The variable overhead spending variance is the difference between the actual variable overhead cost per unit of the cost-allocation base and the budgeted variable overhead cost per unit of the cost-allocation base, multiplied by the actual quantity of variable overhead cost-allocation base used.
Columns 1 and 2 in Exhibit 8-1 depict this variance. The variable overhead spending variance is favorable because actual variable overhead cost per unit of the cost-allocation base ($29 per machine-hour) is lower than the budgeted variable overhead cost per unit of the cost-allocation base ($30 per machine-hour).
To understand why this is the case, recall that Webb used 4,500 machine-hours, which is 12.5% greater than the flexible-budget amount of 4,000 machine-hours. However, actual variable overhead costs of $130,500 are only 8.75% greater than the flexible-budget amount of $120,000. Thus, relative to the flexible budget, the percentage increase in actual variable overhead costs is less than the percentage increase in machine-hours. Hence, the actual variable overhead cost per machine-hour is lower than the budgeted amount.
Why might the percentage increase in actual variable overhead costs be lower than the percentage increase in machine-hours? There are two possible reasons:
In the last stage of the five-step decision-making process, Webb’s managers examine signals provided by the variable overhead variances to evaluate the firm’s performance and learn. Learning leads to better predictions and, as we describe next, actions to improve results in future periods.
Consider potential reasons for actual prices of variable overhead cost items to be lower than budgeted prices (reason 1 above), such as skillful negotiation on the part of the purchasing manager, oversupply in the market, or lower quality of inputs such as indirect materials. Webb’s response depends on what managers believe to be the cause of the variance. If, for example, prices are lower because of low input quality, managers might put in place new quality management systems.
Consider potential reasons for the efficiency with which variable overhead resources are used (reason 2 above), such as the skill levels of workers, maintenance of machines, and the efficiency of the manufacturing process. If, for example, efficiency gains stem from manufacturing process improvements, managers might organize cross-functional teams to achieve more process improvements.
We emphasize, as we have before, that a manager should not always view a favorable variable overhead spending variance as desirable. The variable overhead spending variance would be favorable if Webb’s managers purchased lower-priced, poor-quality indirect materials; hired less-skilled indirect workers; or performed less machine maintenance. These decisions reduce costs in the short run but are likely to hurt product quality and the business in the long run.
To clarify the concepts of variable overhead efficiency variance and variable overhead spending variance, consider the following example. Suppose that (1) energy is the only item of variable overhead cost and machine-hours is the cost-allocation base, (2) actual machine-hours used equals the number of machine-hours under the flexible budget, and (3) the actual price of energy equals the budgeted price. What is the efficiency variance? Zero, because the company has been efficient with respect to the number of machine-hours (the cost-allocation base) used to produce the actual output. Will there be a spending variance? Yes because (3) only eliminates reason 1 above. The energy consumed per machine-hour could be higher than budgeted (reason 2 above), for example, because the machines have not been maintained correctly. The cost of this higher energy usage would be reflected in an unfavorable spending variance.