What is fixed and variable overhead?

Fixed and Variable Overhead: Understanding the Differences

Fixed Overhead Costs

Fixed overhead costs are expenses that remain constant regardless of changes in production output. These costs are typically incurred even if production stops for a period. Examples of fixed overhead costs include rent or mortgage payments, fixed salaries of employees, and taxes.

Variable Overhead Costs

Variable overhead costs, on the other hand, fluctuate with changes in production output. As production output increases, variable overhead expenses also increase. Examples of variable overhead costs include energy bills, raw materials, production supplies, wages for workers handling and shipping the product, and sales commissions.

Key Differences

The key difference between fixed and variable overhead costs is that fixed overhead costs remain the same regardless of production output, while variable overhead costs vary with production output. If production stops for a period, there would be no variable overhead costs, but fixed overhead costs would still be incurred.

Implications for Businesses

Understanding the difference between fixed and variable overhead costs is crucial for businesses to accurately calculate their total costs of production and set appropriate pricing strategies. Fixed overhead costs can be more easily budgeted and planned for, while variable overhead costs can be more difficult to predict and control.

Conclusion

Fixed and variable overhead costs are two important components of a company’s overall operating expenses. By understanding the differences between these two types of costs, businesses can make informed decisions about production levels, pricing, and cost control measures.

Sources:

1. Investopedia: How Are Fixed and Variable Overhead Different?
2. Investopedia: Variable Overhead
3. Plumbing & Mechanical: Fixed vs. Variable Overhead: Do You Know the Difference?

FAQs

1. What is fixed overhead?

Fixed overhead costs are expenses that remain constant regardless of changes in production output. Examples include rent or mortgage payments, fixed salaries of employees, and taxes.

2. What is variable overhead?

Variable overhead costs fluctuate with changes in production output. Examples include energy bills, raw materials, production supplies, wages for workers handling and shipping the product, and sales commissions.

3. What is the key difference between fixed and variable overhead?

The key difference is that fixed overhead costs remain the same regardless of production output, while variable overhead costs vary with production output.

4. Why is it important to understand fixed and variable overhead costs?

Understanding these costs is crucial for businesses to accurately calculate their total costs of production and set appropriate pricing strategies.

5. How can businesses control fixed overhead costs?

Businesses can control fixed overhead costs by negotiating better terms with suppliers, reducing employee turnover, and implementing energy-saving measures.

6. How can businesses control variable overhead costs?

Businesses can control variable overhead costs by carefully managing inventory levels, negotiating favorable prices with suppliers, and improving production efficiency.

7. How can businesses allocate fixed and variable overhead costs to their products or services?

Businesses can use various methods to allocate fixed and variable overhead costs to their products or services, such as the direct method, the absorption costing method, and the activity-based costing method.

8. How can businesses use fixed and variable overhead costs to make informed decisions?

By understanding the behavior of fixed and variable overhead costs, businesses can make informed decisions about production levels, pricing, and cost control measures.