Fixed Overhead Spending Variance (FOSV) is the variance or difference between the actual spend and budgeted spend of manufacturing fixed overhead expenses. Companies usually estimate budgeted fixed overhead at the start of the year. We also call this variance a fixed overhead expenditure variance or fixed overhead budget variance.
This variance can also be favorable or unfavorable (adverse). In case of an unfavorable variance, the actual fixed overhead expenses are more than the budgeted. And, in a favorable variance, the actual spend is less than the standard.
As can be expected, the expenses representing the fixed overhead are more or less fixed. In other words, the fluctuations or variations in the production volume generally do not affect or change the quantum of fixed overhead. And in turn this variance. So, in theory, such overheads should not be very different from the budgeted, or there should not be any such major variance.
But, if during production, there is any change in the process or an addition of a new process, it may result in a significant unfavorable variance. Additionally, the seasonality factor in the fixed overhead expenditures may also result in favorable or unfavorable variance in some months.
Because FOSV brings into attention any significant changes in costs that the management does not expect at the time of formulating the fixed cost budget, it is what makes this variance a valuable tool for the management.
Fixed Overhead Spending Variance – Formula and Example
Following is the formula to calculate Fixed Overhead Spending Variance:
FOSV = Actual Fixed Overhead less Budgeted Fixed Overhead
In the case of the Marginal and Absorption Costing system also a similar formula is being used.
Let us consider a simple example to understand the calculation for FOSV.
Company A estimates that its fixed overhead in a year should be $600,000. However, the production manager of Company A left the job, and there was no new replacement for a few months. Due to this, the actual expenses were less than the estimates. The actual fixed overhead was $550,000.
FOSV in this case will be = $550,000 less $600,000 = $50,000
As the actual overhead cost was less than what was budgeted, it is a favorable variance
Causes of Fixed Overhead Spending Variance
These are popular causes of a favorable FOSV:
- If a company carries business process re-engineering or improves production techniques or optimizes production. This would lower the costs, and result in a favorable variance.
- Any estimation error at the start of the year may also result in a favorable variance.
- If at the time of setting budgets, management did not account for business expansion, this may also result in a favorable variance.
These are popular causes of an unfavorable FOSV:
- If the budget includes the provision of business expansion, but the management did not actually carry the business expansion. This may result in unfavorable FOSV.
- Any surprise rise in the fixed overhead expenses may also result in an unfavorable FOSV. For instance, insurance company increases premium because of new tax rules.
- More wastage and inefficiencies may also result in an unfavorable FOSV,
- If a company buys new machinery to meet the sudden rise in demand.
- In case a company crosses the utility bill usage limit, it may result in the company paying more in fixed cost.
- If there is a labor strike or any breakdown in machinery, it would result in unfavorable FOSV.
- Any changes in the wage level, either as per regulations or as per agreement with union would result in unfavorable variance.
Importance and Limitations of Fixed Overhead Spending Variance
The following points will help to bring out the importance of FOSV:
- As said above, FOSV assists management in identifying any sudden rise or fall in a major expense and that too which is fixed one.
- Suppose a company does not pay its fixed overheads completely in a year. This would increase the balance of current liability, suggesting liquidity issues with the company. In such cases, an analysis of fixed overhead spending variance would give management information on the liquidity that it needs arrange to avoid a low current ratio.
- It may also assist in cost rationalization. Or, in identifying areas where companies can lower or eliminate inefficiencies.
- This variance also assists management in planning future investments for expanding business, buying a new plant or machinery, and more.
- FOSV also helps a company in better managing the resources.
Following are the limitations of FOSV:
- This variance only measures the difference between total overheads. So, it doesn’t give any information about the specific expense that may be causing the variance.
- In order to find the exact expense that is causing the variance, the management may have to carry a comprehensive analysis. This may result in using a lot of resources and costs, and it could be time consuming as well.
- Since the whole process is time consuming, it is possible that by the time analysis results come in, there are new fixed costs and the earlier costs become irrelevant.
- There are several items that go in the calculation of fixed overhead. So any error in estimating any individual item may over and under estimate the variance.
- Production managers may not be able to control such a variance.
Who is Responsible?
Usually, the fixed overheads do not change in a shorter time frame of one to two years. But, if there is a change in the fixed overheads, it is usually a significant one. Any significant change in the overheads usually requires the approval of the top management. So, we may not target and call the production department squarely responsible for such a variance. Rather, the top management is usually responsible for such a variance.
Fixed Overhead Spending Variance is very important for a business. Usually, a company may not witness any FOSV because fixed costs do not vary with volume. But if there is any significant variance, then the management must take it very seriously.
Frequently Asked Questions (FAQs)
The formula to calculate Fixed overhead spending variance is:
Actual Fixed Overhead less Budgeted Fixed Overhead
We also call this variance a fixed overhead expenditure variance or fixed overhead budget variance. Fixed Overhead Spending Variance (FOSV) is the variance or difference between the actual and budgeted manufacturing fixed overhead expenses.