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Manufacturing overhead represents the costs for items that go into the production of many goods rather than just a few. A variable overhead efficiency variance represents a difference between budgeted overhead items and actual overhead items used in production. For example, indirect labor hours are a part of manufacturing overhead; a variable overhead efficiency variance occurs when the actual hours used in production are more or less than expected. Once managerial accountants discover the variance, they must determine whether the variance is favorable or not. Unfavorable variances are a sign of inefficient production methods or improper actions by production employees.
A flexible budget is typically the starting point for the discovery of variances in a company’s production system. This budget uses information from previous production periods in order to obtain a general standard. These standards represent the number of hours, materials, and other items needed to produce goods in the most efficient and effective way possible. From here, managerial accountants can use these standards for manufacturing overhead to estimate whether or not current production is on par with the general standards. In some cases, flexible budgets may be needed for different items produced or different manufacturing overhead pieces.
The computation of a variable overhead efficiency variance starts with the collection of data from the current production process. The data gathered must match that of the flexible budget; failure to collect the same information can lead to difficulties in computing the variance. For example, the number of indirect labor hours to complete the production process in the current period is compared to the flexible budget. A difference in standard hours versus actual hours can indicate if the company spent more or less hours completing a set of goods. More hours spent to produce the certain amount goods can indicate inefficient production activities.
Though a variable overhead efficiency variance may initially be seen as unfavorable, it may actually be favorable. For example, more hours spent at a lower cost may wind up saving the company money in the long run. Additionally, the opposite may be true if there is a variance that is fewer hours than the standard set in the flexible budget. Lower hours spent in order to save money can result in poor-quality products that wind up costing the company more money to replace or reproduce. Either way, the review of variances in a production environment can determine how a company may save money and improve a variable overhead efficiency variance.