Under- and Over-Recovery
The pool is recovered through a rate set in advance, so the two never match. What the difference means, how to split it, and where it must not go.
An overhead pool is recovered through a rate set before the year on volumes estimated before the year, so what is recovered and what is spent never match. The difference is a recovery variance, and what an organisation does with it reveals whether its costing is a measurement or a plug.
The calculation in “Under- and Over-Recovery” depends on reliable source records as well as a documented accounting rule. For organisations researching download time tracking software, download time tracking software can supply consistent time and project context, while the allocation basis and financial interpretation remain decisions for the organisation and its advisers.
Analysed, it is informative. Rolled into next year's rate, it is the start of a spiral.
For a separate reference relevant to “Under- and Over-Recovery”, consult NASBA accountancy resources. Compare the general material with the organisation’s actual contracts, accounting policy and jurisdiction.
Computing the variance
Overhead recovered equals the rate times the actual base. Overhead incurred is what the pool cost. The difference is the variance.
- Recovered: the rate times the actual base.
- Incurred: what the pool cost.
- Variance: the difference, split into volume and spending.
Under-recovery means less was charged out than was spent; over-recovery means more.
The two causes
Spending was different from plan, or volume was different from plan. They are separable and they belong to different people.
A spending variance belongs to whoever owns the pool. A volume variance belongs to whoever owns demand. Reporting one number means neither conversation happens.
Splitting it
Volume variance: the difference between budgeted and actual base, multiplied by the rate. Spending variance: the remainder.
Two subtractions. It is the standard split and it takes a line of arithmetic.
Why under-recovery is usually volume
Because pools are largely fixed within a year. When volumes fall, the pool does not, and the shortfall appears immediately.
Treating that as a cost problem leads to cutting overhead that will be needed when volumes return; treating it as a demand problem leads to the right conversation.
Where it must not go
Into next year's rate. A rate that carries last year's shortfall is not a measurement of this year's cost, and if volumes stay low the correction compounds each year.
This is the single most damaging habit in overhead accounting and it is extremely common because it makes the accounts balance.
Where the variance belongs
To the profit and loss account for the period, as a variance, named and explained.
It is a fact about the year, and burying it in a rate moves it onto jobs that did not cause it.
Over-recovery
The pleasant case and equally distorting. A busy year recovers more than the pool cost, job costs are overstated, and the operation believes its work is less profitable than it is.
The response is the same: report it, do not adjust the rate mid-year.
Chronic under-recovery
Where it happens every year, the rate is wrong rather than the volumes. Either the budgeted base is optimistic or the pool has grown and the rate has not followed.
Three consecutive years in the same direction is the signal, and the fix is in next year's rate build rather than in a correction.
What to report
Pool incurred, pool recovered, variance, split into volume and spending, with one line on each. Five numbers and two sentences, per period.
It takes a small table and it is usually the only place the organisation sees the cost of being below plan stated as a number.
The conversation it should produce
Not "why is overhead over budget", which is usually answerable and small, but "we are running at 84 per cent of the volume the rate assumes, which costs £X a quarter in unrecovered overhead".
That sentence belongs in front of whoever can do something about volume, and it rarely reaches them.
Reporting it where it can be acted on
The volume element belongs in front of whoever owns demand, in the same pack as the sales figures, not buried in a finance appendix.
Reported only to finance, it produces a cost-cutting response to a demand problem, which is the standard sequence and the wrong one.
Why it is reported so rarely
Because it needs no action from the finance function and reflects badly on somebody else. It is nobody's metric, which means nobody publishes it.
That is exactly why it is worth putting in a standing report: a number with no natural owner is the one that goes longest without being examined.
The quarter where both move
Volume down and spending up at once, which is the ordinary shape of a bad quarter: fewer chargeable hours and some unplanned cost.
Reported as one number it looks like a single large failure. Reported split, it is two ordinary facts with two different owners and two different remedies, and both are tractable.
The honest year-end note
"Overhead under-recovered by £112,000: £94,000 volume, £18,000 spending. The volume element reflects chargeable hours at 11 per cent below the rate's assumption. Next year's rate is unchanged in respect of this variance."
Four sentences, and the last one is the one that keeps the rate clean.