Fixed Manufacturing Overhead Volume Variance

The fixed manufacturing overhead volume variance is the difference between the fixed overhead a factory budgeted for a period and the fixed overhead it applied to production at the standard rate. It arises because the fixed overhead rate is set by dividing budgeted fixed costs by an expected, or denominator, level of activity. When actual output requires more or fewer standard hours than that denominator, the amount applied to products differs from the amount budgeted, even if spending is exactly on budget.

It is one of two variances that together explain total under- or over-applied fixed overhead in a standard costing system. The other is the fixed overhead spending variance, also called the budget variance, which compares actual fixed costs with budgeted fixed costs. The volume variance is sometimes called the production volume variance or denominator variance, and it exists only under absorption costing.

A gym pays $10,000 a month in rent and expects 1,000 member visits, so it plans on charging $10 of rent to each visit. If only 800 people come, just $8,000 of rent has been charged to visits, even though the full $10,000 was paid. The $2,000 that was not charged reflects the visits that never happened.

That gap is the volume variance. It does not mean the rent cost more than expected. It means the gym's space was used less than planned. In a factory, the variance shows how well production capacity was used compared with the level assumed when setting the overhead rate.

The volume variance can be written in two equivalent ways:

• $\text{DH}$ is the denominator hours used to set the rate.
• $\text{SH}$ is the standard hours allowed for actual output.
• $\text{FR}$ is the predetermined fixed overhead rate per hour.

A plant budgets fixed overhead of $360,000 on a denominator of 12,000 machine hours, a rate of $30 an hour. The standard is 2 hours per unit. It produces 5,500 units, so 11,000 standard hours are allowed and fixed manufacturing overhead applied is $330,000. The volume variance is $360,000 minus $330,000, or $(12{,}000 - 11{,}000) \times 30 = 30{,}000$. Because less was applied than budgeted, it is a $30,000 unfavorable variance.

If actual fixed overhead was $368,000, the spending variance is $8,000 unfavorable. The two variances add up to the $38,000 by which fixed overhead was under-applied.

An unfavorable volume variance means output fell short of the denominator level, leaving some capacity unused or unabsorbed. A favorable variance means output exceeded it, so more fixed cost was spread across products than budgeted. Neither result means fixed costs themselves changed; the fixed costs were incurred regardless of output.

Causes of an unfavorable variance include weak sales demand, machine breakdowns, material shortages, strikes, or a denominator set too high in the first place. Because volume is often driven by sales rather than production, the variance is not always the responsibility of factory managers. Some companies set the denominator at practical capacity so that the variance highlights the cost of idle capacity, which can inform decisions about selling or redeploying facilities.

When standard costs are recorded in the ledger, the volume variance is isolated in its own account, debited if unfavorable and credited if favorable. At year-end it is closed with the other variances, usually to cost of goods sold if small, or prorated across work in process, finished goods and cost of goods sold if material, so that inventory approximates actual cost under GAAP.

Many management accountants regard the volume variance as an accounting artifact rather than a measure of control. It results from treating a fixed cost as if it were variable per unit, and it can encourage managers to produce more than customers need simply to absorb fixed overhead and turn the variance favorable, which builds unwanted inventory. Under variable costing, where fixed overhead is expensed in full each period, there is no volume variance at all. For performance evaluation, comparing actual fixed costs with the flexible budget and tracking capacity use directly are often more informative. The spending variance and the volume variance together are sometimes grouped with variable overhead variances in a broader budget variance analysis of manufacturing overhead.

• Institute of Management Accountants