Variable Overhead

What is Variable Overhead?

Variable overhead refers to the fluctuation in the manufacturing costs associated with the operation of businesses. To operate continuously, companies need to spend money on the production and sale of goods and services that generate revenue for their business. The overall operational costs usually include the salaries of managers, sales staff, and marketing staff who are part of the production facilities.

The expenses related to running and maintaining the corporate office are known as overhead costs. The overhead cost is an ongoing expense, which means that it must be paid on a continuous basis whether or not the company is meeting its sales or profit objectives.

Overhead Costs – Types

Overhead costs are of two types – fixed and variable. Typically, there is no volatility in the overhead with increases or decreases in the production of a given product. Thus, it is considered to be a fixed cost. Common fixed costs include salaries for supervisors, managers, and administrative staff, rent for buildings, and tax liabilities.

On the other hand, variable overhead expenses move in tandem with the increase or decrease in production output. It means that it fluctuates with unit production of a given product in the factory. In contrast with general overhead expenses that come with fixed budgetary requirements, variable overhead costs are expenditures associated with functions, such as administrative tasks.

The key difference between the two types of overhead costs is that in a case when production is halted, which means that the output is 0, there is no variable overhead. The net overhead costs in such cases only include fixed overheads.

What Costs are Included in Variable Overheads?

Examples of variable overheads include the purchase of production supplies and raw materials, payment of wages associated with the handling and shipping of products, and payment of sales commissions to employees. In cases when additional staff is required in factories due to an increase in output, the costs associated with the additional workers also form part of variable overhead costs, as well as extra hours paid for or overtime wages.

Other costs that tend to fluctuate with changing output levels include the cost of utilities for the equipment. Usage of electric power, gas, and water is directly proportional to total production output, roll-outs of any new product lines, and seasonal changes that impact the manufacturing cycles for existing products. Additional factors include maintenance of equipment, materials, changes in the labor force, etc.

Importance of Calculating Variable Overheads

As a result of the fluctuation, variable overheads can prove tough to evaluate and budget for accurately. Despite such a fact, it is important to calculate the overheads to avoid overspending, correctly set prices, make capital requirement plans, create reserve accounts, etc.

To calculate the total cost of production at the current level of output, manufacturers are required to include variable overhead expenses in addition to the total overhead required to increase the future manufacturing output. The expenses are then included in the calculations for determining the selling price of the product. It is important as setting minimum price levels ensures the profitability of the company.

Related Readings

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below:

• Overheads
• Cost of Production
• Cost Structure
• Fixed and Variable Costs
• See all accounting resources