Variable costing is a method that considers only variable manufacturing costs such as materials, labor, and overhead when determining the cost of goods sold. This approach calculates these costs to assess production expenses, enabling businesses to evaluate profitability based on variable costs.
Both absorption costing and variable costing are essential for businesses in determining product costs. To simplify the calculation process, HashMicro’s accounting software can be utilized. This system automates variable cost calculations, making it user-friendly for accountants while providing accurate, real time financial reports.
To thrive, a company must maximize profits and minimize losses. Production costs can be calculated using two approaches: total costs and variable costs. Below, we provide definitions, advantages, and examples of variable costs.
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What is Variable Costing?
Variable costing is an accounting approach that considers only variable production costs such as materials, labor, and overhead when calculating the cost of goods sold. By excluding fixed costs, this method helps businesses analyze how changes in production volume influence profitability.
Focusing solely on variable costing enables companies to make more precise decisions. It provides insights into how production levels impact profitability, aiding in pricing strategies and efficient production management.
Additionally, this method supports managers in making short-term decisions by highlighting the direct relationship between production and profit without accounting for fixed costs.
Types of Variable Costing
Variable costing is a cost accounting method that emphasizes expenses that fluctuate directly with changes in production or business activity levels. These costs play a vital role in guiding decision-making and shaping pricing strategies. The primary types of variable costs are outlined below:
- Direct materials refer to the raw materials directly used to make a product. Examples include wood for furniture, steel for cars, and fabric for clothing. These costs change based on the production volume and are essential for determining the cost of goods produced.
- Direct labor refers to the wages paid to workers who are directly involved in the manufacturing process. Examples include assembly line workers and machine operators. These costs vary depending on how much labor is needed to produce a certain number of units.
- Variable manufacturing overheads are costs that change with production levels but cannot be directly assigned to a specific product. Examples include utility bills for running machinery, maintenance supplies, and factory consumables. These overheads are necessary for supporting production activities.
- Variable selling costs are expenses that change depending on sales volume. Examples include sales commissions, shipping fees, and customer discounts. These costs directly affect the profitability of the products sold.
- Variable administrative costs include expenses related to administrative tasks that fluctuate with business operations. Examples are temporary staffing costs and travel expenses for business meetings. These costs can vary depending on the administrative support needed during different business cycles.
- Miscellaneous variable costs cover other costs that vary with production or sales but do not fall under the abovementioned categories. Examples include royalties based on units sold or the cost of packaging materials. These costs are usually specific to the situation but are still directly linked to activity levels.
Difference between Variable Cost and Average Variable Cost
Understanding the difference between variable cost and average variable Cost is important for businesses to manage their production expenses effectively. While both relate to costs that change with production volume, they are calculated and applied differently. The table below highlights the key differences between the two:
| Aspect | Variable Cost | Average Variable Cost (AVC) |
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Definition |
The total cost of production that changes with the volume of output. |
The cost per unit produced, is calculated by dividing the total variable costs by the number of units produced. |
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Calculation |
Sum of all variable costs like direct materials, labor, and overhead. |
Total variable costs divided by the number of units produced. |
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Application |
Helps determine total production cost based on the volume. |
Used to analyze cost per unit, which aids in pricing and profitability analysis. |
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Focus |
Reflects total changes in cost as production increases. |
Reflects the cost efficiency per unit of production. |
| Impact of Production Volume |
Increases with the increase in production volume. |
May decrease as production volume increases, due to economies of scale. |
This distinction helps businesses in making decisions related to pricing, cost management, and optimizing production efficiency. Variable costs track the total changes in production costs, while average variable cost focuses on the cost per unit, offering a clearer view of production efficiency.
Difference between Variable Cost and Fixed Cost
Understanding the difference between variable costs and fixed costs is essential for managing business expenses effectively. While both are crucial components of a company’s overall cost structure, they behave differently depending on changes in production levels. The table below outlines the key differences between the two:
| Aspect | Variable Cost | Fixed Cost |
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Definition |
Costs that change directly with the level of production or business activity. |
Costs that remain constant regardless of the production volume or business activity. |
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Example |
Direct materials, direct labor, variable overheads (e.g., utilities for production). |
Rent, salaries of permanent staff, insurance. |
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Behavior with Production |
Increases as production volume increases and decreases as production volume decreases. |
Remains the same regardless of the level of production. |
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Impact on Cost per Unit |
The cost per unit produced is affected as production volume changes. |
The cost per unit produced can decrease with higher production due to spreading fixed costs over more units. |
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Time Frame |
Short-term costs that vary with production levels. | Long-term costs that do not fluctuate with production changes. |
This distinction helps businesses understand how their costs behave under different levels of production and activity, enabling more effective pricing, budgeting, and financial planning. Variable costs are directly tied to production volume, while fixed costs remain unchanged over time.
Difference between Variable Costing and Absorption Costing
Both variable costing and absorption costing are methods used to calculate product costs, but they treat costs differently. Understanding the distinction between these two costing methods is essential for accurate financial analysis and decision making. The table below highlights the key differences between variable costing and absorption costing:
| Aspect | Variable Cost | Absorption Cost |
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Treatment of Fixed Costs |
Fixed costs are treated as period costs and are not included in the cost of goods sold. |
Fixed costs are included in the cost of goods sold, and assigned to each unit produced. |
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Cost Per Unit |
Only variable costs (materials, labor, variable overhead) are included in the cost per unit. |
Both variable and fixed costs are included in the cost per unit. |
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Impact on Profit |
Profits may vary depending on production volume, as fixed costs are not included in product cost. |
Profits are affected by both production volume and fixed costs, which are absorbed into product costs. |
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Usefulness for Decision Making |
More useful for short-term decision-making, pricing, and cost control. |
Better for external reporting and long-term financial analysis. |
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Income Statement Format |
Separate variable and fixed costs, which allows clear insight into cost behavior. |
The total cost of goods sold includes both fixed and variable costs, making it less transparent. |
This comparison helps businesses choose the appropriate costing method for their needs. While variable costing is more suited for internal decision-making and understanding cost behavior, absorption costing is commonly used for external financial reporting and meeting accounting standards.
Variable Costing Functions for Your Business
Variable costing assists management in making short term decisions by:
- Providing information on the contribution margin helps in planning profits through cost-volume-profit analysis and guides short-term policies.
- Making it easier to track operations, evaluate performance, and ensure accountability across departments by considering variable cost factors.
- Offering valuable insights to better control costs by focusing on variable expenses.
- Assisting in setting the right product pricing strategy to maximize profitability.
- Simplifying budget comparisons by focusing solely on relevant variable costs.
To better understand variable costs and how to simplify them, read our article on accounting software in Malaysia to learn how to automate calculations and enhance cost management.
Formula and Calculation of Variable Costs
To calculate variable costs, it’s important to focus on the costs that change in direct relation to the production level. The formula for calculating variable costs is:
Variable Costs = Direct Materials + Direct Labor + Variable Manufacturing Overhead
This formula helps businesses determine the total cost of producing goods based on the fluctuating expenses of materials, labor, and production overhead. For example, if a company’s production increases, the costs for direct materials and labor will rise accordingly, while fixed costs such as rent or salaried employees will remain unchanged.
Calculating these costs allows businesses to better understand how production volume affects overall costs, making it easier to manage expenses and set appropriate pricing strategies.
Example of Variable Costing
Here are two examples of variable costing to help you better understand what it is and how to calculate it.
Example 1:
Manufacturing of T-Shirts
Imagine a company in the Philippines that produces custom T-shirts. Here’s a breakdown of the costs to produce one T-shirt:
- Direct Materials: The cost of fabric and other materials for one T-shirt is MYR120.
- Direct Labor: The wages for workers involved in producing one T-shirt is MYR80.
- Variable Manufacturing Overhead: The cost of utilities and factory supplies used for one T-shirt is MYR30.
So, the total variable cost for one T-shirt would be:
MYR120 (Direct Materials) + MYR80 (Direct Labor) + MYR30 (Variable Manufacturing Overhead) = MYR230
This example highlights how variable costs change with the number of T-shirts produced, providing clear insights for pricing decisions and cost management.
Example 2:
Bakery Producing Cupcakes
Now, consider a bakery in the Philippines that specializes in making cupcakes. Here’s the breakdown of the variable costs for producing one batch of cupcakes:
- Direct Materials: The cost of flour, sugar, and other ingredients for one batch of cupcakes is MYR250.
- Direct Labor: The wages for workers to prepare and bake one batch is MYR200.
Variable Manufacturing Overhead: The electricity used for baking the cupcakes costs MYR50. - The total variable cost to produce one batch of cupcakes is:
MYR250 (Direct Materials) + MYR200 (Direct Labor) + MYR50 (Variable Manufacturing Overhead) = MYR500
This example demonstrates how variable costing helps the bakery understand the cost per batch and manage production costs more efficiently, especially as production volume increases.
Streamline Variable Cost Calculation with HashMicro Software
Tracking variable costs is essential for managing production effectively. Tools such as profit and loss vs budget and forecast, along with budget and realization comparisons, allow you to assess actual spending against your budget. With HashMicro, this becomes much easier, providing valuable insights to help increase your profits.
HashMicro’s accounting software offers more than basic tracking by providing comprehensive financial statements with budget comparisons. This allows you to keep track of revenue costs and maintain precise financial control. The automated reporting feature saves time and enables quicker, smarter decision-making, especially when integrated with reliable business budgeting software.
If you need to monitor variable costs across different branches or projects, HashMicro’s multi-level analysis makes it simple to compare costs effortlessly.
These features help streamline your cost management processes, driving improvements in your overall profitability. Request your free demo of HashMicro Accounting Software today and experience the difference!
Conclusion
Variable costing offers a clear view of production costs by focusing on expenses that fluctuate with production levels. By applying the variable costing formula, businesses can make well-informed decisions for short-term planning.
When comparing absorption costing to variable costing, the latter provides greater flexibility for internal management. For effective cost control, understanding the costing formula allows managers to assess special orders without overestimating costs.
By reviewing variable cost examples, businesses can predict how an increase in production will affect profitability, helping to avoid errors in decision making.
If these methods seem complicated, try HashMicro’s Accounting Software. It delivers accurate financial insights and streamlines tasks like bookkeeping and asset depreciation, thanks to its powerful financial reporting software.
HashMicro also includes additional valuable features. Try it now! Get your free demo today!
FAQ Variable Costing
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What is variable costing also called?
Variable costs are the cost that are incurred on variable factors, the supply of these factors can easily be changed in the short run, the quantities of variable inputs rise and fall with the level of output produced. Thus they are direct costs.
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Why use variable costing?
Variable costing provides businesses with useful data on their variable costs. This information can help you make daily decisions on capacity expansion and special orders. Having a detailed understanding of direct materials, direct labour, direct expense and variable overheads can help you make useful estimates.
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Is packaging a variable cost?
The packaging costs associated with a product would be a variable cost since the packaging costs would increase as sales increased. The raw materials used to make the product would also be variable costs since the cost of materials would rise and fall depending on the sales volume of the product.
