In the realm of business operations, understanding and managing costs is crucial for financial success. Among the various cost categories, variable overhead costs play a significant role in determining a company’s profitability and pricing strategies. This article delves into the concept of variable overhead costs, providing a comprehensive overview of their definition, examples, and calculation methods.
Key Facts
- Variable overhead costs are the fluctuating manufacturing costs associated with operating businesses. These costs change with the level of business or manufacturing activity.
- Production overhead is a type of overhead cost that includes both fixed and variable components. Fixed overhead costs remain constant regardless of the level of production, while variable overhead costs fluctuate with production output.
- Examples of variable overhead costs in production include production supplies, energy costs to run production lines, wages for those handling and shipping the product, raw materials, and sales commissions for workers.
- Variable overhead costs can include pay for workers added when production is increased. Extra hours paid for production increases would be considered a variable cost.
- Variable overhead costs can vary depending on production output, the rollout of new products, manufacturing cycles for existing products, and seasonal patterns. Additional factors that may be included in variable overhead expenses are materials and equipment maintenance.
- Manufacturers must include variable overhead expenses to calculate the total cost of production at current levels and determine the minimum price levels for products to ensure profitability.
- While variable overhead costs tend to be small in relation to fixed overhead costs, they can change over time, unlike fixed costs that typically remain constant.
Definition of Variable Overhead Costs
Variable overhead costs are a type of indirect manufacturing cost that fluctuates in proportion to changes in the level of production or business activity. Unlike fixed overhead costs, which remain constant regardless of production output, variable overhead costs vary directly with the volume of goods or services produced.
Examples of Variable Overhead Costs
Several expenses fall under the umbrella of variable overhead costs. Some common examples include:
- Production Supplies: These are materials directly consumed in the production process, such as raw materials, components, and packaging.
- Energy Costs: The cost of electricity, fuel, and other forms of energy used to power production equipment and facilities.
- Wages for Production Workers: The compensation paid to employees directly involved in the production process, including overtime pay and bonuses tied to output.
- Sales Commissions: Variable payments made to sales personnel based on their sales volume.
- Materials and Equipment Maintenance: The cost of maintaining and repairing production equipment and facilities.
Calculation of Variable Overhead Cost Variance
To assess the efficiency of variable overhead cost management, companies can calculate the variable overhead cost variance. This metric compares the actual variable overhead costs incurred with the standard variable overhead costs that were budgeted or expected. The formula for calculating variable overhead cost variance is:
Variable Overhead Cost Variance = Actual Variable Overhead Costs – Standard Variable Overhead Costs
A favorable variance indicates that the actual variable overhead costs were lower than the budgeted amount, while an adverse variance suggests that the actual costs exceeded the budget.
Conclusion
Variable overhead costs are a critical component of a company’s cost structure. Understanding and effectively managing these costs are essential for accurate pricing, profitability analysis, and efficient operations. By closely monitoring variable overhead costs, businesses can optimize their production processes, minimize expenses, and enhance their overall financial performance.
References
- Investopedia. (2021, May 17). How Are Fixed and Variable Overhead Different? Retrieved from https://www.investopedia.com/ask/answers/033015/how-does-fixed-overhead-differ-varied-overhead.asp
- Investopedia. (2022, March 28). What Is Variable Overhead? How It Works Vs. Variable, and Example. Retrieved from https://www.investopedia.com/terms/v/variable-overhead.asp
- GoCardless. (2023, January). Guide to Variable Overhead Costs. Retrieved from https://gocardless.com/en-us/guides/posts/variable-overhead-cost/
FAQs
What is production overhead?
Production overhead refers to the indirect costs incurred during the manufacturing process, excluding direct labor and direct materials. It includes expenses such as factory rent, utilities, depreciation of production equipment, and supervisory salaries.
Is production overhead a variable cost?
Production overhead can include both fixed and variable components. Fixed production overhead costs remain constant regardless of production output, while variable production overhead costs fluctuate with the level of production.
What are examples of variable production overhead costs?
Examples of variable production overhead costs include:
- Electricity and fuel consumed during production
- Maintenance and repairs of production equipment
- Production supplies such as lubricants and cleaning materials
- Overtime pay and bonuses for production workers tied to output
How can companies manage variable production overhead costs?
Companies can manage variable production overhead costs through various strategies, such as:
- Optimizing production processes to reduce waste and improve efficiency
- Negotiating favorable terms with suppliers for raw materials and utilities
- Implementing preventive maintenance programs to minimize equipment downtime
- Offering incentives to production workers to increase productivity
How does variable production overhead impact product pricing?
Variable production overhead costs are included in the calculation of the total cost of production, which is a key factor in determining product pricing. Higher variable production overhead costs can lead to higher product prices, while lower variable production overhead costs can allow for more competitive pricing.
How can companies reduce variable production overhead costs?
Companies can reduce variable production overhead costs by:
- Automating production processes to minimize labor costs
- Investing in energy-efficient equipment and technologies
- Implementing lean manufacturing principles to eliminate waste and improve efficiency
- Negotiating favorable contracts with suppliers and service providers
How does variable production overhead affect profitability?
Variable production overhead costs directly impact a company’s profitability. Higher variable production overhead costs can reduce profit margins, while lower variable production overhead costs can improve profitability.
How can companies forecast variable production overhead costs?
Companies can forecast variable production overhead costs using historical data, industry benchmarks, and estimates of future production levels. Accurate forecasting is crucial for budgeting and planning purposes.