Production Volume Variance

Production volume variance is a statistic that measures the amount of overhead applied to the number of goods produced. Production volume variance helps corporate managers understand whether their staff is able to produce goods in line with the firm's long-term expectations, enabling the proper amount of overhead to be allocated to the project.  Production volume variance = (number of actual units produced - number of budgeted production units) x budgeted overhead rate per unit.

The production volume variance, which takes into account actual units produced, budgeted units produced, and a budgeted overhead rate, is based on the assumption that total production overhead is directly linked to the total number of units produced. The assumption is not entirely accurate because certain overhead items, such as factory rent, potential equipment rent, and insurances, will be realized even if the total number of units produced is zero. Other types of overhead, such as management salaries, do not typically vary with incremental changes in production and generally vary only with larger ranges of production. Also, the production volume variance may be a stale statistic as it might be calculated against a budget drafted many months or years before actual production.

When actual production is greater than budgeted production, production volume variance is favorable because total fixed overhead is allocated to a greater number of units resulting in a lower production cost per unit. Conversely, 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 and that the overhead rate per unit is $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).

In this scenario, the total budgeted overhead costs for the production of the product is $60,000 (5,000 x $12). If the company budgeted for 5,400 units of production, the total overhead costs would be $64,800 (5,400 x $12). The difference of $4,800 is savings that occurred by producing more on the same allocated overhead budget. With this same logic, it can be said that underproducing units versus budgeting units means a higher cost per unit and lower net income on the project.