The fixed overhead volume variance is the difference between the amount of fixed overhead actually applied to produced goods based on production volume, and the amount that was budgeted to be applied to produced goods. This variance is reviewed as part of the period-end cost accounting reporting package.
For example, a company budgets for the allocation of $25,000 of fixed overhead costs to produced goods at the rate of $50 per unit produced, with the expectation that 500 units will be produced. However, the actual number of units produced is 600, so a total of $30,000 of fixed overhead costs are allocated. This creates a fixed overhead volume variance of $5,000.
The fixed overhead costs that are a part of this variance are usually comprised of only those fixed costs incurred in the production process. Examples of fixed overhead costs are:
- Factory rent
- Equipment depreciation
- Salaries of production supervisors and support staff
- Insurance on production facilities
Being fixed within a certain range of activity, fixed overhead costs are relatively easy to predict. Because of the simplicity of prediction, some companies create a fixed overhead allocation rate that they continue to use throughout the year. This allocation rate is the expected monthly amount of fixed overhead costs, divided by the number of units produced (or some similar measure of activity level).
Conversely, if a company is experiencing rapid changes in its production systems, as may be caused by the introduction of automation, cellular manufacturing, just-in-time systems, and so forth, it may need to revise the fixed overhead allocation rate much more frequently, perhaps on a monthly basis.
When the actual amount of the allocation base varies from the amount built into the budgeted allocation rate, it causes a fixed overhead volume variance. Examples of situations in which this variance can arise are:
- The allocation base is the number of units produced, and sales are seasonal, resulting in irregular production volumes on a monthly basis. This disparity tends to even out over the course of a full year.
- The allocation base is the number of direct labor hours, and the company implements new efficiencies that reduce the actual number of direct labor hours used in production.
- The allocation base is the number of machine hours, but the company then outsources some aspects of production, which reduces the number of machine hours used.
When the cumulative amount of the variance becomes too large over time, a business should alter its budgeted allocation rate to bring it more in line with actual volume levels.