The Parco Company applies manufacturing overhead costs to products on the basis of direct labor-hours. The standard cost card shows that 12 direct labor-hours are required per unit of product. For August, the company budgeted to work 360,000 direct labor-hours and to incur the following total manufacturing overhead costs:
| Total variable overhead costs | $396,000 |
| Total fixed overhead costs | $475,200 |
During August, the company completed 28,000 units of product, worked 344,000 direct labor-hours, and incurred the following total manufacturing overhead costs:
| Total variable overhead costs | $395,600 |
| Total fixed overhead costs | $461,200 |
The denominator activity in the predetermined overhead rate is 360,000 direct labor-hours. What is the variable overhead efficiency variance for August?
First, compute the variable overhead (VOH) rate as follows:
Budgeted variable overhead costs ÷ budgeted direct labor hours = VOH rate
$396,000 ÷ 360,000 direct labor hours = $1.10 per direct labor hour
Then, compute the efficiency variance as follows:
Flexible Budget for VOH Overhead at AH – Flexible budget for VOH at SH
Or
(AH hours x VOH rate) – (SH hours x VOH rate)
(344,000 hours x $1.10/DL hour) – ((28,000 units x 12 DL hours/unit) x $1.10/hour)
$378,400 – (336,000 x $1.10) = $378,400 – $369,600 = $8,800 F (see discussion below)
More direct labor hours (344,000) were worked than were allowed at standard (336,000); as such, the overhead efficiency variance is unfavorable. Note that, in this situation, the efficiency variance would be better called a direct labor-hours efficiency variance, since it results from using more direct labor hours than expected (rather than efficient use of overhead resources).
