Variable Overhead Costs as Relevant Costs in Managerial Decision-Making

In managerial accounting, relevant costs are those costs that will be affected by a specific decision being considered. Variable overhead costs are a type of indirect cost that fluctuates with the level of production or activity within a company. These costs can include expenses such as utilities, maintenance, and supplies that vary based on the volume of production. In this article, we will explore the concept of variable overhead costs and discuss why they are considered relevant costs in managerial decision-making.

Definition of Variable Overhead Costs

Variable overhead costs are indirect costs that change with the level of production or activity. These costs are not directly related to the production of a specific unit of output but are necessary for the overall production process. Examples of variable overhead costs include:

• Utilities: The cost of electricity, water, and other utilities used in the production process.
• Maintenance: The cost of maintaining equipment and machinery used in production.
• Supplies: The cost of materials and supplies that are consumed in the production process but are not directly traceable to a specific unit of output.

Relevant Costs in Managerial Decision-Making

Relevant costs are those costs that will be affected by a managerial decision. These costs are future costs that can change depending on the alternative chosen. Relevant costs are considered in decision-making because they can impact the profitability of different alternatives.

Variable Overhead Costs as Relevant Costs

Variable overhead costs can be relevant costs because they vary with the level of activity or output. These costs can change depending on the decision made, such as:

• Shutting down a division: If a company decides to shut down a division, the variable overhead costs associated with that division will be eliminated. These costs are therefore relevant to the decision of whether or not to shut down the division.
• Accepting a special order: If a company accepts a special order, the variable overhead costs associated with producing the order will be incurred. These costs are relevant to the decision of whether or not to accept the order.
• Outsourcing a product: If a company decides to outsource a product, the variable overhead costs associated with producing the product will be eliminated. These costs are therefore relevant to the decision of whether or not to outsource the product.

Differentiating Relevant and Irrelevant Costs

It is important for managers to distinguish between relevant and irrelevant costs. Relevant costs are those that will change in the future based on the decision made, while irrelevant costs, such as fixed overhead costs and sunk costs, are not affected by the decision and are therefore ignored.

Conclusion

Variable overhead costs can be relevant costs in managerial decision-making because they vary with the level of activity or output. These costs can change depending on the decision made, such as shutting down a division, accepting a special order, or outsourcing a product. Therefore, it is important for managers to consider variable overhead costs when making decisions that will impact the profitability of the company.

FAQs

What are variable overhead costs?

Variable overhead costs are indirect costs that fluctuate with the level of production or activity within a company. Examples include utilities, maintenance, and supplies that vary based on the volume of production.

Why are variable overhead costs considered relevant costs?

Variable overhead costs are considered relevant costs because they change with the level of activity or output. These costs can be affected by managerial decisions, such as shutting down a division, accepting a special order, or outsourcing a product.

How can variable overhead costs be relevant in decision-making?

Variable overhead costs can be relevant in decision-making because they can impact the profitability of different alternatives. For example, if a company is considering shutting down a division, the variable overhead costs associated with that division will be eliminated. This cost saving can be a factor in the decision-making process.

What are some examples of decisions where variable overhead costs are relevant?

Variable overhead costs can be relevant in a variety of decisions, including:

• Shutting down a division
• Accepting a special order
• Outsourcing a product
• Make-or-buy decisions
• Product pricing

How can managers determine if variable overhead costs are relevant to a decision?

To determine if variable overhead costs are relevant to a decision, managers should consider whether the costs will change as a result of the decision being made. If the costs will change, then they are relevant and should be included in the decision-making process.

What are some examples of variable overhead costs that may not be relevant in decision-making?

Some examples of variable overhead costs that may not be relevant in decision-making include:

• Costs that have already been incurred (sunk costs)
• Costs that will not change regardless of the decision made (fixed costs)
• Costs that are not affected by the level of activity or output

Why is it important for managers to distinguish between relevant and irrelevant costs?

It is important for managers to distinguish between relevant and irrelevant costs because relevant costs can impact the profitability of different alternatives, while irrelevant costs cannot. By focusing on relevant costs, managers can make more informed decisions that are likely to lead to improved profitability.

What are some of the challenges in identifying relevant costs?

Some of the challenges in identifying relevant costs include:

• Distinguishing between variable and fixed costs
• Identifying costs that are affected by the decision being made
• Estimating the magnitude of the cost changes

Despite these challenges, it is important for managers to make a reasonable effort to identify relevant costs in order to make informed decisions.