Updated June 8, 2023
Definition of Variable Costing
Variable costing is widely used for production expenses that change proportionally to production output. It increases or decreases as per the company’s production volume. They rise with increases in production and fall with a decrease in production. All variable costs are included during the period. In this topic, we are going to learn about Variable Costing examples.
Variable Costing Example
Any business’s total expenses consist of fixed and variable costs. Variable or direct costing is an accounting method for allocating production costs to products being produced for a tenure.
For Example
PQR is a clothing manufacturer company; the variable costs would be the cost of the direct material for cloth and direct labor. The amount of these two for each garment increases directly to the number of garments produced. The cost “varies” as per production.
Basics of Variable Cost
- Variable costs are dependent on production output. Variable costs are directly related to production volume.
- Total variable cost is the total cost, which is not fixed cost incurred for the total quantity of output expressed as:
Total Variable Cost = Total Quantity * Variable cost per unit
- A company with many variable costs is more consistent and predictable for a greater profit than a company with fewer variable costs. A company with fewer variable costs can amplify potential profits and losses since changes in overall revenue directly impact the company’s profit or loss at a constant cost level.
Illustrative Example of Variable Costing
The following are examples of variable costing to understand the concept in a better manner:
Example 1
XYZ is an American company with a 1000 iPod order for a price of $1000. Let’s assume
Annual ipod Produced: 10000
Costs of Raw Materials: $10,00
Direct Labour Costs: $50,000
Here, we can see that raw materials and labor costs are variable in nature. If the production of an iPod is to be increased or decreased, raw materials and labor cost is to be increased and decreased, respectively.
Example 2
ABC is another American bakery. Let’s assume the variable cost incurred for a cake is $17.
For ingredients(raw materials) like sugar, flour, and milk, the cost incurred is $5
For direct labor, the cost incurred is $11.
The variable costs will increase if the production output increases and decreases with a decrease in output. The variable cost will be zero if there is no production.
Some More Examples of Variable Costs
Some more examples of variable costs are given and discussed here:
Direct Material
Raw materials are the most common and pure variable cost in production. Let’s assume that a bakery uses one pound of flour for $0.50 per pound for every biscuit pack. The total variable cost of flour will be $0 if no biscuit is produced. If one packet is produced, the variable cost will be $0.50. When 10 packets are produced, the cost will be $5.00.
Rate Labour
Piece rate labor is another common example of a variable cost, as workers are paid a specific amount for every unit they complete. This payment method differs from direct labor, which is a fixed cost. In piece work, workers receive a fixed piece rate for each unit they produce, irrespective of the time taken.
Production Supplies
Supplies like machinery oil are consumed per the amount of machinery usage; that’s why they vary depending on production volume. Plant upkeep supplies like lubricants, gaskets, repair tools, etc.
Freight Out
Freight out can be considered a variable cost. A business incurs a shipping cost only when it sells and ships out a product. It includes many costs like packing costs, palletizing costs, the cost required for documentation and loading-unloading charges or cost, carriage costs, and marine insurance costs. All these costs fall under this category and vary with the volume of goods. Majorly, the cost incurred by the company in moving goods from one place to another comes under this category.
Commissions Paid
Commissions paid to salespeople are a common example of a variable cost, as they are paid when they sell products or services. For instance, a sales commission on every sale for a company is $5. The total sales commission will be $0 when the company has no sales. The sales commission will be $5,000 if the sales are $100,000. Likewise, if sales are $200,000, commissions will be $10,000, and so on.
Billable Staff Wages
Paying employees based on their work hours is a variable cost because it depends on their billable hours. This cost differs from fixed salaries. Billable staff wages represent the expenses incurred by companies to compensate hourly employees. The wage expenses vary across different periods based on the number of business days and the overtime that needs to be paid. Again business days differ from month to month and may be affected by holidays.
Credit Card Fees
Such credit card fees are charged to a business if the business enters into a credit purchase with customers. Borrowing money always comes with a cost. Credit card fee cost varies based on the credit card and way of using the credit facility.
Conclusion – Variable Costing Example
- While determining the price for goods and services, variable costing can be problematic. This is because the variable cost does not directly include all the costs a company has to incur to achieve a profitable position. However, on the other hand, it becomes easy to compare the possible profitability of manufacturing one product over another by assessing the variable costs involved. So it is beneficial in terms of trade-offs.
- The company can use cost-volume-profit analysis to determine the break-even point by considering the variable cost. This analysis enables them to calculate the number of products that must be produced and sold. The percentage of variable cost must be higher than the fixed cost as in this scenario, the chances of break-even point are more. It must be monitored from time to time.
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