Reasons for Overhead Variances Useful for Control Reasons
Overhead variances are essentially a book balancing exercising giving an arithmetic reconciliation between the actual costs and standard costs. Apart from the expenditure variance, the calculation of the other overhead variances gives little real control information, because they are related more to the conventions of overhead absorption rather than to the organization's operational reality. Conversely, the information utilized in calculating the efficiency and volume variances that is the budgeted labour hours, and the standard labour hours and the actual labour hours, can be employed to calculate various ratios that provide clear information on significant aspects of the firm's operations. These ratios are as:
i. The Activity Ratio: This is calculated as given below:
Activity Ratio = (Standard Hours produced/Budgeted Hours) x 100
This ratio is equivalent to fixed overhead volume variance.
ii. Capacity Ratio: This is calculated as given below:
Capacity Ratio = (Actual labour Hours/Budgeted Labour Hours) x 100
This ratio is equivalent to fixed overhead capacity variance.
iii. Efficiency Ratio: This is calculated as given below:
Efficiency Ratio= (Standard Hours produced/ Actual labour Hours) x 100
This ratio is equivalent to the variable and fixed overheads and also labour efficiency ratios.
NB: The above control ratios are directly concerned to the variances they are connected to and they provide management along with a useful relative measure rather than the absolute measures provided with the variances.