Idle Capacity Variance. The rate used for applying factory overhead is $1.50 per direct labor hour which is based on 200,000 normal capacity hours. However, direct labor hours worked during the period totaled only 190,000 hours; capacity not used, 10,000 direct labor hours. The capacity attained was 95 percent (190,000 / 200,000) of normal.
The $1.50 overhead rate is considered the proper costing price for each direct labor hour used. The fact that operations were at a level below normal should not increase the factory overhead cost of each unit. The cost of idle capacity should be recorded separately and considered a part of total manufacturing cost. The $6,250 idle capacity variance arises because 1 0,000 available hours were not used, and is computed as follows:
Budget allowance (based on capacity utilized) $291,250
Factory overhead applied 285,000
Idle capacity variance — unfavorable S 6,250
The idle capacity variance can also be computed by multiplying the 10,000 idle hours by the $.625 fixed expense rate or by multiplying total budgeted fixed expenses of $125,000 by 5 percent (100% – 95%).
Responsibility for the idle capacity variances rest with executive management , inasmuch as this variance indicates the under- or over-utilization portion of plant and equipment. The cause of a capacity variance, whether favorable or unfavorable, should always be determined and possible reasons for the variance discovered. One cause may be a lack of proper balance between production facilities and sales. On the other hand, it might be due to a favorable sales price that recovers fixed overhead at an unusually low volume level.
Comparison of actual with budgeted overhead for capacity worked should be made by the management on a regular basis.
The budgeted figures utilize the concept of the flexible budget. Basically, the budget figures represent the budge for the level of activity attained (e.g., for indirect labor) from the estimates. Corrective action should be taken where called for; likewise, effective and eflficient performance should be recognized and rewarded.