The production volume variance measures the amount of overhead applied to the number of units produced. It is the difference between the actual number of units produced in a period and the budgeted number of units that should have been produced, multiplied by the budgeted overhead rate. The measurement is used to ascertain whether the materials management and production employees are able to produce goods in accordance with long-range planned expectations, so that an expected amount of overhead can be allocated.
From the perspective of the production process, a production volume variance is likely to be useless, since it is measured against a budget that may have been created months ago. A better measure would be the ability of a production operation to meet its production schedule for that day.
The calculation of the production volume variance is:
(Actual units produced - Budgeted units produced) x Budgeted overhead rate
The reason why a larger production volume is considered favorable is that this means factory overhead can be allocated across more units, which reduces the total allocated cost per unit. Conversely, if fewer units were to be produced, this means the amount of overhead allocated on a per-unit basis would be higher. Thus, the designation of the production volume variance as being favorable or unfavorable is only from the accounting perspective, where a lower per-unit cost is considered better. From a cash flow perspective, it might be better to only produce just that number of units immediately needed by customers, thereby reducing the company's working capital investment.
The production volume variance is based on the assumption that factory overhead is directly associated with units of production, which is not necessarily the case. Some overhead, such as facility rent or building insurance, will be incurred even if there is no production, while other types of overhead, such as management salaries, only vary across very large ranges of production volume. Instead, there may be a number of other ways in which factory overhead can be broken into smaller units, known as cost pools, and allocated using several methods that represent a more intelligent association of activities with costs incurred.