Introduction to Indirect Cost Variances

What you will learn to do: identify indirect costs standards and variances

Accountants usually use a formula to allocate overhead to production. For instance, if the Boulevard Blanks management team wants real-time information during the month, rather than waiting for the financial accountants to produce the month end reports, they might use an estimate. Based on historical information, they could come up with a “burden” rate. If they know that variable overhead, such as sandpaper and other finishing supplies, runs about $1.20 per body, they could allocate that amount during the production run. Usually, they do it based on some metric they are collecting, such as direct labor hours. They know the standard for one completed body is 1.5 hours. If they allocate $0.80 per direct labor hour worked, they can automate the allocation process without having to stop production to count units, since hours worked are already being collected.

Fixed overhead can be allocated the same way. If the budget is $12,375 for the month, and expected production is 1,500, that’s $8.25 per body completed, which could be allocated by charging $5.50 per direct labor hour, since a completed body should take 1.5 hours (1.5 x 5.5 = $8.25).

Many different paint cansVariable overhead will be materials like paint, supplies, and even in some cases utilities (such as electricity for a refinery) that are too hard to trace directly to the cost object but vary directly with production (often these will include some mixed costs items).

Fixed overhead remains the same at every level of production within a relevant range. This would include factory rent, property taxes, most utilities, supervisor salaries, depreciation on equipment, janitorial, insurance, etc.

Just as we calculate variances for direct costs like labor and materials, we calculate variances for indirect costs, both variable and fixed.

When you are done with this section, you will be able to:

  • Compute the variable manufacturing overhead cost variance
  • Compute the variable manufacturing overhead efficiency variance
  • Compute the fixed manufacturing overhead variance

Learning Activities

The learning activities for this section include the following:

  • Reading: Variable Manufacturing Cost Overhead Variance
  • Self Check: Variable Manufacturing Cost Overhead Variance
  • Reading: Variable Manufacturing Overhead Efficiency Variance
  • Self Check: Variable Manufacturing Overhead Efficiency Variance
  • Reading: Fixed Manufacturing Overhead Variance
  • Self Check: Fixed Manufacturing Overhead Variance