Overhead variance analysis is where many students get stuck. The split goes further than materials or labor — variable overhead has its own two variances, and fixed overhead has a second pair built on a different logic. This walkthrough takes one example all the way through both, so you can see when each variance applies and why fixed overhead has that strange "volume" piece.
The Four Variances at a Glance
Overhead splits into variable and fixed, and each gets its own two-variance treatment.
Variable overhead is applied with a rate per hour (or per machine-hour) and behaves like labor — more activity, more cost. Its variances mirror the labor rate-and-efficiency pair:
- Variable overhead spending variance = (AR − SR) × AH
- Variable overhead efficiency variance = (AH − SH allowed) × SR
Fixed overhead is a different animal: it does not change with activity. Its variances do not follow the same shape:
- Fixed overhead budget (or spending) variance = Actual fixed overhead − Budgeted fixed overhead
- Fixed overhead volume variance = Budgeted fixed overhead − Applied fixed overhead
That last one is unusual enough that it deserves its own section below.
The Setup: A Bakery's Cookie Line
A bakery applies overhead to its cookie line based on direct labor hours. The standards:
- Variable overhead rate (standard): $4 per labor hour
- Fixed overhead budgeted: $30,000 per month
- Denominator activity (expected hours used for applying fixed OH): 6,000 hours per month
- Standard labor hours per batch of cookies: 0.5 hours
For June the bakery:
- Produced 11,000 batches
- Worked 5,800 actual labor hours
- Incurred $24,360 of variable overhead and $31,500 of fixed overhead
A couple of reference numbers built up front. Standard hours allowed for 11,000 batches is 11,000 × 0.5 = 5,500 hours. The fixed overhead rate used to apply fixed cost to product is budgeted fixed ÷ denominator hours = $30,000 ÷ 6,000 = $5 per hour. With those in hand, all four variances follow.
Variable Overhead: Spending and Efficiency
Actual variable overhead rate = $24,360 ÷ 5,800 hours = $4.20 per hour.
Variable overhead spending variance: ($4.20 − $4.00) × 5,800 = $0.20 × 5,800 = $1,160 Unfavorable
The bakery paid 20¢ more per hour of variable overhead than the standard. That covers things like indirect supplies, electricity tied to running the line, and any other rate-driven overhead. Despite the name, "spending" here behaves like a price variance — it captures what was paid per unit of the driver, not whether more of the driver was used.
Variable overhead efficiency variance: (5,800 − 5,500) × $4.00 = 300 × $4 = $1,200 Unfavorable
The bakery worked 300 more hours than the standard allowed for 11,000 batches. Because variable overhead is applied per labor hour, those extra hours also dragged variable overhead up by $1,200 at the standard rate. Notice the trap: this variance is driven by labor efficiency, not by overhead spending. If the labor efficiency variance is unfavorable, the variable overhead efficiency variance will be unfavorable for the same reason.
Total variable overhead variance: $2,360 Unfavorable ($1,160 + $1,200).
Fixed Overhead: Budget and Volume
Now the strange pair.
Fixed overhead budget (spending) variance: Actual fixed OH − Budgeted fixed OH = $31,500 − $30,000 = $1,500 Unfavorable
The bakery spent $1,500 more on fixed overhead than the master budget called for. Causes are non-volume items: a rent increase, an unbudgeted salaried hire, higher insurance. Fixed cost should not move with activity, so any gap here is a planning or commitment issue.
Fixed overhead volume variance: Budgeted fixed OH − Applied fixed OH
Applied fixed OH = standard hours allowed × fixed OH rate = 5,500 × $5 = $27,500.
Volume variance = $30,000 − $27,500 = $2,500 Unfavorable
This one is unusual. The bakery did not spend an extra $2,500 — it spent exactly the $31,500 captured in the budget variance. The volume variance is an artifact of how fixed cost is applied to product. The company committed to $30,000 of fixed cost expecting 6,000 hours of work; it only got 5,500 hours of standard work, so only $27,500 of fixed cost was absorbed into product. The gap of $2,500 sits as a variance.
A favorable volume variance means standard hours allowed exceeded the denominator — capacity was over-utilized. An unfavorable volume variance means capacity was under-utilized. It is more a comment on production planning than on cost control.
Total fixed overhead variance: $4,000 Unfavorable ($1,500 + $2,500).
Putting the Pieces Together
| Variance | Amount | Direction |
|---|---|---|
| Variable OH spending | $1,160 | Unfavorable |
| Variable OH efficiency | $1,200 | Unfavorable |
| Fixed OH budget | $1,500 | Unfavorable |
| Fixed OH volume | $2,500 | Unfavorable |
| Total overhead variance | $6,360 | Unfavorable |
Each variance points at a different conversation. Variable spending sits with whichever utility or supply line shifted. Variable efficiency rides on the labor efficiency story already covered. Fixed budget is a planning or commitments question. Fixed volume is a capacity question — did the company under-produce relative to what it was paying to be ready to produce?
Why the Volume Variance Is Not Really About Spending
Worth saying plainly: the fixed overhead volume variance does not represent extra cash spent or saved. The fixed cost is the same $31,500 whether the bakery makes 11,000 batches or 12,000. The volume variance measures how that fixed cost was spread across the units made. Under standard costing, fixed overhead is applied to product as if it were variable — using a rate per hour — and any time actual activity differs from the denominator activity, the applied amount differs from the budgeted amount. The volume variance closes that gap on paper. Many managers ignore it as a control measure and look only at the budget variance for fixed-cost discipline.
Getting Help
Overhead variance analysis sits on top of the same logic as the direct materials variance walkthrough and direct labor variance walkthrough. For the bigger picture of where standards come from in the first place, see standard costing explained.
Conclusion
Overhead variance analysis is four variances built on two different logics. Variable overhead splits like labor — spending and efficiency — because variable cost moves with the activity driver. Fixed overhead splits differently: a budget variance for actual versus budgeted spending, and a volume variance that exists only because fixed cost is applied to product through a rate. Compute them in order, keep applied fixed overhead separate from the cash amount actually spent, and the four numbers will tell you exactly where overhead went off plan.
