Variable overheads are costs that fluctuate in direct proportion to changes in a company's production volume or the number of services it provides. Unlike fixed costs, these expenses are not static; they increase as production output rises and decrease when production output falls. Crucially, if there is no production, there are no variable overhead costs incurred.
Understanding Variable Overhead Costs
These costs are an essential component of a company's total overhead, which refers to all indirect costs associated with running a business. What distinguishes variable overheads is their direct relationship with activity levels. As the volume of goods manufactured or services delivered changes, so too does the total amount spent on these overheads. This dynamic nature means that the total variable overhead cost will be higher during periods of high activity and lower during periods of reduced activity.
Key Characteristics
- Direct Proportionality: Total variable overhead costs increase or decrease in direct proportion to changes in production or activity levels.
- Per-Unit Consistency: While the total variable overhead changes, the variable overhead cost per unit typically remains constant within a relevant range of activity.
- Activity-Dependent: If there is no production or service activity, these costs are zero.
- Controllability: Businesses often have more control over variable overheads compared to fixed overheads, as they can adjust production levels to manage these costs.
Common Examples of Variable Overheads
Understanding specific examples can help clarify the concept of variable overheads:
- Indirect Materials: These are materials not directly traceable to a specific product but vary with production. For example, lubricants used for machinery that produces goods, or cleaning supplies used more frequently with higher production.
- Indirect Labor: Wages paid to employees who support the production process but are not directly involved in manufacturing the product itself. This could include supervisors whose hours increase with production shifts, or quality control inspectors whose numbers scale with output.
- Utilities (Variable Portion): While some utility costs (like a base electricity charge) might be fixed, the portion of electricity, water, or gas consumed by production machinery will vary with output. The more units produced, the more power is typically consumed by the equipment.
- Sales Commissions: While often classified as a selling expense, if commissions are paid to sales staff based on the volume of sales, they behave like a variable overhead in relation to sales activity.
- Shipping Costs: The cost of packaging and shipping products to customers often increases directly with the number of units sold or shipped.
- Production Supplies: Items like small tools, gloves, or protective gear for workers that are used more extensively as production output rises.
Impact on Business
Understanding variable overheads is crucial for accurate financial forecasting, budgeting, and pricing decisions. Businesses need to track these costs carefully to determine their true cost of production, make informed decisions about scaling operations, and set competitive prices. Effective management of variable overheads contributes significantly to a company's profitability and financial health. This understanding is key for effective cost accounting and operational efficiency.
