Production Volume VarianceA variance that occurs when there is a difference between actual and budgeted production

When you produce goods, you’ll notice that some costs go up or down along with the level of production.

You’ll also notice that other costs will stay as is no matter how many you produce.

Among these costs are those that you can directly attribute to specific goods.

For example, certain materials and labor go towards the production of a certain product.

Other costs of production cannot be directly attributed to specific goods.

Rather than that, these costs are attributed to the production process as a whole. We refer to these costs as the factory overhead, manufacturing overhead, or overhead costs.

While overhead costs are not usually directly attributable to a certain product, since they are production costs, they still contribute to the final cost of a product.

Most overhead costs are fixed costs. This means that most of them stay as is no matter how many you produce.

With that in mind, wouldn’t it be more efficient if you produce goods?

Since most overhead costs are fixed, their allocation per unit of products goes down the more products you produce.

For example, let’s say that your total overhead cost is $5,000.

If you only produce 1 unit of product, the overhead cost per unit will be $5,000.

However, if you produce 10 units, the overhead cost per unit will go down to $500.

And this overhead cost per unit will only go down the more units of a product you produce.

Now sometimes, actual production doesn’t match its budgeted amount.

This produces a variance in the number of units produced.

Of course, this also creates a variance in the overhead cost (and overall production cost).

We aptly refer to this variance as the production volume variance.

In this article, we will be talking about the production volume variance.

What is Production Volume Variance?

Actual production and budgeted production may not always match.

Actual production might be more or less.

This creates a variance in the production volume which may lead to a variance in the actual and budgeted overhead costs.

We refer to this variance as the production volume variance (a.k.a. volume variance).

The production volume variance is a statistic that businesses use to compare actual and budgeted overhead costs that are related to the production process.

To calculate the production volume variance, we deduct the budgeted unit of production from the actual number of units produced.

We then multiply the resulting figure by the budgeted overhead cost per unit. Put into formula form, it should look like this:

Production Volume Variance = (Actual Units Produced – Budgeted Units of Production) x Budgeted Overhead Rate Per Unit

Favorable Production Volume Variance

A positive volume variance occurs when the actual number of units produced is greater than its budgeted amount.

This is said to be a favorable variance because the total fixed overhead is being allocated to a greater number of units.

This results in a lower overhead cost per unit, and ultimately, a lower production cost per unit.

For example, let’s say that a business has a budgeted overhead rate of $5 per unit.

It anticipates that it can produce 10,000 units for the current period. At the end of the period, the business was able to produce 11,000 units. Ls calculate the production volume variance:

Production Volume Variance = (Actual Units Produced – Budgeted Units of Production) x Budgeted Overhead Rate Per Unit

= (11,000 – 10,000) x $5

= 1,000 x $5

Production Volume Variance = $5,000

As per our calculation, there is a favorable production volume variance of $5,000.

What this means is that by producing more units, the business is able to save $5,000 in production costs.

Unfavorable Production Volume Variance

On the other hand, a negative volume variance will occur when the actual number of units produced is lesser than its budgeted amount.

This is said to be an unfavorable variance because it indicates that the budgeted total fixed overhead cost isn’t fully utilized by the actual number of units produced.

It also results in a higher production cost per unit.

To illustrate let’s go back to our example. But instead of producing 11,000 units for the period, the business was only able to produce 8,800 units.

The production volume variance will then be:

Production Volume Variance = (Actual Units Produced – Budgeted Units of Production) x Budgeted Overhead Rate Per Unit

= (8,800 – 10,000) x $5

= -1,200 x $5

Production Volume Variance = -$6,000

As per our calculation, there is an unfavorable production volume variance of $6,000.

What this means is that the business is losing $6,000 by producing less than what was anticipated.

Understanding Production Volume Variance

Many consider production volume variance as a stale statistic.

This is because it’s basically comparing current production against a budget that may have been created months or even years ago.

A lot of things can happen by then. Because of this, some businesses prefer to rely on other statistics.

One of these statistics is a measurement of the number of units that a business can produce per day given a set cost.

That being said, production volume variance is still a useful metric that can assist a business in determining whether or not it’s doing a good job in controlling its production costs.

It’s also useful in determining how a business can produce its products at a high enough volume and a low enough cost to earn maximum profits.

A Problem with Production Volume Variance

A favorable volume variance occurs when a business is able to produce more units of a product than the anticipated amount.

This creates a situation where businesses might think that producing more is always better because it results in lower overhead costs per unit.

The thing is, that isn’t always the case. Sure, if the business is able to sell all of the units of product it produces, there won’t be an issue.

But if a business produces more than what it can realistically sell, there is a problem.

Unsold finished goods become part of the business’s inventory.

If these goods remain unsold for a very long time, they can become obsolete.

This is undesirable because obsolete inventory only causes avoidable losses for the business.

To combat this, rather than producing more just for the sake of lower production costs per unit, a business should only produce what it can realistically sell.