Variable OverheadDefined along with Examples

Written By:
Lisa Borga

Variable overhead measures the overhead expenses which a company faces that vary with business activity.

As production rises or falls, variable overhead costs will as well contrast with general overhead expenditures, which possess fixed budgets.

Variable overhead costs are an important factor in setting future product prices in order to avoid loss of profit margin and in analyzing past performance.

How Variable Overhead Works

Companies face three general categories of product costs, including direct materials, direct labor, and overhead.

This last category operates as a catch-all to include all other expenses outside of these other two categories, which companies with continuous operations must spend.

Some of the categories of overhead are fixed, which means that they will not generally change as production activity changes.

Some common examples of fixed overhead costs include rent for the production facility, salaries for administrators, and insurance.

Whereas others are variable, which means that they will vary as the production level changes.

This includes examples such as supplies for production equipment, commissions for sales staff, replacement parts for manufacturing equipment, and utility expenses for the production facility.

How Variable Overhead Affects Product Pricing

The cost of variable overhead must be accounted for when determining the cost of production.

This will allow a company to set minimum prices that will ensure a profit from sales and adjust pricing to reflect changes in production level.

For example, if demand for a manufacturing company’s product was to increase, and production was raised to compensate then the company’s energy expense would correspondingly increase.

This means that product pricing would need to reflect this increase in variable overhead; otherwise, this increase in demand could potentially result in a loss of profit.

Notably, an increase in production will typically result in an increase in variable overhead, but efficiency can increase with higher levels of production as well.

Further, some suppliers may provide greater discounts with larger orders of raw material, which in addition to greater efficiency can reduce the direct costs associated with production.

This means that though variable overhead may increase, a corresponding decrease in direct costs of production may offset the former.

If a company produced 15,000 units per production run for the cost of $2 per unit, the company could have a decrease in their direct costs to $1.50 if they increased their production to 45,000 units.

Then, should the manufacturer continue selling the units for the same price, the reduction in costs of $.50 per unit would create a savings of $7,500 per production run.

Therefore, in this situation, if the total increase in the company’s indirect costs remains below $7,500, the company will be able to keep its prices the same and increase its sales, as well as its profit margin.

Variable Overhead Example

As an example, a football manufacturer had total variable overhead costs of $45,000 when it produced 30,000 footballs for the month.

This would be $1.50 in variable overhead costs per football ($45,000/30,000).

However, if the company decides to increase its production of footballs to 35,000, the variable overhead costs would increase.

The variable overhead costs would be $52,500 ($1.50 x 35,000) for the month.

What is Overhead?

Overhead is the expenses and costs related to products that are not a direct part of the production.

This would be utilities, supplies, or rent that are necessary for production but not a direct part of the production process.

How Are Fixed and Variable Overhead Different?

Fixed overhead costs stay the same regardless of the number of goods the company produces.

Examples of this would be insurance or rent for the production facility, which would remain the same no matter how much the factory produces.

Whereas variable overhead will change based on the amount being produced. This would include electricity for the factory or the wages for the workers shipping the goods.

Are Salaries or Wages Considered Variable Overhead Costs?

This can vary.

Typical pay is considered an operating cost rather than an overhead cost.

But, companies do need to pay employees for extra or overtime hours when production is increased, which could be recorded as a variable cost.

Key Takeaways

• Variable Overhead Costs are the overhead costs that change based on production activity.
• As business activity rises or falls, the variable overhead will move likewise.
• Common types of variable overhead include electricity, supplies, and wages for shipping expenses.