## 'Variable Overhead Efficiency Variance' Definition:

In variance analysis, the total variable overhead variance may be split into two: **spending variance** and **efficiency variance**. The *variable overhead efficiency variance* refers to the variance that arises due to the difference between the standard variable overhead allocation base and actual base.

- Definition of variable efficiency variance
- Allocation base and application rate
- Formula
- Example
- Favorable and unfavorable variance

## Allocation Base and Application Rate

In standard costing, factory overhead is applied based on a certain allocation base. The most common allocation bases for factory overhead are:* direct labor hours* and *machine hours*. Other bases are also used (especially in activity-based costing).

**Example:** A company has a production budget of 20,000 units. Each unit requires 4 labor hours to complete. The company has a factory overhead budget of $400,000. Using labor hours as base, the budgeted FOH application rate would be **$5 per labor hour**, i.e. the FOH budget of $400,000 divided by the budgeted allocation base of 80,000 hours.

Standards are used to facilitate better control and speed up the recording process. To better manage accounts, standards may be established separately for variable and fixed factory overhead.

## Formula

The formula for variable factory overhead (VFOH) efficiency variance is:

*VFOH efficiency variance = (AB - SB) x BR*

where: AB = actual allocation base, SB = standard base, and BR = budgeted rate.

It may also be expressed as: * (AB x BR) - Applied VFOH*, or *(AB x BR) - (SB x BR)*. The applied variable factory overhead is equal to *(SB x BR).*

## Example

XYZ Company has a *variable* factory overhead budget of $1,320,000 in producing 120,000 units of its product. One unit requires 2.75 labor hours to complete -- a total of 330,000 hours. Hence, the application rate for VFOH is $4 per labor hour (1,320/330). Last month, XYZ produced 9,600 units and employed 29,000 direct labor hours. The actual variable factory overhead is $121,800. Compute for the variable efficiency variance.

VFOH efficiency variance | = | (AB - SB) x BR |

= | (29,000 - 26,400) x $4 | |

VFOH efficiency variance | = | $10,400 unfavorable |

The standard allocation base of 26,400 is computed by multiplying the number of units produced by the standard time required to produce a unit (9,600 units x 2.75 hours).

The variance may also be expanded and expressed as:

VFOH efficiency variance | = | (AB x BR) - (SB x BR) |

= | (29,000 x $4) - (26,400 x $4) | |

VFOH efficiency variance | = | $10,400 unfavorable |

## Favorable and Unfavorable VFOH Efficiency Variance

If the actual allocation base is greater than the standard, the company used more of it (more hours) than expected. Hence, the variance is **unfavorable**. If the actual base is less than the standard base, the variance is **favorable**.