Production volume variance definition
/What is the Production Volume Variance?
The production volume variance measures the amount of overhead applied to the number of units produced. It is the difference between the actual number of units produced in a period and the budgeted number of units that should have been produced, multiplied by the budgeted overhead rate. The measurement is used to ascertain whether the materials management and production employees are able to produce goods in accordance with long-range planned expectations, so that an expected amount of overhead can be allocated.
From the perspective of the production process, a production volume variance is likely to be useless, since it is measured against a budget that may have been created months ago. A better measure would be the ability of a production operation to meet its production schedule for that day.
Calculation of the Production Volume Variance
To calculate the production volume variance, subtract the budgeted or standard number of units produced from the number of actual units produced, and then multiply the remainder by the budgeted overhead rate. The formula is as follows:
(Actual units produced - Budgeted units produced) x Budgeted overhead rate = Production volume variance
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Favorable and Unfavorable Production Volume Variances
An excessive quantity of production is considered to be a favorable variance, while an unfavorable variance occurs when fewer units are produced than expected.
The reason why a larger production volume is considered favorable is that this means factory overhead can be allocated across more units, which reduces the total allocated cost per unit. Conversely, if fewer units were to be produced, this means the amount of overhead allocated on a per-unit basis would be higher. Thus, the designation of the production volume variance as being favorable or unfavorable is only from the accounting perspective, where a lower per-unit cost is considered better. From a cash flow perspective, it might be better to only produce just that number of units immediately needed by customers, thereby reducing the company's working capital investment.
Problems with the Production Volume Variance
There are several problems with the production volume variance, which are as follows:
No link between overhead and units produced. The variance is based on the assumption that factory overhead is directly associated with units of production, which is not necessarily the case. Some overhead, such as facility rent or building insurance, will be incurred even if there is no production, while other types of overhead, such as management salaries, only vary across very large ranges of production volume. Instead, there may be a number of other ways in which factory overhead can be broken into smaller units, known as cost pools, and allocated using several methods that represent a more intelligent association of activities with costs incurred.
Encourages more production. A major problem with this variance is that it tends to encourage management to manufacture more units, so that the overhead cost per unit is reduced. However, doing so increases the working capital investment in inventory, since more inventory will be kept on hand. In addition, this extra inventory may become obsolete, which increases the out-of-pocket cost for the business.