Variable overhead is those manufacturing costs that vary roughly in relation to changes in production output. The concept is used to model the future expenditure levels of a business, as well as to determine the lowest possible price at which a product should be sold.
Examples of variable overhead are:
- Production supplies
- Equipment utilities
- Materials handling wages
For example, Kelvin Corporation produces 10,000 digital thermometers per month, and its total variable overhead is $20,000, or $2.00 per unit. Kelvin ramps up its production to 15,000 thermometers per month, and its variable overhead correspondingly rises to $30,000, resulting in the variable overhead remaining at $2.00 per unit.
Variable overhead tends to be small in relation to the amount of fixed overhead. Since it varies with production volume, an argument exists that variable overhead should be treated as a direct cost and included in the bill of materials for products.
Variable overhead is analyzed with two variances, which are:
- Variable overhead efficiency variance. This is the difference between the actual and budgeted hours worked, which are then applied to the standard variable overhead rate per hour.
- Variable overhead spending variance. This is the difference between the actual spending and the budgeted rate of spending on variable overhead.
The variable overhead concept can also be applied to the administrative side of a business. If so, it refers to those administrative costs that vary with the level of business activity. Since most administrative costs are considered to be fixed, the amount of administrative variable overhead is usually considered to be so small as to not be worth reporting separately.
Variable manufacturing overhead is a subset of variable overhead, because it only includes those variable overhead costs incurred in the manufacturing process.