Fixed and variance OH

Okay, let's continue our Addis Ababa bakery story and dive into why those overhead variances we talked about happen! Remember, a variance is the difference between what should have happened (our standard cost) and what actually happened.

The image shows how we can break down the total overhead variance into more specific reasons. Just like we can have different reasons why our teff flour costs more than expected (price increase vs. using too much), we can have different reasons for overhead variances.

Variable Overhead Variances: Why Our "Changing" Costs Differ

Think back to our variable overhead costs like electricity and packaging – the ones that change with how many injera cakes we bake. The image shows two main reasons why our actual variable overhead costs might be different from what we expected (our standard):

* Variable Overhead Spending Variance (Think "Price"): This is like asking: "Did we pay more or less per unit of our activity than we planned for our variable overhead?"

* Back to Electricity: Maybe the price of electricity in Addis Ababa went up unexpectedly during the month. Even if we used the exact amount of electricity we planned for each cake, our total electricity cost would be higher because the price per kilowatt-hour was higher. This would result in an unfavorable (bad) variable overhead spending variance.

* Packaging: Perhaps the cost of cardboard boxes increased, leading to a higher actual cost for packaging each cake than our standard allowed. Again, this is a spending variance.

* Variable Overhead Efficiency Variance (Think "Quantity" or "Usage"): This asks: "Did we use more or less of our activity per cake than we planned for our variable overhead?"

* Electricity Again: Maybe our oven is getting old and less efficient, so it takes longer to bake each batch of injera cakes, using more electricity per cake than our standard assumed. Even if the price of electricity stayed the same, our total cost would be higher because we used more of it. This is an unfavorable (bad) efficiency variance.

* Packaging: Perhaps our bakers are being a bit wasteful with the plastic bags we use for each cake, using more bags per cake than the standard allows. This would also be an unfavorable efficiency variance.

Fixed Overhead Variances: Why Our "Stable" Costs Differ

Now let's consider our fixed overhead costs, like the rent for our bakery – costs that generally stay the same no matter how many cakes we bake in a month. The image shows two main variances for fixed overhead:

* Fixed Overhead Spending Variance (Again, Think "Price"): Similar to variable overhead, this looks at whether we paid more or less in total for our fixed overhead costs than we budgeted.

* Rent: Maybe our landlord in Addis Ababa increased the rent for the bakery. Our actual total rent cost for the month would be higher than what we planned, leading to an unfavorable fixed overhead spending variance.

* Salaries of Fixed Staff: If we had a fixed salary for a cleaning person, and we had to hire an extra cleaner at short notice for a higher rate, our actual fixed overhead spending on salaries would be higher than planned.

* Volume Variance (Think "Usage of Capacity"): This one is a bit different. It doesn't focus on how much we spent on fixed overhead, but rather on how efficiently we used our bakery's capacity.

* Our Bakery Capacity: Let's say our bakery has the capacity to bake 25,000 injera cakes per month. We used this capacity to calculate our fixed overhead cost per cake. For example, if our total fixed costs are 50,000 birr, and we planned to bake 25,000 cakes, our fixed overhead per cake in our standard cost would be 2 birr (50,000 / 25,000).

* Baking Fewer Cakes: Now, what if we only baked 20,000 cakes this month? Our total fixed costs (rent, etc.) would likely still be 50,000 birr. However, we spread that same 50,000 birr over fewer cakes. This means each of the 20,000 cakes has absorbed a larger share of the fixed costs than our standard of 2 birr per cake. This results in an unfavorable volume variance because we didn't utilize our full production capacity as planned.

* Baking More Cakes: Conversely, if we baked 30,000 cakes (more than our planned capacity), each cake would absorb a smaller share of the total fixed costs, leading to a favorable volume variance.

In a Nutshell:

* Spending Variances (for both variable and fixed): Did we pay more or less for the overhead resources than expected?

* Efficiency Variance (for variable): Did we use more or less of the activity that drives variable overhead than expected for each cake?

* Volume Variance (for fixed): Did we produce at the level we used to calculate our fixed overhead cost per cake?

By breaking down the total overhead variance into these specific sub-variances, we can get a much clearer picture of why our actual overhead costs differed from our standards in our Addis Ababa bakery. This helps us pinpoint problems (like rising electricity prices or inefficient oven usage) and take corrective actions!