Variable Overhead

Variable Overhead

Variable overhead are manufacturing and operating costs that change in direct proportion to production output. Unlike fixed overhead (rent, insurance, salaried managers), variable overhead rises when production increases and falls when production decreases. Examples include production supplies, utilities for equipment, and wages or overtime for production and shipping staff.

Key points

• Variable overhead fluctuates with activity level; fixed overhead does not.
• It must be included in unit-cost calculations and pricing decisions.
• If production stops entirely, variable overhead typically falls to zero while fixed overhead remains.

Common examples

• Production supplies (packaging, consumables)
• Utilities to run machinery (electricity, gas, water)
• Hourly wages, overtime, or temporary labor tied to production volume
• Sales commissions tied to units sold
• Materials and routine equipment maintenance related to production

How it affects pricing and profitability

Manufacturers include variable overhead in the total cost per unit to determine minimum profitable prices. As output rises, unit costs can fall due to efficiencies and bulk discounts on materials, but total variable overhead usually increases.

Example:
* A factory producing 10,000 units incurs $20,000 in total variable overhead → $2.00 per unit.
* Producing 15,000 units at the same $2 per unit → $30,000 total variable overhead.

Another scenario:
* Direct cost per unit falls from $1.00 to $0.75 when output increases from 10,000 to 30,000 units. The $0.25 saving per unit yields $2,500 in savings per production run (0.25 × 10,000). If the increased indirect costs (utilities, extra labor) are less than $2,500, profit margins improve even at the same selling price.

Basic calculation

Variable overhead per unit = Total variable overhead / Number of units produced

Common questions

Q: Are salaries or wages considered variable overhead?
A: It depends. Regular salaried staff are usually fixed overhead. Pay that rises with production—overtime, temporary labor, or piece-rate pay—is treated as variable overhead.

Q: What is the main difference between fixed and variable overhead?
A: Fixed overhead remains constant regardless of production level (e.g., rent). Variable overhead changes with production volume (e.g., electricity for machinery).

Takeaway

Accurately identifying and tracking variable overhead helps firms set prices, plan capacity, and evaluate profitability as production levels change. Include these costs in per-unit calculations and reassess as output and input prices fluctuate.