Whenever you see direct labor and direct materials, overhead can’t be far behind. To compute overhead applied, multiply the overhead application rate by the standard number of hours allowed:

Overhead applied = Overhead application rate x SH

So you can determine overhead variance by subtracting actual overhead from applied overhead:

Band Book Company incurs actual overhead costs of \$95,000. The company’s overhead application rate is \$25 per hour. You use direct labor hours as the activity level for applying overhead. In order for Band Book’s workers to produce 1,000 cases, you can expect them to work standard hours of 4 direct labor hours per case.

SH equals 1,000 cases produced x 4 direct labor hours per case, or 4,000 direct labor hours. This amount results in overhead applied of \$100,000:

Overhead applied = Overhead application rate x SH = \$25.00 x 4,000 = \$100,000

To compute the variance, subtract actual overhead from the overhead applied:

Overhead variance = Overhead applied – Actual overhead = \$100,000 – \$95,000 = \$5,000

Because actual overhead is less than overhead applied, the \$5,000 variance is favorable.

Spending too much or too little on overhead — or using overhead inefficiently — often causes overhead variance.

Like direct labor and direct materials, overhead, too, can have price and quantity variables. However, fixed and variable cost behaviors considerably complicate the calculation of overhead variances.