Overhead Variances: Fixed

Overview

• What you’ll learn: Fixed overhead budgeted vs. actual spending variance, the production-volume variance, why fixed overhead has no efficiency variance, and how denominator level choice affects product costing.
• Prerequisites: Lesson 6 — Variable Overhead Variances
• Estimated reading time: 16 minutes

Introduction

The Grand Historian records: Variable overhead moves with the army; fixed overhead is the fortress itself — it stands whether the garrison is at full strength or half-empty. The rent does not care whether you produced 10,000 units or 1. The factory supervisor’s salary does not fluctuate with the production schedule. Fixed overhead is the cost of having capacity available, and its variances tell a different story from variable costs.

Horngren (Chapter 8) reveals that fixed overhead produces only two variances — a spending variance and a production-volume variance. There is no efficiency variance for fixed overhead because, by definition, fixed costs do not change with the volume of the allocation base.

Fixed Overhead Spending Variance

FOH Spending Variance = Actual Fixed OH − Budgeted Fixed OH

This is the simplest variance in all of cost accounting. Did we spend more or less on fixed overhead than we budgeted? If budgeted fixed overhead is $300,000 and actual is $310,000, the spending variance is $10,000 unfavorable.

Causes include: unexpected salary increases, unplanned equipment lease, property tax reassessments, or insurance premium changes. These are largely non-controllable in the short term — the fortress costs what it costs.

Fixed Overhead Allocation Rate

To assign fixed overhead to products, we need an allocation rate:

Standard FOH Rate = Budgeted Fixed OH / Denominator Level (budgeted allocation base)

The denominator level is the budgeted volume of the allocation base (e.g., budgeted DLH or budgeted machine hours). This choice is critical and controversial.

The Production-Volume Variance

Production-Volume Variance = Budgeted Fixed OH − (Standard FOH Rate × Standard Qty Allowed for Actual Output)

Or equivalently: PVV = Standard FOH Rate × (Denominator Level − Standard Qty Allowed)

This variance measures the difference between budgeted fixed overhead and the amount allocated to actual production. It exists because fixed overhead is allocated at a per-unit rate, but fixed costs do not actually change with volume.

Interpretation

• Unfavorable PVV: Actual production is below the denominator level — capacity is underutilized. The fortress is half-empty; its full cost is borne by fewer units.
• Favorable PVV: Actual production exceeds the denominator level — capacity is more than fully utilized. The fortress shelters more troops than planned.

太史公曰：The production-volume variance is not about spending control — it is about capacity utilization. An unfavorable PVV does not mean the manager overspent; it means the empire did not fill the fortress it built.

Denominator Level Choices

The choice of denominator affects product cost, inventory valuation, and the size of the production-volume variance. Using practical capacity reveals the cost of unused capacity as a period expense — a powerful signal for strategic decision-making.

The Four-Variance Summary

Combining variable and fixed overhead variances:

Key Takeaways

• Fixed overhead has two variances: spending (cost control) and production-volume (capacity utilization).
• There is no fixed overhead efficiency variance — fixed costs are independent of volume.
• The production-volume variance measures capacity utilization, not spending efficiency.
• Denominator level choice (theoretical, practical, normal, master-budget) significantly affects unit costs and variance size.
• Practical capacity as denominator reveals the cost of unused capacity.

What’s Next

In Lesson 8, we explore how inventory costing methods (absorption vs. variable) interact with capacity concepts, completing our study of budgeting and variance analysis.