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Variances and the life of Brian

Neil Arnott explains how you can tackle exam questions on fixed overhead variances

July 2016

Students often struggle to calculate the fixed overhead variances correctly – and in particular the volume, capacity and efficiency variances. There seem to be so many variables involved – actual cost, budgeted cost, actual quantity, budgeted quantity, standard quantity and so on. It’s a nightmare!
And there are so many ways to remember the variances – some tutors love formulas, some suggest drawing graphs… I’ve always believed that if you understand the logic behind any subject you are more likely to carry out any calculations correctly, but also to be able to explain the meaning of your findings.
So let’s have a look at explaining these troublesome variances in a much simpler way than you will usually encounter in a typical accounting text book.
Meet Brian. Brian is a typical AAT Level 4 student studying the Financial Performance unit. He is hard-working, committed and motivated. He also struggles to understand fixed overhead variances.
Brian has his exam in a couple of weeks, so his tutor has given him some additional homework to do. This is to complete four practice exams and to bring them back in to be marked the following week. The tutor explains that each practice exam has a time limit of three hours and Brian should stick to this when he completes them.
With this information we can establish some ‘standards’. The plan (budget) is that Brian will complete:
4 exams in 3 hours each = 12 hours work
A week later Brian approaches his tutor and tells her that he has done really well with his homework this week – he didn’t just work for the 12 hours which were budgeted, he actually worked for 15 hours on the practice assessments. Brian is happy with this. So too is his tutor.
“That’s excellent, Brian. You worked more hours than we budgeted for – well done!”
She then asks Brian for the completed assessments so she can mark them.
“Ah… I only managed to complete three of the assessments.”
Brian’s tutor isn’t so happy now.
“So you worked for 15 hours, but you only completed three papers! What were you doing?”
“Well”, replies Brian, “You see they took a bit longer than I thought… and I went on Facebook… and I watched EastEnders…and then my friend came round...”
This little tale demonstrates perfectly the fixed overhead variances.
Brian had a favourable capacity variance of three hours. By comparing the budgeted hours with the actual hours we can see that Brian worked for 15 hours against a plan of 12 hours – which is, of course, a good thing.
But this is not the whole picture; we also need to think about how efficiently he worked during these hours. And this is where Brian underperformed; the three practice exams he completed should only have taken him three hours each, or nine hours in total. So he took 15 hours to complete work which should only have taken nine hours, which is an adverse efficiency variance of six hours.
If we add the capacity and the efficiency variances together (taking into account which is favourable and which is adverse) we get a figure of three hours adverse. This is effectively the volume variance, except the volume variance deals with units rather than hours. In three hours the standard output is one mock exam (ie one unit) – which of course reflects that Brian only completed three mock exams instead of four.
Of course, in a manufacturing setting we would need to multiply each of these variances by the overhead absorption rate per hour (for the efficiency and capacity variances) and the overhead absorption rate per unit (for the volume variance), to express the variances in monetary terms. But the principles remain the same.
Many students struggle to understand how working more hours than budgeted leads to a favourable capacity variance, or how a favourable capacity variance can be ‘paired’ with an adverse efficiency variance.
Hopefully the story of Brian has helped to clarify what each of these variances mean so you will feel more confident in both calculating and explaining them in your exam. Of course, the other thing that would help would be having favourable efficiency and capacity variances in your own revision!
• Neil Arnott is a course tutor at Premier Training

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