Overheads are the cost that cannot be traced to a unit, so their variances need more care. Variable overhead behaves like labour: it depends on the hours worked, so the variance method is almost the same. Fixed overhead is different.
By definition it does not change with output, yet the absorption system charges it to units as if it did, so a difference arises when output is not the planned amount. Splitting that difference into spending, volume, capacity and efficiency parts is the main skill in this topic.
This topic covers the variable production overhead variances (total, expenditure and efficiency), the fixed production overhead variances under absorption costing (total, expenditure, volume, and the capacity and efficiency parts of volume), the position under marginal costing, the causes and interrelationships of overhead variances, and worked and practice examples.
The earlier topics on overhead absorption and under- and over-absorption are the foundation, and the same expenditure and volume split is extended here.
In 30 seconds
Variable overhead: expenditure = (standard rate × hours worked) − actual overhead; efficiency = (standard hours for actual output − hours worked) × standard rate. Fixed overhead (absorption costing): total variance = overhead absorbed (actual units × standard fixed overhead per unit) − actual overhead, which is over- or under-absorption. Expenditure = budgeted − actual fixed overhead.
Volume = (actual units − budgeted units) × standard fixed overhead per unit, which splits into capacity = (hours worked − budgeted hours) × fixed rate per hour, and efficiency = (standard hours for actual output − hours worked) × fixed rate. Under marginal costing, fixed overhead has only an expenditure variance.
The standard data used in this topic
The company makes Product Z. The standard and the budget are:
| Item | Standard or budget |
|---|---|
| Standard labour hours per unit | 2.5 hours |
| Budgeted production | 1,000 units (2,500 hours) |
| Variable production overhead | ₦300 per labour hour (₦750 per unit) |
| Budgeted fixed production overhead | ₦1,250,000 |
| Fixed overhead absorption rate | ₦1,250,000 ÷ 2,500 hours = ₦500 per hour (₦1,250 per unit) |
Actual results: 1,200 units made; hours worked 3,080; hours paid for 3,150 (70 hours idle); variable overhead incurred ₦957,000; fixed overhead incurred ₦1,290,000. Standard hours for the actual output = 1,200 × 2.5 = 3,000.
Variable production overhead variances
The method is like that for direct labour, because variable overhead is normally driven by labour hours.
Total cost variance
| ₦ | |
|---|---|
| Standard variable overhead for actual output (1,200 × ₦750) | 900,000 |
| Actual variable overhead | (957,000) |
| Total variable overhead variance | 57,000 A |
Expenditure variance
It is assumed that variable overhead is incurred in the hours actively worked, and not in idle hours. So the expenditure variance uses the hours worked. It compares the actual overhead with what the hours worked should have cost at the standard rate. It is similar to a labour rate or materials price variance.
Variable overhead expenditure variance = (hours worked × standard rate) − actual variable overhead.
3,080 × ₦300 = ₦924,000. Actual ₦957,000. Expenditure variance = ₦33,000 A.
Efficiency variance
The efficiency variance in hours is exactly the same as the direct labour efficiency variance in hours (excluding idle time). It is valued at the standard variable overhead rate per hour. It represents the extra (or saved) variable overhead cost caused by working more (or fewer) hours than the standard.
Variable overhead efficiency variance = (standard hours for actual output − hours worked) × standard variable overhead rate per hour.
(3,000 − 3,080) = 80 hours adverse × ₦300 = ₦24,000 A.
Check. ₦33,000 A + ₦24,000 A = ₦57,000 A. ✓
Line-by-line method
| Line | Working | ₦ | Variance |
|---|---|---|---|
| Hours worked at actual rate | actual overhead | 957,000 | |
| Hours worked at standard rate | 3,080 × ₦300 | 924,000 | 33,000 A expenditure |
| Standard hours at standard rate | 3,000 × ₦300 | 900,000 | 24,000 A efficiency |
Notice that there is no idle time variance for variable overhead. Idle hours are paid for as labour but do not cause variable overhead, so the idle time (70 hours) appears only in the labour variances.
Fixed production overhead variances (absorption costing)
With standard absorption costing, the standard cost per unit includes an amount of fixed production overhead, derived from a standard number of labour hours per unit at a fixed overhead rate per hour. Every unit made is valued at this standard. So fixed overhead is absorbed into production at the standard cost per unit produced, not at an actual rate.
Total fixed overhead cost variance
This is the over- or under-absorption of fixed production overhead: overhead absorbed (actual units × standard fixed overhead per unit) minus overhead actually incurred. Under-absorption is adverse and over-absorption favourable.
| ₦ | |
|---|---|
| Absorbed: 1,200 units × ₦1,250 | 1,500,000 |
| Actual fixed overhead | (1,290,000) |
| Total fixed overhead variance (over-absorption) | 210,000 F |
Expenditure variance
The simplest of all: the difference between budgeted and actual fixed overhead spending. An adverse variance arises when actual exceeds the budget.
Fixed overhead expenditure variance = budgeted fixed overhead − actual fixed overhead.
₦1,250,000 − ₦1,290,000 = ₦40,000 A. Similar expenditure variances can be reported for administration and for selling and distribution fixed overheads.
Volume variance
The volume variance measures the fixed overhead over- or under-absorbed because the actual production volume differs from the budgeted volume. It is converted into naira at the standard fixed overhead per unit (or per standard hour).
Fixed overhead volume variance = (actual units produced − budgeted units) × standard fixed overhead per unit.
(1,200 − 1,000) = 200 units favourable × ₦1,250 = ₦250,000 F. More units than budgeted were made, so more overhead was absorbed than budgeted.
Check. Expenditure ₦40,000 A + volume ₦250,000 F = ₦210,000 F = total variance. ✓
Capacity and efficiency variances
The volume variance has two possible causes. The company may have worked a different number of hours from the budget (a capacity effect), and during the hours worked it may have operated at a different level of efficiency. So the volume variance splits into:
| Variance | Formula | Working | ₦ |
|---|---|---|---|
| Capacity | (hours worked − budgeted hours) × fixed rate per hour | (3,080 − 2,500) = 580 hours F × ₦500 | 290,000 F |
| Efficiency | (standard hours for actual output − hours worked) × fixed rate per hour | (3,000 − 3,080) = 80 hours A × ₦500 | 40,000 A |
| Volume | 250,000 F |
The efficiency variance in hours is exactly the same as for direct labour and variable overhead. Idle hours (paid but not worked) are excluded from the hours worked in the capacity variance. A direct way to see the total: (standard hours − budgeted hours) × ₦500 = (3,000 − 2,500) × ₦500 = ₦250,000 F. ✓
Summary of all the overhead variances
| Variance | ₦ |
|---|---|
| Variable overhead expenditure | 33,000 A |
| Variable overhead efficiency | 24,000 A |
| Fixed overhead expenditure | 40,000 A |
| Fixed overhead capacity | 290,000 F |
| Fixed overhead efficiency | 40,000 A |
| Net overhead variance | 153,000 F |
Net = ₦290,000 F − (33,000 + 24,000 + 40,000 + 40,000 = ₦137,000 A) = ₦153,000 F, which is the total variable variance (57,000 A) plus the total fixed variance (210,000 F). ✓
Fixed overhead under standard marginal costing
In a marginal costing system the standard cost excludes fixed overhead, which is a period cost. There is no absorption, so there is no volume, capacity or efficiency variance for fixed overhead. There is only the expenditure variance: budgeted fixed overhead − actual fixed overhead = ₦40,000 A in the example. The variable overhead variances are unchanged.
Causes of overhead variances
| Variance | Possible causes |
|---|---|
| Variable overhead expenditure, favourable | A forecast increase in costs that did not happen |
| Variable overhead expenditure, adverse | Unexpected increases in costs such as energy prices |
| Variable overhead efficiency | Anything that causes labour efficiency variances, since overhead is incurred as labour works: efficient methods, good morale, incentive schemes and experienced workers (favourable); less experienced workers and poor morale (adverse) |
| Fixed overhead expenditure | Good or poor control of spending. An unrealistic budget (a planning failure, not poor control). Unplanned changes in items such as factory rent |
| Fixed overhead volume | Anything that made output different from budget: efficient working by labour; working more or fewer hours than budgeted; higher or lower demand; strikes; machine breakdowns |
Interrelationships
- Labour efficiency and the overhead efficiency variances. The hours saved or lost are the same for labour, variable overhead and fixed overhead. The variances differ only in the rate used. An adverse labour efficiency variance usually comes with adverse variable and fixed overhead efficiency variances.
- Capacity and efficiency. If the production process becomes more efficient, it may not need to run for as many hours as budgeted to produce the budgeted volume. A favourable fixed overhead efficiency variance can then come with an adverse capacity variance. The reverse is also true: if the process is less efficient and works longer hours, the efficiency variance is adverse but the capacity variance is favourable. The two must be read together.
- Rate and variable overhead efficiency. The true cost of a change in efficiency is the sum of all the costs linked to labour hours: labour, variable overhead and fixed overhead.
The ideas in more depth
Why fixed overhead variances are different
Variable overhead and labour move with activity, so “standard cost for actual output” is a flexed standard that changes with output. Fixed overhead does not change. The budget for fixed overhead is the same whether 800 or 1,200 units are made. So the expenditure variance compares actual spending with the unflexed budget, and the volume variance arises only because the absorption system assumes that fixed overhead is a rate per unit.
What a volume variance does and does not mean
A favourable volume variance does not mean fixed costs fell. It means that more units were produced than planned, so more fixed overhead was recovered into product cost. In the example, the ₦250,000 F volume variance is simply the 200 extra units × ₦1,250. It is a bookkeeping adjustment to correct the under-recovery that would arise if the budgeted volume were not reached, and an indicator that capacity was used more fully than planned.
Reading a capacity variance
A large favourable capacity variance shows that the factory worked more hours than budgeted. It spread fixed cost over more output. But if this came from working overtime (a labour rate cost), the benefit may be less than it looks. Always examine the cause.
Under and over-absorption link
The total fixed overhead variance is the same figure as the under- or over-absorption described in the topic on overhead absorption. Expenditure and volume are exactly the two reasons given there. Capacity and efficiency are a further split of volume that standard costing allows.
Worked example: all the overhead variances
Scenario. Kano Plastics Ltd budgets to make 4,000 units a month, each taking 2 labour hours. Budgeted fixed overhead is ₦1,600,000. Variable overhead is ₦150 per labour hour. In the month, 3,700 units were made. Hours worked were 7,600 and hours paid for 7,800. Actual variable overhead was ₦1,180,000 and actual fixed overhead ₦1,640,000. Calculate the variable and fixed overhead variances.
- Standard hours for actual output.
3,700 × 2 = 7,400.
Budgeted hours = 8,000.
Fixed overhead rate = ₦1,600,000 ÷ 8,000 = ₦200 per hour (₦400 per unit). - Variable overhead expenditure:
7,600 × ₦150 = ₦1,140,000 against ₦1,180,000 = ₦40,000 A. - Variable overhead efficiency:
(7,400 − 7,600) = 200 hours A × ₦150 = ₦30,000 A.
Total variable variance = ₦70,000 A, which equals standard ₦1,110,000 (7,400 × ₦150) less actual ₦1,180,000. ✓ - Fixed overhead absorbed:
3,700 × ₦400 = ₦1,480,000.
Actual ₦1,640,000.
Total variance = ₦160,000 A (under-absorbed). - Fixed expenditure:
₦1,600,000 − ₦1,640,000 = ₦40,000 A. - Fixed volume:
(3,700 − 4,000) = 300 units A × ₦400 = ₦120,000 A. - Capacity:
(7,600 − 8,000) = 400 hours A × ₦200 = ₦80,000 A.
Efficiency: (7,400 − 7,600) = 200 hours A × ₦200 = ₦40,000 A.
Together ₦120,000 A, matching the volume variance. ✓ - Check:
₦40,000 A + ₦120,000 A = ₦160,000 A. ✓
When the activity base is machine hours
In a highly automated factory, overhead may be absorbed on machine hours instead of labour hours. The variances are calculated in exactly the same way, replacing labour hours with machine hours. Example. Budgeted fixed overhead is ₦900,000 for 3,000 machine hours, a rate of ₦300 per machine hour. The actual output needed 2,700 standard machine hours, and 2,800 machine hours were actually used.
- Capacity variance.
(2,800 − 3,000) = 200 hours A × ₦300 = ₦60,000 A. - Efficiency variance.
(2,700 − 2,800) = 100 hours A × ₦300 = ₦30,000 A. - Volume variance.
capacity + efficiency = ₦90,000 A.
Check: (2,700 − 3,000) × ₦300 = ₦90,000 A. ✓
If a question gives both labour and machine hours, use the hours stated as the absorption base. A good exam habit is to underline the base in the question before starting.
How overhead variances appear in an operating statement
Overhead variances are reported to management together with the sales, materials and labour variances in a statement that reconciles budgeted profit to actual profit. Adverse variances are deducted and favourable ones added. In the earlier example the overhead lines are:
| Overhead variances (₦) | Favourable | Adverse |
|---|---|---|
| Variable overhead expenditure | 33,000 | |
| Variable overhead efficiency | 24,000 | |
| Fixed overhead expenditure | 40,000 | |
| Fixed overhead capacity | 290,000 | |
| Fixed overhead efficiency | 40,000 | |
| Total | 290,000 | 137,000 |
The net favourable ₦153,000 adds to profit. Notice how a large favourable capacity variance can mask several small adverse ones. A reader who looks only at the net figure would miss the three adverse variances totalling ₦137,000, which are the ones requiring action.
Capacity as the cost of idle or extra capacity
An adverse capacity variance is, in effect, the fixed cost of capacity that was paid for but not used. If a factory budgets 8,000 hours and works only 7,600, the 400 hours of capacity not used cost 400 × the fixed overhead rate. That is a signal to examine demand, scheduling, breakdowns and staffing. Conversely, a favourable capacity variance means that the existing fixed cost base produced more than planned, which is generally good.
But if the extra hours were obtained by overtime, the labour rate variance should also be checked.
Deciding which overhead variances to investigate
Not every variance deserves a study. Common triggers are:
- a variance above a set percentage of the standard (say 5%) or above a naira limit
- variances that repeat in the same direction month after month
- variances that are linked, such as the efficiency and capacity pair
For fixed overhead, the expenditure variance is the most controllable by the budget holder.
The volume variance is usually the responsibility of the production and sales managers, because it follows from output levels.
Common mistakes in the exam
- Using hours paid instead of hours worked in the variable overhead expenditure variance.
- Calculating a fixed overhead variance by flexing the budget. Fixed overhead budgets are not flexed.
- Using the variable overhead rate in the fixed overhead variances, or the reverse.
- Mixing up the volume variance (units × rate per unit) with the capacity variance (hours × rate per hour).
- Forgetting that capacity + efficiency = volume.
- Calculating the capacity variance using hours paid rather than hours worked.
- Including a volume variance in a marginal costing answer.
- Not stating whether each variance is favourable or adverse.
Quick revision
- Variable overhead: expenditure = (SR × hours worked) − actual; efficiency = (SH − hours worked) × SR.
- Fixed overhead total = absorbed − actual. Expenditure = budget − actual. Volume = (actual − budgeted units) × rate per unit.
- Volume = capacity + efficiency. Capacity = (hours worked − budgeted hours) × rate. Efficiency = (SH − hours worked) × rate.
- Marginal costing: only the fixed overhead expenditure variance.
- The same hours difference drives labour, variable overhead and fixed overhead efficiency.
Practice questions
These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer.
Section A style: multiple choice
Question 1. The variable overhead expenditure variance is based on:
- Hours paid for
- Hours worked
- Budgeted hours
- Units sold
Show the answer
B. Variable overhead is incurred in hours actively worked.
Question 2. The standard variable overhead rate is ₦200 per hour. Standard hours are 4,000 and hours worked 4,100. The variable overhead efficiency variance is:
- ₦20,000 adverse
- ₦20,000 favourable
- ₦800,000
- Nil
Show the answer
A. 100 hours × ₦200 = ₦20,000 adverse.
Question 3. The fixed overhead expenditure variance is:
- Budgeted fixed overhead − actual fixed overhead
- Actual hours × rate
- Absorbed overhead − budget
- Units × rate
Show the answer
A. It is budget less actual spending.
Question 4. Budgeted fixed overhead ₦2,880,000 and actual ₦2,500,000. The expenditure variance is:
- ₦380,000 favourable
- ₦380,000 adverse
- ₦100,000 adverse
- Nil
Show the answer
A. Spending was below budget.
Question 5. The fixed overhead volume variance equals:
- Capacity variance + efficiency variance
- Capacity variance − expenditure variance
- Expenditure variance only
- Efficiency variance only
Show the answer
A. The volume variance splits into these two.
Question 6. Budget 1,000 units, actual 1,200 units, standard fixed overhead ₦1,250 per unit. The volume variance is:
- ₦250,000 favourable
- ₦250,000 adverse
- ₦200 favourable
- ₦1,500,000
Show the answer
A. 200 × ₦1,250 = ₦250,000 favourable.
Question 7. Budgeted hours 2,500; hours worked 3,080; fixed overhead rate ₦500 per hour. The capacity variance is:
- ₦290,000 favourable
- ₦290,000 adverse
- ₦40,000 adverse
- ₦580,000
Show the answer
A. 580 hours × ₦500, favourable as more hours were worked.
Question 8. Under standard marginal costing, which fixed overhead variance exists?
- Expenditure only
- Volume only
- Capacity only
- Efficiency only
Show the answer
A. Fixed overhead is not absorbed, so there is no volume variance.
Question 9. The total fixed overhead variance equals:
- Under- or over-absorbed fixed overhead
- Sales variance
- Materials variance
- The efficiency variance
Show the answer
A. It is the over- or under-absorption.
Question 10. A favourable fixed overhead efficiency variance is likely to be accompanied by:
- An adverse capacity variance
- A favourable capacity variance always
- No other variance
- An adverse expenditure variance
Show the answer
A. Efficient workers may need fewer hours than budgeted.
Section B style: written questions
Question 11 (10 marks). Explain the fixed production overhead expenditure, volume, capacity and efficiency variances, and show how they are related.
Question 12 (20 marks). Lagos Paints Ltd budgets to make 2,000 units a month at 3 labour hours each. Budgeted fixed production overhead is ₦1,800,000 and variable overhead is ₦100 per labour hour. Actual output was 2,100 units, using 6,500 hours worked (all hours paid were worked). Actual variable overhead was ₦640,000 and actual fixed overhead ₦1,830,000.
(a) Calculate the variable overhead total, expenditure and efficiency variances. (8 marks)
(b) Calculate the fixed overhead total, expenditure and volume variances. (6 marks)
(c) Calculate the capacity and efficiency variances. (4 marks)
(d) Comment on the results. (2 marks)
A further written question
Question 13 (10 marks). A company budgets fixed overhead of ₦800,000 for 4,000 units. Actual output was 3,600 units and actual fixed overhead ₦820,000. (a) Calculate the standard fixed overhead per unit, and the total, expenditure and volume variances. (6 marks) (b) State two possible causes of an adverse volume variance. (2 marks) (c) State which of these variances would exist if marginal costing were used. (2 marks)
Model answers
Show the model answer to Question 11
With standard absorption costing, fixed overhead is absorbed at a standard cost per unit. The expenditure variance is the difference between budgeted and actual fixed overhead; it is adverse if actual spending exceeds the budget. The volume variance is (actual units − budgeted units) × standard fixed overhead per unit; it shows over- or under-absorption because output differed from the budget. It is favourable if output exceeds the budget.
The volume variance has two parts. The capacity variance is (hours worked − budgeted hours) × the fixed overhead rate per hour; it shows the effect of working more or fewer hours than budgeted. The efficiency variance is (standard hours for actual output − hours worked) × the fixed overhead rate per hour; it shows the effect of working faster or slower than standard.
Capacity + efficiency = volume, and expenditure + volume = the total fixed overhead variance (under- or over-absorption).
Show the model answer to Question 12
Data. Standard hours for actual output = 2,100 × 3 = 6,300. Budgeted hours = 6,000. Fixed overhead rate = ₦1,800,000 ÷ 6,000 = ₦300 per hour (₦900 per unit).
(a) Variable overhead.
- Standard cost.
6,300 × ₦100 = ₦630,000. - Actual ₦640,000.
- Total = ₦10,000 A. Expenditure: 6,500 × ₦100 = ₦650,000 against ₦640,000 = ₦10,000 F.
- Efficiency: (6,300 − 6,500) = 200 hours A × ₦100 = ₦20,000 A.
- Check.
₦10,000 F − ₦20,000 A = ₦10,000 A. ✓
(b) Fixed overhead.
- Absorbed = 2,100 × ₦900 = ₦1,890,000.
- Actual ₦1,830,000.
- Total = ₦60,000 F (over-absorbed).
- Expenditure: ₦1,800,000 − ₦1,830,000 = ₦30,000 A.
- Volume: (2,100 − 2,000) = 100 units F × ₦900 = ₦90,000 F.
- Check.
₦90,000 F − ₦30,000 A = ₦60,000 F. ✓
(c)
- Capacity: (6,500 − 6,000) = 500 hours F × ₦300 = ₦150,000 F.
- Efficiency: (6,300 − 6,500) = 200 hours A × ₦300 = ₦60,000 A.
- Net = ₦90,000 F, equal to the volume variance. ✓
(d) The factory worked more hours than budgeted (favourable capacity), which absorbed more fixed overhead, but it was slower than standard, using 200 more hours than the output should have needed. The slowness cost ₦20,000 in variable overhead and ₦60,000 in fixed overhead efficiency, besides labour. Management should investigate the cause of the inefficiency.
Show the model answer to Question 13
(a)
- Standard fixed overhead per unit.
₦800,000 ÷ 4,000 = ₦200. - Absorbed = 3,600 × ₦200 = ₦720,000.
- Actual ₦820,000.
- Total variance = ₦100,000 A (under-absorbed).
- Expenditure: ₦800,000 − ₦820,000 = ₦20,000 A.
- Volume: (3,600 − 4,000) = 400 units A × ₦200 = ₦80,000 A.
- Check.
₦20,000 + ₦80,000 = ₦100,000 A. ✓
(b) Any two of: lower demand than expected; strikes; extensive machine breakdowns; fewer hours worked than budgeted; inefficient working.
(c) Only the fixed overhead expenditure variance (₦20,000 A) would exist, because fixed overhead is a period cost under marginal costing and there is no absorption.
Pathfinder on Variable and fixed production overhead variances
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
Asks you to calculate the variable overhead efficiency variance from given standard hours and actual hours. It tests the efficiency variance valued at the standard variable overhead rate.
Revise first: Variable production overhead variances
An item gives budgeted overhead and budgeted machine hours and asks for the absorption rate, which is the base for the fixed overhead variances.
Revise first: Fixed production overhead variances (absorption costing)
A standard costing question that can extend to overhead variances for the single product, together with the materials and labour variances.
Revise first: The ideas in more depth
Multiple-choice items often ask for the fixed overhead volume, expenditure or capacity variance from given budgeted and actual figures. Check Section A of every diet you practise.
Revise first: Fixed overhead under standard marginal costing
Source: ICAN Pathfinder, Management Accounting. Diets covered: May Diet, 2026 and November Diet, 2025. May Diet, 2025 and November Diet, 2024 are not covered here.
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