance can be further split into:

- Fixed overhead efficiency variance
- Fixed overhead capacity variance

> **Key Term: fixed overhead efficiency variance**
> The difference between standard hours for actual output and actual hours worked, multiplied by the standard fixed overhead absorption rate.
> **Key Term: fixed overhead capacity variance**
> The difference between actual hours worked and budgeted hours, multiplied by the fixed overhead absorption rate.

### Worked Example 1.2

A business budgets to produce 4,000 units in a month, requiring 8,000 labour hours. Fixed overheads are budgeted at \$32,000 per month, absorbed at \$4 per hour. Actual production was 4,200 units, using 8,400 hours. Actual fixed overheads incurred: \$34,000.

**Required:** Calculate the fixed overhead expenditure, efficiency, capacity, and volume variances.

> **Answer:**
>
> - FO absorption rate = \$32,000 / 8,000 hrs = \$4/hr
> - Fixed overhead expenditure variance:
>   - \$32,000 (budgeted) – \$34,000 (actual) = \$2,000 Adverse
>
> - Standard hours for 4,200 units: (8,000 hrs / 4,000 units) × 4,200 = 8,400 hrs\*
> - Assume standard usage is 2 hours/unit, so 4,200 × 2 = 8,400 hrs
> - Fixed overhead efficiency variance:
>   - (Standard hours for actual output – Actual hours worked) × \$4 = (8,400 – 8,400) × \$4 = \$0 (no variance)
>
> - Fixed overhead capacity variance:
>   - (Actual hours worked – Budgeted hours) × \$4 = (8,400 – 8,000) × \$4 = \$1,600 Favourable
>
> - Fixed overhead volume variance:
>   - (Standard hours for actual output – Budgeted hours) × \$4 = (8,400 – 8,000) × \$4 = \$1,600 Favourable
>
> **Exam Warning:**
> Common error: Confusing capacity and efficiency variances. Capacity relates to total hours worked versus budget; efficiency relates to output achieved per hour worked.
>
> **Revision Tip:**
> Always compare overheads at the actual level of activity (flexed budget), never at static budgeted figures. This avoids misleading variance results.

### INTERPRETING AND USING OVERHEAD VARIANCES

Calculating overhead variances is not enough—they must be interpreted in the context of managerial responsibility. Only variances over which a manager has control should be attributed to that person in performance reviews.

- Expenditure variances often relate to spending decisions (e.g., utility savings, unplanned repairs).
- Capacity variances can arise from absenteeism, machine breakdown, or scheduling inefficiency.
- Efficiency variances reflect productive use of resources and can be influenced by staff skill, supervision, or process changes.

Analyzing these variances helps identify the causes of over/under absorption and guides corrective action.

## Summary

- Variable overheads are split into expenditure (rate) and efficiency variances.
- Fixed overheads are split into expenditure and volume variances; the latter is further divided into capacity and efficiency for absorption costing.
- These variances allow for cost control, performance evaluation, and profit reconciliation.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- Calculate variable overhead expenditure and efficiency variances
- Calculate fixed overhead expenditure, volume, capacity, and efficiency variances
- Apply correct variance formulas using activity-based and output-based measures
- Use variance analysis to support performance management and profit reporting

## Key Terms and Concepts

- overhead variance
- variable overhead expenditure variance
- variable overhead efficiency variance
- fixed overhead expenditure variance
- fixed overhead volume variance
- fixed overhead efficiency variance
- fixed overhead capacity variance


Basic variances - Variable and fixed overhead variances