The choice of production volume as a denominator for calculating its factory overhead rate

What Is Production Volume Variance?

Production volume variance is a statistic used by businesses to measure the cost of production of goods against the expectations reflected in the budget. It compares the actual overhead costs per unit that were achieved to the expected or budgeted cost per item.

The formula for production volume variance is as follows:

• Production volume variance = (actual units produced - budgeted production units) x budgeted overhead rate per unit

Production volume variance is sometimes referred to simply as volume variance.

Key Takeaways

• Calculating production volume variance can help a business determine whether it can produce a product in enough quantities to run at a profit.
• It focuses on overhead costs per unit, not the total costs of production.
• Many production costs are fixed, so higher production means higher profits.

Understanding Production Volume Variance

Calculating its overhead costs per unit is important for a business because so many of its overhead costs are fixed. That is, they will be the same whether a million units are produced or zero.

Factory rent, equipment purchases, and insurance costs all fall into this category. They must be paid regardless of the number of units produced. Management salaries do not usually vary with incremental changes in production.

Other costs are not fixed as volume changes. Total spending on raw materials, transportation of goods, and even storage may vary significantly with greater volumes of production.

Production volume variance can be considered a stale statistic. It may be calculated against a budget that was drafted months or even years before actual production. For this reason, some businesses prefer to rely on other statistics, such as the number of units that can be produced per day at a set cost.

Nevertheless, volume variance is a useful number that can help a business determine whether and how it can produce a product at a low enough price and a high enough volume to run at a profit.

Production volume variance is favorable if actual production is greater than budgeted production.

Good and Bad Production Volume Variance

If actual production is greater than budgeted production, the production volume variance is favorable. That is, the total fixed overhead has been allocated to a greater number of units, resulting in a lower production cost per unit.

When actual production is lower than budgeted production, production volume variance is unfavorable.

For example, assume a company budgeted to have 5,000 units produced the following year at an overhead rate per unit of $12. After calculating the production results for that year, it was confirmed that 5,400 units were actually produced. The production volume variance in this example is $4,800 ((5,400 - 5,000) x $12 = $4,800).

The company has produced more units for the price than it had anticipated. The difference of $4,800 is savings created by producing more units than the budget assumed.

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