Variable production overhead

Dear Dace
Many students find variable production overhead to understand.

As part of level 3 costs and revenues they learn that indirect costs are called overheads. That is fine and the typical definition of indirect is that it is not part of the individual product. After all, direct means " can be attributed to specific" products.
At level 3 they also learn about cost behaviour. Some costs vary as production changes, others are fixed.
Sometimes a misleading assumption then creeps in. Some students think variable means the same as direct and that fixed means overhead.
I have tried to overcome this on several occasions. I hope this works for you.

Think of direct/overhead cost as something you can identify by looking at the finished product. A chair made in overtime will typically have the same direct cost as another chair made in normal time, but the staff cost would be higher. The extra staff cost would be the premium paid for hours worked in overtime and charged to the production overhead account. So classify direct/overhead by looking at the finished product and work back to the costs of making it.

Variable and fixed costs start with the cost itself. Variable means that the total of a variable cost changes depending on the units produced. Look at staff cost again. The chair we looked at above may be made by staff who are paid a salary, a weekly wage or by the hour. Staff who are not paid per unit produced are a fixed cost. Their wages change depending on hours worked, not units produced. Staff paid on the basis of the number of chairs produced are a different matter, that would be a cost that varies with production. To be honest the majority of staff costs are fixed, but near where I am based in West Sussex tomato and pepper pickers are paid per kg so they would be an exception. So classify variable and fixed costs by looking at the cost first and work on from there to the product being produced.

Sorry this is so long, but variable overhead is an area a lot of students have struggled to understand in the past.

Sandy
sandy@sandyhood.com

How do you calculate the variable production overhead?

Within the accounting procedures, identify all the overheads which vary with the number of units produced. Either list them by expense type or combine them as a single value. In a budget the variable production overhead would be the total variable overhead cost per unit multiplied by the budgeted production volume.

At the end of the accounting period, take the total variable production overhead cost incurred from the accounting system.
The difference between the variable overhead cost per unit x the number of units produced and the total incurred is a variance useful for budgetary control. It can then be broken down (assuming it is absorbed on labour/machine hours) into two sub variances: efficiency and expenditure.

Sandy
sandy@sandyhood.com

www.sandyhood.com