What Is Variable Manufacturing Overhead?
Understand variable manufacturing overhead: how production levels impact specific costs and its crucial role in accurate product costing.
Manufacturing overhead represents indirect costs incurred during production that cannot be directly traced to specific products. Accurate cost determination supports informed decision-making.
Defining Variable Manufacturing Overhead
Variable manufacturing overhead refers to indirect production costs that change in total directly with fluctuations in the level of production activity. As the volume of goods manufactured increases, total variable manufacturing overhead costs also increase proportionally. Conversely, if production decreases, these costs will decline.
While the total cost of variable manufacturing overhead changes with production volume, the cost per unit of production remains constant. For instance, if one unit incurs a certain variable overhead, ten units will incur ten times that total, but the cost per unit remains the same. This characteristic allows businesses to predict how these costs will behave at different production levels.
Components of Variable Manufacturing Overhead
Several types of costs fall under the category of variable manufacturing overhead because their consumption is directly tied to production volume. Indirect materials are a common example, encompassing items like lubricants for machinery, cleaning supplies used in the factory, or small tools consumed as production runs.
Indirect labor costs can also be variable, such as overtime pay for production support staff or wages for temporary workers hired specifically for increased production runs. Utility costs, like electricity to power machinery, are another example, as higher production volumes mean greater electricity consumption. These costs are necessary for production but are not directly incorporated into the product itself, nor are they directly tied to the wages of workers assembling the product.
Distinguishing from Fixed Manufacturing Overhead
Understanding variable manufacturing overhead is enhanced by contrasting it with fixed manufacturing overhead, which behaves differently in relation to production volume. Fixed manufacturing overhead costs remain constant in total regardless of how many units are produced within a relevant range of activity. Examples include factory rent, straight-line depreciation of production equipment, and salaries of factory managers not directly involved in production.
While the total fixed overhead cost stays the same, the fixed cost per unit decreases as production volume increases because the total fixed cost is spread over more units. Conversely, if production volume drops, the fixed cost per unit rises. This is a key distinction from variable overhead, where the per-unit cost remains stable. Both types of overhead are crucial for determining the full cost of production, but their differing behaviors impact cost analysis and decision-making.
Role in Product Costing
Variable manufacturing overhead plays an important role in cost accounting, particularly in determining the total cost of manufactured goods. These costs, along with direct materials and direct labor, are considered inventoriable costs and are assigned to products. They are included in inventory value on the balance sheet until sold, then become part of the cost of goods sold on the income statement.
Accurately tracking and allocating these costs allows businesses to determine the true cost of each unit. This information is used for internal decision-making, such as setting selling prices, evaluating product line profitability, and making informed choices about production levels. The fundamental purpose is to ensure indirect production costs are properly accounted for in the finished product’s cost.