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Accounting Information > Cost Accounting > Variable Costs

Variable Costs

Variable Costs A variable cost is a cost that changes directly and in proportion with the volume of activity. Some examples of variable costs are direct materials, direct labor, payroll taxes, and sales commissions. Variable costs in total change based on activity, while the variable cost per unit stays the same regardless of the level of activity. When there is no activity, there is no variable cost. The equation expressing the relationship between activity and variable cost is Y = bX, where Y is total variable cost, X is the activity level, and b is the variable cost per unit of activity. For example, if 500 units are produced with a variable cost of $2 per unit, the total variable cost is $1,000. Certain variable costs are called controllable costs or manageable costs. They are called this because management can exercise some control over the amount of these costs, or they can determine whether or not the cost should be incurred. One example of a controllable cost is direct labor, since management can monitor and control their employees’ production efficiency. Not all variable costs are controllable by management. An example of a variable cost that is not controllable would be when a company has to pay a royalty to the government for every ton of coal or other mineral mined. As long as the company continues to mine, they will be required to pay the royalty. They have no control over this cost. Variable overhead costs are an important part of the manufacturing overhead budget. The manufacturing overhead budget estimates both fixed and variable costs. Variable overhead costs will rise or fall proportionately with the volume produced, while fixed overhead costs will not change based on production. Variable overhead costs are not able to be assigned directly to the production of a specific product, but they vary based on the level of production. Examples of some variable overhead costs are indirect labor and indirect materials. Variable costs are important in determining the contribution margin of a unit. The contribution margin is defined as the difference between revenue and variable costs. In absorption costing, all costs of production, including fixed and variable, direct and indirect, get assigned to the product. In contrast, when the contribution approach to costing is used, only the variable costs incurred in production get assigned to the product. Many people feel that the contribution approach can provide more useful information than the full or absorption costing approach. The contribution costing approach is more useful in evaluating potential changes in profits based on changing levels of production. Non-manufacturing variable costs related to selling or distributing products must also be considered. Some examples of these are sales commissions, shipping and freight costs, and the costs of processing sales orders. These non-manufacturing costs need to be deducted from the manufacturing contribution margin to arrive at the contribution margin. If you are looking for a CPA or Accounting Firm to assist you with your general accounting, cost accounting, income tax reporting, bookkeeping, or financial planning needs, then you have come to the right place! Use the CPA Search feature on this website to find a qualified professional in your area to meet all of your needs.

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