Variable Overhead Cost

Variable overhead costs represent the elements of an organization's indirect expenses for a product that change in total with fluctuations in production or sales levels. Examples include power, commissions earned by sales personnel, and consumable materials.
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Definition

Variable overhead cost refers to the indirect expenses incurred by an organization that vary in total with changes in the levels of production or sales. Unlike fixed overhead costs, which remain constant irrespective of production volume, variable overhead costs fluctuate as the level of business activity changes. Common examples of variable overhead costs include power for operating machinery, commissions paid to sales personnel based on sales, and other consumable materials used during the production process.

Examples

  1. Power Consumption: The cost of electricity needed to operate machinery. As production increases, power consumption, and thus its cost, also increases.
  2. Sales Commissions: Sales personnel who earn a commission based on the number of units sold. Higher sales mean higher commission costs.
  3. Consumable Materials: Materials such as lubricants, cleaning supplies, or small tools used during production, which vary in usage with the level of production.
  4. Packaging Costs: The costs associated with packaging more products as the production level increases.

Frequently Asked Questions

What are variable overhead costs?

Variable overhead costs are indirect costs that change in direct proportion to changes in the levels of production or sales, such as power, sales commissions, and consumable materials.

How do variable overhead costs differ from fixed overhead costs?

Fixed overhead costs remain constant regardless of production levels, while variable overhead costs fluctuate with changes in business activity.

Why are variable overhead costs important?

They are an essential component of total manufacturing costs and impact pricing, profitability, and budgeting.

How can an organization manage variable overhead costs effectively?

Effective management includes monitoring consumption levels, optimizing production processes, and negotiating better rates for variable cost items.

Can variable overhead costs affect product pricing?

Yes, variations in variable overhead costs can lead to adjustments in product pricing to maintain profitability.

Fixed Overhead Cost

These are indirect expenses that do not fluctuate with production volume, such as rent, salaries, and insurance.

Direct Costs

Costs directly attributable to the production of a product, like raw materials and direct labor.

Contribution Margin

The amount remaining from sales revenue after variable production costs have been deducted, which contributes to covering fixed costs and generating profit.

Break-even Point

The production level at which total revenues equal total costs, meaning there is no profit or loss.

Online References

  1. Investopedia: Variable Overhead Definition
  2. Management Study Guide: Types of Overhead Costs
  3. AccountingCoach: Overhead Costs

Suggested Books for Further Studies

  1. Accounting for Dummies by John A. Tracy
  2. Cost Accounting: A Managerial Emphasis by Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan
  3. Financial and Managerial Accounting by John J. Wild and Ken Shaw
  4. Managerial Accounting by Ray H. Garrison, Eric W. Noreen, and Peter C. Brewer

Accounting Basics: “Variable Overhead Cost” Fundamentals Quiz

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