Management Accounting - Fixed Overhead Variance Ratios

 

Management Accounting

Fixed Overhead Variance Ratios

 

We have so far considered the various cost variances in absolute monetary terms. Although these show the extent of the variances, the information is insufficient if the management wants to study the trend of variances from period to period. Absolute figures in themselves do not give the full picture and it is only by comparison of one item with another that their correct relationship is obtained. Variance Ratios serve this need and comparison of these ratios from one period to another can be gainfully made for taking appropriate relevant decisions by the management at the right time. Another advantage of Variance Ratio is in regard to its applicability in the dual plan of standard cost accounting. With the help of the Cost Variance Ratios, standard costs of production and the standard values of inventory can be easily converted into actual costs for the purpose of incorporation in the financial accounts.

 

A number of ratios are used for reporting to the management of a concern about how effectively materials, labour and other resources of the concern are being used in carrying out the production and selling activities. Some of these ratios, particularly those concerning the fixed overhead expenses, are now explained below:

1.       Efficiency Ratio.

2.       Activity Ratio (also known as Volume Ratio).

3.       Calendar Ratio.

4.       Capacity Ratio

 

1. Efficiency Ratio:

It is the standard hours equivalent to the work produced (SHAO), expressed as a percentage of the actual hours spent in producing that work (AH).

Efficiency Ratio

= (SHAO ÷ AH) × 100%

= (F5 ÷ F4) × 100%

 

2. Activity Ratio (also known as Volume Ratio):

It is the number of standard hours equivalent to the work produced (SHAO), expressed as a percentage of the budgeted hours (BH).

Activity Ratio (also known as Volume Ratio)

= (SHAO ÷ BH) × 100%

= (F5 ÷ F2) × 100%

 

3. Calendar Ratio:

It is the relationship between the number of actual working days available in a budget period and the number of budgeted working days for the same budget period.

Calendar Ratio

= (RBH ÷ BH) × 100%

= (F3 ÷ F2) × 100%

= [(Number of actual working days available in a budget period) ÷    (Number of budgeted working days in the budget period)] × 100%

 

4. Capacity Ratio (If there is no Calendar Variance):

It is the relationship between actual working hours in a budget period and the budgeted working hours in the budget period.

Capacity Ratio (If there is no Calendar Variance)

= (AH ÷ BH) × 100%

= (F4 ÷ F2) × 100%

 

5. Capacity Ratio (If there is Calendar Variance):

It is the relationship between actual working hours in a budget period and the revised budgeted working hours in the budget period.

Capacity Ratio (If there is Calendar Variance)

= (AH ÷ RBH) × 100%

= (F4 ÷ F3) × 100%

 

 Where,

F1	= AR x AH = Actual Cost
F2	= SR x BH = Budgeted Cost
F3	= SR x RBH
F4	= SR x AH
F5	= SR x SHAO = Standard Cost of Actual Output
AR	= Actual Rate
AH	= Actual Hours
SR	= Standard Rate
BH	= Budgeted Hours
RBH	= Revised Budgeted Hours
SHAO	= Standard Hours for Actual Output

 

 

  NOTE: HOW TO CALCULATE ‘SR’, ‘RBH’ AND ‘SHAO’

SR	= Budgeted Fixed Overhead per Budgeted Hours
	= (Budgeted Fixed Overhead for a Budget Period) ÷ (Budgeted Hours for the Budget Period)
RBH	= (Budgeted Hours for the Budget Period) x [(Actual Days Available during the Budget Period) ÷ (Budgeted Days for the Budget Period)]
SHAO	= Actual Output x Standard Hours required per unit of output
	= Actual Output x [(Standard or Budgeted Hours) ÷ (Standard or    Budgeted Output)]

 

 

Illustration

A Company manufactures two products X and Y. Product X requires 8 hours to produce while Y requires 12 hours. In April, 2023 in 22 effective working days of 8 hours a day 1,200 units of X and 800 units of Y were produced. The company employs 100 workers in production department to produce X and Y. The budgeted hours are 1, 86,000 for the year.

 

Calculate Capacity, Activity and Efficiency ratios for the month of April, 2023 and establish their relationship.

 

 Solution:

Actual Hours (AH)

= 100 workers × 8 hours × 22 days = 17,600 hours

Budgeted Hours (BH)

= 1,86,000 hours ÷ 12 = 15,500 hours

Standard Hours for Actual Output (SHAO)

For Product X

= 1,200 units × 8 hours = 9,600 hours

For Product Y

= 800 units × 12 hours = 9,600 hours

Total 9,600 hours + 9,600 hours = 19,200 hours

 

 Ratios:

Capacity Ratio

= (AH ÷ BH) × 100% = (17,600 hours ÷ 15,500 hours) × 100% = 113.55%

Efficiency Ratio

= (SHAO ÷ AH) × 100% = (19,200 hours ÷ 17,600 hours) × 100% = 109.09%

Activity Ratio

= (SHAO ÷ BH) × 100% = (19,200 hours ÷ 15,500 hours) × 100% = 123.87%

 

Relationship of the Ratios:

Efficiency Ratio × Capacity Ratio

= 109.09% × 113.55%

= (109.09 ÷ 100) × (113.55 ÷ 100)

= (109.09 ÷ 100) × 1.1355

= 123.87 ÷ 100

= 123.87%

= Activity Ratio

 

Þ Activity Ratio = Efficiency Ratio × Capacity Ratio