Cost and Management Accounting

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Overhead Cost Variance

Overhead Costs are the sum of indirect material, indirect labour cost and all other indirect expenses.

Overhead cost variance is the difference between the standard overhead costs and the actual overhead costs.

  • It helps businesses identify deviations from their standard overhead, enabling them to assess performance in managing costs.

It can be done in following ways:

  • Two Overhead Variance Analysis
  • Three Overhead Variance Analysis
  • Four Overhead Variance Analysis
  • Five Overhead Variance Analysis

Three Overhead Variance Analysis is a method used to break down the total overhead variance into three specific components: capacity variance, efficiency variance, and spending variance.

  • Each of these variances provides insights into different aspects of overhead cost management, helping businesses assess their resource utilization, operational efficiency, and cost control effectiveness.

Three Overhead cost variances are often divided into three components:

  • Capacity Variance
  • Efficiency Variance
  • Spending Variance or Expenditure Variance

1.) Capacity Variance

Capacity variance is the difference between the standard overhead costs based on the planned capacity level and the overhead applied to actual hours worked.

  • This variance reflects how effectively the company used its available capacity (i.e., if it operated at, above, or below the planned level).

2.) Efficiency Variance

Efficiency variance is the difference between the standard hours allowed for actual production output and the actual hours worked.

  • This variance helps to evaluate the efficiency with which the workforce and resources are used in relation to overhead costs.

3.) Spending Variance

Spending variance (or expenditure variance) is the difference between the actual overhead costs incurred and the standard overhead costs based on the actual hours worked.

  • This variance measures how well the company controlled its overhead expenses relative to the budget.

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