Overview of FOH cost variance formula

The fixed overhead (FOH) cost variance is analyzed differently than all the previous variances because so far we have discussed costs that vary directly with production levels or variable costs, which includes direct materials, direct labor and variable overhead.

Under standard costing, fixed overhead (FOH) is generally considered independent of production within the relevant range of activity. However, FOH is still applied to units of output using a predetermined standard FOH rate. This rate functions in the same way as the standard labor rate or the standard cost per unit of direct materials, ensuring that each unit produced carries a share of fixed overhead. This approach is known as absorption costing.

Definitions

Absorption costing

Absorption costing is a method of product costing in which all manufacturing costs (i.e., direct materials, direct labor, variable overhead, and fixed overhead) are assigned to units of production.

Because FOH is applied at a predetermined rate, the FOH absorbed by inventory and COGS usually differs from the FOH actually incurred. When absorbed FOH exceeds actual FOH, FOH is over-absorbed; when it falls short, FOH is under-absorbed.

Take for example the scenario below:

The over/under absorbed FOH above is effectively the FOH cost variance and is formally represented by the following formula:

$$\text{Fixed overhead cost variance}=\text{Absorbed FOH}-\text{Actual FOH}$$

Where:

• $\text{Absorbed FOH}$ is the fixed overhead applied to production using the predetermined FOH rate
• $\text{Actual FOH}$ is the actual fixed overhead incurred

Sign convention: with this orientation (absorbed − actual), a positive result means FOH was over-absorbed. That’s favorable, because too much cost was charged to production, which increases operating income. A negative result means FOH was under-absorbed, which is unfavorable. Keep in mind that a favorable production volume variance (covered in a later chapter) reflects higher output, not cost control - it isn’t the same kind of “favorable” as spending less than budgeted.

The absorption of the FOH can be through units produced or hours used depending on the cost driver. The FOH cost variance can be broken down into different components:

Overview of variance formula

The total of all calculated variances should equal the fixed overhead cost variance. This provides a useful way to verify the accuracy of your calculations by comparing the sum of the individual variances to the total FOH cost variance. In text form, the spending variance equals budgeted FOH minus actual FOH, and the volume variance equals absorbed FOH minus budgeted FOH; together they add up to the FOH cost variance. The spending variance is covered in the next chapter, and the production volume variance in the chapter after that.

From the figure below, it should be noted that you have several options of computing the FOH variances depending on what is the situation.