Overview Of Variable Costing
Variable costing is widely used for production expenses that change in proportion to production output. It increases or decreases as per the company’s production volume. They rise with increases in production and fall with a decrease in production. All variable costs are included during the period.
Variable Costing Example
The total expenses incurred by any business consist of fixed costs and variable costs. Variable costing also is known as direct costing is an accounting method for the allocation of production costs to products being produced for a tenure.
For Example
PQR is a clothing manufacturer company, the variable costs would be the cost of the direct material for cloth and direct labor. The amount of these two for each garment increases in direct proportion to the number of garments produced. The cost “varies” as per production.
Basics of Variable Cost
- Variable costs are dependent on production output. Variable costs are directly related to production volume.
- Total variable cost is the total of cost which is not fixed cost incurred for the total quantity of output expressed as:
- A company with a large number of variable costs is more consistent and hence are more predictable for a greater profit than a company with fewer variable costs. On the other hand, a company with less variable costs may magnify potential profits and losses because overall revenue increases or decreases are applied for a constant cost level.
Illustrative Example of Variable Costing
The following are examples of variable costing in order to understand the concept in a better manner:
Example 1
XYZ is an American company with a 1000 iPod order for a price of $1000. Let’s assume
Annual ipod Produced: 10000
Costs of Raw Materials: $10,00
Direct Labour Costs: $50,000
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Here, we can see that raw materials and labor costs are variable in nature. If the production of an iPod is to be increased or decreased raw materials and labor cost is to be increased and decreased respectively.
Example 2
ABC is another American bakery. Let’s assume the variable cost incurred for a cake is $17.
For ingredients(raw materials) like sugar, flour, and milk, the cost incurred is $5
For direct labor, the cost incurred is $11.
The variable costs will increase if the production output increases and decreases with a decrease in output. The variable cost will be zero if there is no production.
Some More Examples of Variable Costs
Some more examples of variable costs are given and discussed here:
Direct Material
Raw materials are the most common and pure variable cost that goes into production. Let’s assume that a bakery uses one pound of flour at a cost of $0.50 per pound for every biscuit pack. The total variable cost of flour will be $0 if no biscuit is produced. If one packet produced the variable cost will be $0.50. When 10 packets are produced, the cost will be $5.00.
Rate Labour
Piece rate labor is yet another common example of variable cost. It is the amount paid to workers for every unit completed. It is different from direct labor as direct labor is a fixed cost. Since, in Piece work, a worker is paid a fixed piece rate for each unit he produces regardless of time, it is a variable cost.
Production Supplies
Supplies like machinery oil are consumed as per the amount of machinery usage, that is why these costs vary with production volume. Plant upkeep supplies like lubricants, gaskets, repair tools, etc. It depends on the number of units produced, therefore they are variable costs.
Freight Out
Freight out can be considered a variable cost A business incurs a shipping cost only when it sells and ships out a product. It includes many costs like packing cost, palletizing cost, the cost required for documentation and loading-unloading charges or cost, carriage costs, and marine insurance cost, and all these costs fall under this category and varies with the volume of goods. Majorly, the cost incurred by the company in moving goods from one place to other comes under this category.
Commissions Paid
Commissions paid are one of the common variable costs as it is paid to Salespeople if they sell products or services. For instance, a sales commission on every sale for a company is $5. The total sales commission will be $0 when the company has no sales. The sales commission paid will be $5,000 if the sales are $100,000. Likewise, if sales are $200,000, commissions will be $10,000, and so on.
Billable Staff Wages
It is a variable cost if a company pays the employee as per the time of their working and in this way, those employees are only paid according to their billable hours. They are different from salaries as salaries are fixed costs. Billable staff Wages are the cost incurred by companies to pay hourly employees. Such wage expenses vary from one period to another depending on the number of business days in the period and the amount of overtime to be paid. Again business days vary from month to month and may be affected by holidays.
Credit Card Fees
Such credit card fees are charged to a business if the business enters into a credit purchase with customers. Borrowing money always comes with a cost. Credit card fee cost varies based on the credit card and way of using the credit facility.
Conclusion
- While determining the price for goods and services, variable costing can be problematic. This is because the variable cost does not include all the costs directly that a company has to incur to reach a gain position. However, on the other hand, it becomes easy to compare the possible profitability of manufacturing one product over another with the assessment of the variable costs involved. So it is beneficial in terms of trade-offs.
- Cost-volume-profit analysis can also be done if the variable cost is taken into consideration. With the help of this analysis, the break-even point can be reached and it can be calculated as to how many products a company must produce and sell. The percentage of variable cost must be higher than the fixed cost as in this scenario, the chances of break-even point are more. It must be monitored from time to time.
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