Overhead variances constitute the difference between the actual overhead and the applied overhead in a given business (Messer, 2016). The overhead variances can be determined by applying the actual overhead costs over the predetermined rate and the cost drivers. There are two types of overhead variances, which include variable and fixed variances. For the variable variances, the cost varies in proportion, where there can be a change in expenditure, which can lead to variance in costs. In contrast, for the fixed cost variances, the costs hardly change.
Adopting Overhead Variances in Accounting Systems
To adopt overhead variances in accounting systems, a company needs to have a standard costing system. This is an accounting technique that helps in breaking the overspending and underspending on the company resources, which include labor, time, and materials (Edwards, 2019). The system can, therefore, easily identify the estimated overhead costs and the actual costs, and help to determine the variances in place directly.
Unlike materials and labor standards, the overhead standards are somehow more challenging to hypothesize. One of the best ways of imagining the overhead standards is by thinking about the ways through which this allocation could go wrong. The allocation would probably be inaccurate, or one could either apply to little or too much (Bragg, 2016). The correct allocations of the overhead are the variable overhead price standard, while the correct application of the rate is the overhead quantity standards. The quality overhead standards are determined annually, whereas the overhead estimates are deliberated on by the management of the business. Owing to the difficulties in estimating these amounts, businesses opt to seek services from a cost accountant. A standard cost system helps in ensuring that the overhead variances are effectively adopted in the accounting system (Scott, 2019). Adopting an overhead variance in the accounting system will help a business to easily determine its costs, through understanding the exact amounts a business uses for the overhead costs (Graybeal, Franklin, & Cooper, 2018). It is also critical in that it helps in future allocation and budgeting, where the company can budget accordingly, to have smaller margin variance.
How Estimated Budget Volume Influences the Overhead Rate
A significant factor that influences the overhead rate is the estimated budget volume. Before determining the overhead rate, there is a need for the company to initially evaluate its financial health through its financial reports (Graybeal et al., 2018). Overhead cost allocation helps a business in understanding the costs of its products. Through capital budgeting, a business can forecast on the value of buying new assets and how it could impact on its purchases.
There are different ways of allocating overhead costs. However, when one method is chosen, then it must be consistent and in line with the budget expectations. The first step involves the selection of the base of the allocation (Jiambalvo, 2019). The base can involve a person’s hours or the production of a specific product. By dividing the base by the number of products, it gives a percentage that is used in determining the overhead variances which can be accredited to the production.
High Estimated Budget Volume Equate
There are different types of costs which are incurred when dealing with the overhead. Concerning fixed overhead, costs hardly change, but rather stay within the range specified in the budget. On the other hand, variable overheads cost change based on the output of the organizations or the services provided. Variable overhead costs are likely to increase or decrease depending on the organization’s output (Graybeal et al., 2018). With regard to the variable overhead costs, a high estimated budget is most likely to result in a lower overhead rate. This is because, in considerable allocation, it will directly go to the production of goods and services, as the indirect costs of the business will take the lesser ration (Edwards, 2019). By having lower overhead rations, the business will have better pricing for its products, therefore making it more attractive to prospective clients. This will ultimately help in increasing the profit margin for the business (Graybeal et al., 2018). Nevertheless, it is also likely that, in some circumstances, poor budgeting allocation may lead to a high overhead rate when the factors of determining the overhead rates are not effectively determined.
The Usefulness of Overhead Variances in Performance Measurement
Overhead variances are critical in the performance measurement of the company. Depending on the size of a company, the supervisor is responsible for determining the constable overhead variables. The overhead variances help in providing critical information regarding the management, mostly by determining whether there has been an efficient use of the resources, which include time, materials, and labor (Graybeal et al., 2018). These areas are very critical in that they show how overhead costs are affected, and whether the actual costs are in line with the budget or way over what is expected (Edwards, 2019). They also help in determining whether a business has been able to meet its expected goals and objectives.
In the event of drastic differences between the budget and the actual overhead cost, a business can monitor whether it was able to keep up with its expectations. This will consequently enable the business to fix and correct any issues that may be leading to high costs and increased expenses (Graybeal et al., 2018). Overhead variance also helps to determine whether an organization can reach its long-term goals. The variance helps in determining the business culture and behavior, where the issues affecting the company can be corrected and ensure that ultimately the business attains its set long term goals and objectives (Edwards, 2019). It also helps in influencing the accounting department of the company and contributes to shaping the financial outcomes.
In summation, overhead variances are the differences between the actual overhead and the applied overhead in a business. They are vital in accounting in that they help in determining whether a business is efficiently using its resources, which include labor, time, and materials. Many managers have continuously used the overhead variance in determining the short-term outcome without analyzing a long-term impact. It is vital that managers should analyze the reported variances, as a way of ensuring that there is a collaborative effort within business departments to have better budgeting and estimations that will ultimately help in improving the operations of a company. A business needs to be keen in determining its overhead variances, through ensuring that they are considered in the course of budgeting.
Bragg, S. M. (2016). Cost accounting fundamentals. Colorado, CO: Accounting Tools.
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Graybeal, P., Franklin, M., & Cooper, D. (2018). Distinguish between Financial and Managerial Accounting. Principles of Accounting, Volume 2: Managerial Accounting. Retrieved on May 4, 2020, from https://opentextbc.ca/principlesofaccountingv2openstax/chapter/distinguish-between-financial-and-managerial-accounting/
Jiambalvo, J. (2019). Managerial accounting (7th Ed.). Hoboken, New Jersey: John Wiley & Sons, University of Washington.
Messer, R. (2016). Teaching Variance Analysis for Cost Accounting: How to Achieve above Par Performance’. Advances in Accounting Education: Teaching and Curriculum Innovations (Advances in Accounting Education, Volume 18). Emerald Group Publishing Limited, 51-63.
Scott, P. (2019). Introduction to Management Accounting. USA: Oxford University Press.