Variable overhead refers to the indirect costs of operating a business that fluctuate with levels of production or activity. These costs are incurred in the day-to-day running of facilities but are not directly tied to the production of goods or services.
Types of Variable Overhead Costs
Manufacturing Overhead
Manufacturing overhead encompasses all the factory costs that are not directly associated with producing goods. This includes costs such as utility expenses, maintenance of equipment, and supplies.
Non-Manufacturing Overhead
Non-manufacturing overhead includes indirect costs associated with activities outside the production process. Examples are sales commissions based on sales volume and shipping costs.
Key Components
Indirect Labor
Indirect labor costs include wages for employees who do not directly contribute to product creation, such as maintenance staff and quality control inspectors.
Utilities
Utility expenses, such as electricity and water, often fluctuate based on production levels. Increased production usually results in higher utility usage.
Maintenance Supplies
The cost of maintenance supplies, such as lubricants and cleaning materials, varies with the usage of machinery and production intensity.
How Variable Overhead Works
Variable overhead costs change in proportion to business activity. When production increases, variable overhead costs rise. Conversely, when production decreases, these costs fall. This behavior differentiates them from fixed overhead costs, which remain constant regardless of production levels.
Variable Overhead vs. Fixed Overhead
Variable Overhead
Variable overhead costs vary with production levels. They are flexible and adjust with changes in manufacturing activity. These costs include indirect labor, utilities, and maintenance supplies.
Fixed Overhead
Fixed overhead costs remain constant regardless of production levels. Examples include rent, salaries for administrative personnel, and insurance premiums.
Practical Examples of Variable Overhead
Example 1: Indirect Labor Costs
A factory producing toys increases shifts during the holiday season to meet higher demand. The wages for additional maintenance staff hired during this period represent variable overhead costs.
Example 2: Utility Expenses
An electronics manufacturing plant ramps up production for a new product launch, leading to higher electricity consumption. This increment in utility costs is a variable overhead.
Special Considerations
Cost Allocation
Proper allocation of variable overhead costs is crucial for accurate product costing and profitability analysis.
Budgeting
Variable overhead costs should be estimated and incorporated into budgeting to ensure comprehensive financial planning.
Historical Context
Variable overhead concepts have evolved with industrialization and more sophisticated manufacturing processes. The need to correctly categorize and allocate these costs became more pronounced as businesses sought to optimize operations and profitability.
FAQs
What are examples of variable overhead costs in a service industry?
How can businesses manage variable overhead costs?
Related Terms
- Direct Costs: Costs directly attributable to the production of goods or services, such as raw materials and direct labor.
- Semi-Variable Costs: Costs that have both fixed and variable components, such as a fixed rental fee with an additional cost per unit of usage.
Summary
Variable overhead represents the indirect, fluctuating costs tied to production levels in a business. Understanding these costs and how they operate in different contexts helps in effective cost management and financial planning. By differentiating from fixed overhead, businesses can better allocate resources and optimize profitability.
References
- Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2018). Managerial Accounting. McGraw-Hill Education.
- Drury, C. (2015). Management and Cost Accounting. Cengage Learning.
- Horngren, C. T., Datar, S. M., & Rajan, M. V. (2015). Cost Accounting: A Managerial Emphasis. Pearson.
This structured and detailed entry will provide readers with a deep understanding of the concept of variable overhead, its implications for business operations, and how it can be effectively managed.
