Fixed Overhead Capacity Variance

Definition

Fixed Overhead Capacity Variance (also known as Capacity Usage Variance or Idle Capacity Variance) is a variance metric used in standard costing to represent the difference between the actual hours worked and the budgeted hours (or capacity) available. This difference is valued at the standard fixed overhead absorption rate per hour and can be calculated in terms of machine hours or labor hours. This metric helps businesses understand how effectively they are utilizing their available capacity relative to what they had budgeted.

Examples

Example 1: Machine Hours
A company budgets 1,000 machine hours for the month. The actual machine hours worked come to 900 hours. The standard fixed overhead rate per hour is $10.
Fixed Overhead Capacity Variance = (Budgeted hours - Actual hours) x Standard rate per hour
= (1,000 - 900) x $10
= 100 hours x $10
= $1,000 unfavorable
Example 2: Labor Hours
A company budgets 2,000 labor hours but ends up using 2,200 hours. The standard fixed overhead rate per hour is $12.
Fixed Overhead Capacity Variance = (Budgeted hours - Actual hours) x Standard rate per hour
= (2,000 - 2,200) x $12
= (-200) hours x $12
= $2,400 unfavorable

Frequently Asked Questions

Q: What does a favorable fixed overhead capacity variance indicate?
A: A favorable fixed overhead capacity variance indicates that the actual hours worked were higher than the budgeted hours. This often implies better utilization of the available capacity or a higher production level than anticipated.

Q: How does the fixed overhead capacity variance affect financial performance?
A: This variance can affect the allocation of costs in financial statements. An unfavorable variance means higher overhead costs were incurred, which can reduce the operating income, whereas a favorable variance implies lower overhead costs and can potentially increase operating income.

Q: Why is it important to track fixed overhead capacity variance?
A: Tracking this variance helps in assessing the efficiency of resource utilization, identifying potential operational bottlenecks, planning future budgets more accurately, and controlling fixed overhead costs.

Q: How can companies reduce an unfavorable fixed overhead capacity variance?
A: Companies can reduce this variance by improving machine and labor scheduling, minimizing idle time, enhancing workforce productivity, and optimizing production processes.

Standard Costing
A cost accounting method where standard costs are assigned to each element of production, typically materials, labor, and overhead. It simplifies cost control and variance analysis.
Budgeted Capacity
The planned or expected amount of production capacity available during a specific period, often used in budgeting computations.
Overhead Absorption Rate
A rate used to allocate fixed overhead costs to cost objects, generally calculated by dividing total estimated overhead costs by an allocation base such as total labor hours or machine hours.
Idle Capacity
The portion of production capacity that is not utilized during a specific period. Idle capacity can be due to a lack of demand, maintenance, or inefficiencies.
Idle Capacity Ratio
A metric expressing idle capacity as a percentage of total budgeted capacity, highlighting the extent of underutilization.

Online References

Suggested Books for Further Studies

Cost Accounting: A Managerial Emphasis by Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan
Managerial Accounting by Ray H. Garrison, Eric Noreen, and Peter C. Brewer
Cost Accounting: Foundation and Evolutions by Kinney and Raiborn

Accounting Basics: “Fixed Overhead Capacity Variance” Fundamentals Quiz

### What does the fixed overhead capacity variance measure? - [ ] The total fixed overheads incurred. - [ ] The unit cost of fixed overheads. - [x] The difference between actual hours worked and budgeted hours, valued at the standard rate. - [ ] The efficiency of variable overheads. > **Explanation:** The fixed overhead capacity variance measures the difference between actual hours worked and the budgeted capacity available, valued at the standard fixed overhead absorption rate per hour. ### If a company has budgeted 1,000 labor hours but only uses 950 hours, what type of variance does this result in? - [x] Unfavorable variance - [ ] Favorable variance - [ ] No variance - [ ] Neutral variance > **Explanation:** If fewer hours are worked than budgeted, the fixed overhead capacity variance is unfavorable because this suggests underutilization of available capacity. ### How is the fixed overhead capacity variance calculated? - [x] (Budgeted hours - Actual hours) x Standard rate per hour - [ ] (Actual hours x Standard rate per hour) / Budgeted hours - [ ] (Budgeted hours / Actual hours) x Standard rate per hour - [ ] Actual hours - Budgeted hours > **Explanation:** The variance is calculated by the formula (Budgeted hours - Actual hours) x Standard rate per hour. ### Which of the following contributes to an unfavorable fixed overhead capacity variance? - [x] Lower actual utilization of capacity than budgeted. - [ ] Higher actual utilization of capacity than budgeted. - [ ] Equal actual and budgeted utilization. - [ ] None of the above. > **Explanation:** An unfavorable variance occurs when the actual utilization of capacity is lower than the budgeted capacity, indicating inefficiencies or idle capacity. ### What is the impact of an unfavorable fixed overhead capacity variance on financial performance? - [ ] It increases the operating income. - [x] It reduces the operating income. - [ ] It has no impact on operating income. - [ ] It doubles the operating income. > **Explanation:** An unfavorable variance means higher overhead costs were incurred than planned, reducing the operating income. ### Which of these conditions can lead to idle capacity? - [x] Lack of demand. - [ ] Excess overtime. - [ ] Efficient workforce. - [ ] Fulfilled production targets. > **Explanation:** Idle capacity often occurs due to a lack of demand, resulting in underutilization of available capacity. ### A favorable fixed overhead capacity variance indicates what about the actual hours worked? - [x] They were higher than budgeted. - [ ] They were lower than budgeted. - [ ] They were exactly as budgeted. - [ ] The hours were irrelevant. > **Explanation:** A favorable variance indicates that actual hours worked were higher than budgeted, suggesting better utilization of capacity. ### If a company improves its machine scheduling to minimize idle time, how will this affect the fixed overhead capacity variance? - [ ] Make it more unfavorable. - [ ] Have no impact. - [x] Make it more favorable. - [ ] Increase idle capacity. > **Explanation:** Improving machine scheduling to minimize idle time will make the fixed overhead capacity variance more favorable, indicating more efficient usage of capacity. ### What does a neutral or zero fixed overhead capacity variance indicate? - [ ] Over-budgeting. - [ ] Under-utilization. - [ ] Excess capacity. - [x] Actual hours matched budgeted hours. > **Explanation:** A neutral or zero variance indicates that the actual hours matched the budgeted hours, suggesting the company utilized its capacity as planned. ### Which of the following could be a reason for a favorable fixed overhead capacity variance? - [ ] Equipment maintenance downtime exceeded expectations. - [x] Higher than anticipated demand. - [ ] Prolonged power outages. - [ ] Reduced production output. > **Explanation:** A favorable variance could be due to higher than anticipated demand, leading to higher utilization of the available capacity.

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