Variable overhead addresses the dynamic manufacturing costs tied to business operations. These costs fluctuate with production output, contrasting with the steady, fixed costs generally associated with administrative and non-production functions.
Understanding variable overhead is vital for businesses to accurately set product prices and avoid overspending, thereby safeguarding profit margins.
Key Takeaways
- Variable overhead costs fluctuate with production or business activity levels.
- These expenses rise and fall as production output varies.
- Typical variable overhead costs include production supplies, energy costs, and wages associated with product handling and shipping.
Understanding Variable Overhead Costs
Operating a business continuously requires investing in both production and sales processes. These comprehensive operational costs are collectively known as overhead. Fixed overhead doesn’t change with production volume, while variable overhead fluctuates.
Examples of Fixed Overhead Costs:
- Mortgage or rent for buildings like the company headquarters.
- Salaries for administrative staff, managers, and supervisors.
- Taxes and insurance.
Characteristics of Variable Overhead Costs:
Variable overhead changes with levels of production, making them harder to predict and control within a budget. If production ceases, variable overhead costs disappear, unlike fixed overhead which persists regardless.
Examples of Variable Overhead Costs
- Production supplies
- Utilities for operating equipment and maintaining the facility.
- Wages for workers managing and shipping products.
- Raw materials required for production.
- Sales commissions for employees based on the sales performance.
These costs can also include additional pay for workers hired to support increased production. Utilities costs, such as electricity, gas, and water, also vary with output levels and operational cycles, adding complexity to budget management.
Variable Overhead and Pricing
Manufacturers must factor in variable overhead expenses when calculating total production costs. This approach helps set minimum product prices for sustaining profitability.
For instance, a manufacturing facility’s electricity expenses vary with output. Increased shifts to meet demand lead to higher power usage, making it crucial to include these variable costs in unit pricing calculations.
Although higher production generally raises variable overhead, efficiencies can reduce per-unit costs, such as through bulk raw material discounts.
Imagine a production run of 10,000 units at $1 per unit cost. Increasing this to 30,000 units might reduce per-unit cost to $0.75 due to economies of scale. Maintaining selling prices while achieving $0.25 savings per unit results in $2,500 savings for the batch, amplifying profit margins.
Real-life Variable Overhead Example
Scenario:
A mobile phone company incurs $20,000 in variable overhead to produce 10,000 phones monthly, amounting to $2 per unit. If production rises to 15,000 units next month, maintaining the $2 per unit cost increases the total variable overhead to $30,000.
Common Questions
What Does Overhead Mean?
Overhead refers to the costs and expenses tied to production but not directly borne by production activities. These include utilities, rent, administrator salaries, supplies, and raw materials.
Fixed vs. Variable Overhead
Fixed overhead remains unchanged regardless of output volume, unlike variable overhead which scales with production levels. Examples include rent and insurance costs versus raw materials and electricity expenses.
Are Salaries or Wages Variable Overhead Costs?
Typically, regular pay constitutes an operating cost rather than an overhead. However, overtime or additional hours due to increased production can be considered a variable overhead cost.
Related Terms: Fixed Overhead, Overhead Costs, Profit Margins, Production Costs, Operating Expenses.
