Understanding variable overhead and fixed overhead costs is crucial for businesses to effectively manage costs, create budgets, and determine pricing strategies. These costs differ in their behavior and significance in managerial accounting.
Variable Overhead Costs
Definition
Variable overhead costs are expenses that fluctuate in direct proportion to changes in production levels or volume of operations.
Relationship to Output/Activity
Variable overhead costs vary with the level of output or activity in a business. As production or sales increase, these costs also increase, and vice versa.
Examples
Common examples of variable overhead costs include direct materials, direct labor, utilities, supplies, and maintenance and repair costs.
Calculation
Variable overhead costs are typically calculated by dividing the total variable overhead costs by the total activity base, such as machine hours, labor hours, or units produced.
Importance
Understanding variable overhead costs is essential for effective cost control, budgeting, and pricing strategies. It helps businesses accurately estimate costs associated with different levels of production or activity.
Fixed Overhead Costs
Definition
Fixed overhead costs are constant expenses that do not vary as a function of productive output.
Independence from Output/Activity
Fixed overhead costs remain the same regardless of the level of production or sales. They are incurred even if there is no production or sales activity.
Examples
Examples of fixed overhead costs include rent or mortgage payments, fixed salaries of employees, and insurance.
Incurrence Regardless of Activity
Fixed overhead costs are typically incurred even if there is no production or sales activity. They are necessary to maintain the basic structure and operations of a business.
Importance
Fixed overhead costs are essential for determining the total cost of doing business and calculating profitability. They help businesses plan for expenses that remain constant regardless of production levels.
Conclusion
Variable overhead and fixed overhead costs are two distinct types of expenses with different behaviors and significance in business. Understanding and managing these costs are crucial for effective financial management and decision-making. By accurately calculating and analyzing variable and fixed overhead costs, businesses can optimize their operations, control costs, and make informed pricing and budgeting decisions.
Sources:
- https://www.investopedia.com/ask/answers/033015/how-does-fixed-overhead-differ-varied-overhead.asp
- https://www.pmmag.com/articles/102055-fixed-vs-variable-overhead-do-you-know-the-difference
- https://www.superfastcpa.com/what-is-variable-overhead/
FAQs
What are variable overhead costs?
Variable overhead costs are expenses that fluctuate in direct proportion to changes in production levels or volume of operations. Examples include direct materials, direct labor, utilities, supplies, and maintenance and repair costs.
How do variable overhead costs differ from fixed overhead costs?
Variable overhead costs vary with the level of production or activity, while fixed overhead costs remain constant regardless of production or sales levels.
Why is it important to understand variable overhead costs?
Understanding variable overhead costs is crucial for effective cost control, budgeting, and pricing strategies. It helps businesses accurately estimate costs associated with different levels of production or activity.
How are variable overhead costs calculated?
Variable overhead costs are typically calculated by dividing the total variable overhead costs by the total activity base, such as machine hours, labor hours, or units produced.
What are some examples of fixed overhead costs?
Examples of fixed overhead costs include rent or mortgage payments, fixed salaries of employees, insurance, and depreciation.
Why is it important to understand fixed overhead costs?
Understanding fixed overhead costs is essential for determining the total cost of doing business and calculating profitability. It helps businesses plan for expenses that remain constant regardless of production levels.
How do fixed overhead costs impact pricing and budgeting decisions?
Fixed overhead costs are a significant factor in pricing and budgeting decisions. Businesses need to consider their fixed costs when setting prices and creating budgets to ensure they cover all expenses and generate a profit.
How can businesses manage and control variable and fixed overhead costs?
Businesses can manage and control variable and fixed overhead costs through various strategies, such as cost-cutting measures, optimizing production processes, and negotiating better deals with suppliers.