Variable Manufacturing Overhead

Definition

Variable manufacturing overhead refers to the indirect production costs that fluctuate in proportion to changes in the level of production activity. These costs vary with the volume of goods produced and include items such as indirect materials, indirect labor, and variable factory utilities.

5 Must Know Facts For Your Next Test

1. Variable manufacturing overhead is a key component in calculating a product's unit cost under absorption costing.
2. Increases in production volume will lead to a proportional increase in variable manufacturing overhead costs.
3. Accurate estimation of variable manufacturing overhead is crucial for determining a product's break-even point.
4. Managers can use variable manufacturing overhead information to evaluate make-or-buy decisions for components.
5. Separating variable and fixed manufacturing overhead costs is important for analyzing the impact of changes in production levels.

Review Questions

• Explain how variable manufacturing overhead is used in the calculation of a break-even point in units and dollars.
  • Variable manufacturing overhead is a crucial element in calculating a product's break-even point, which is the level of sales (in units or dollars) required to cover all fixed costs, resulting in neither profit nor loss. To determine the break-even point, the total fixed costs are divided by the contribution margin per unit, which is the selling price per unit minus the variable costs per unit (including variable manufacturing overhead). Accurately estimating variable manufacturing overhead is essential for accurately calculating the contribution margin and, consequently, the break-even point.
• Compare and contrast the role of variable manufacturing overhead in variable costing and absorption costing.
  • Under variable costing, only variable manufacturing overhead is included in the unit cost of a product, while fixed manufacturing overhead is treated as a period cost. In contrast, absorption costing includes both variable and fixed manufacturing overhead in the unit cost of a product. The inclusion of fixed manufacturing overhead in absorption costing results in a higher unit cost compared to variable costing. This difference in product costing methods can impact the evaluation of inventory, cost of goods sold, and profitability, particularly when production levels fluctuate.
• Evaluate how variable manufacturing overhead information can be used to determine whether to make or buy a component.
  • When making a make-or-buy decision for a component, managers must consider the variable manufacturing overhead costs associated with producing the component in-house. If the variable manufacturing overhead costs of producing the component internally are lower than the purchase price of the component from an external supplier, it may be more economical to make the component rather than buy it. Conversely, if the variable manufacturing overhead costs of in-house production are higher than the purchase price, it may be more advantageous to buy the component. Careful analysis of variable manufacturing overhead is crucial in evaluating the relative costs of make-or-buy options and ensuring the most efficient use of resources.

Related terms

Fixed Manufacturing Overhead: Fixed manufacturing overhead are indirect production costs that remain constant regardless of changes in the production volume, such as rent, property taxes, and depreciation on production equipment.

Absorption Costing: Absorption costing is a method of product costing that includes both variable and fixed manufacturing overhead costs in the unit cost of a product.

Break-Even Analysis: Break-even analysis is a technique used to determine the level of sales (in units or dollars) required to cover all fixed costs, where there is no profit or loss.