Variable costing is a method that includes only variable manufacturing costs, such as materials, labor, and overhead, in the cost of goods sold. The formula calculates these costs to determine the cost of production, helping businesses evaluate profitability based on variable expenses.
Both absorption costing and variable costing help businesses calculate the cost of a product, which makes them important in business. To easily calculate using these methods, you can use HashMicro Accounting Software.
This system will automatically calculate variable cost, making it madali lang gamitin for accountants. It also gives accurate, real-time financial reports.
To succeed, a company must boost profits and reduce losses. There are two ways to calculate production costs: total costs and variable costs. Below, you’ll find definitions, strengths, and variable cost examples.
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What is Variable Costing?
Variable costing is an accounting method that includes only variable production costs like materials, labor, and overhead in the cost of goods sold. It helps businesses assess how changes in production volume affect profitability by excluding fixed costs from the calculation.
Variable costing helps businesses make more accurate decisions by focusing on variable costs and ignoring fixed costs. This approach allows companies to see how changes in production levels impact profitability and helps in setting prices or managing production efficiently. It also helping managers make short-term decisions by showing how production affects profit without including fixed costs.
Types of Variable Costing
Variable costing is a cost accounting method focusing on costs that vary directly with production or business activity levels. These costs are crucial for decision-making and pricing strategies. Below are the main types of variable costs:
- Direct Materials are the costs of raw materials that are directly used in producing a product. Examples include wood for furniture, steel for cars, and fabric for clothing. These costs fluctuate based on the production volume and are integral to calculating the cost of goods manufactured.
- Direct Labor refers to the wages of workers who are directly involved in the manufacturing process. Examples include assembly line workers and machine operators. These costs vary depending on the amount of labor required to produce a specific number of units.
- Variable Manufacturing Overheads are costs that vary with production levels but are not directly assignable to a specific product. Examples include utility costs for operating machinery, maintenance supplies, and factory consumables. These overheads are essential for supporting production activities.
- Variable Selling Costs are expenses that change based on the sales volume. Examples include sales commissions, shipping expenses, and promotional discounts offered to customers. These costs directly impact the profitability of products sold.
- Variable Administrative Costs include expenses related to administrative activities that vary with business operations. Examples are temporary staffing costs and travel expenses for sales meetings. These costs may fluctuate 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 into the categories mentioned above. Examples include royalties based on the number of units sold or the cost of packaging materials. These costs are often situation-specific but still directly tied to activity levels.
The Function of Variable Costing
Variable costing helps management make short-term decisions by:
- Letting them know the contribution margin to plan profits through cost-volume-profit analysis and guide short-term policies.
- Making it easier to monitor operations, assess performance, and ensure accountability across departments, considering variable cost factors.
- Providing insights to control costs effectively by focusing on variable expenses.
- Helping in determining the best product pricing strategy for higher profitability.
- Simplifying budget comparisons by focusing only on relevant variable cost.
For a better understanding of variable cost and how to simplify it, read our article on the accounting system to discover how to automate calculations and improve cost management.
Example of Variable Costing
Below, we provide two examples of variable costing, so that you can gain a clearer picture of what it is and how to calculate it.
Example 1:
This template is a tool designed to calculate and analyze variable costs for businesses. It provides a structured way to categorize and quantify costs that change with production or sales levels.
The template includes sections for various cost categories, such as direct materials, direct labor, manufacturing overheads, selling costs, administrative costs, and other miscellaneous expenses. For each category, it records the number of units produced or sold, the cost per unit, and the total cost.
Additionally, the summary section helps businesses understand their total variable costs, revenue, and contribution margin, offering a clear picture of their financial performance.
Example 2:
JDN, a phone case manufacturer, shared parts of its income statement for 2024. In 2024, the company produced 1,000,000 phone cases with total manufacturing costs of ₱33,700,000 (around ₱33.70 per phone case). Recently, they received a special order for 1,000,000 phone cases at a total cost of ₱22,500,000.
Although the company has enough production capacity, the manager hesitates to accept the special order because it is lower than the ₱33,700,000 manufacturing cost stated in their financial report. As the company’s cost accountant, the manager asks for your input on whether to accept the order.
It’s important to note that the ₱33,700,000 includes fixed costs like insurance, equipment, and utilities. Variable costing should be used to evaluate the special order.
Direct materials cost ₱8,325,000, direct labor is ₱4,162,500, and variable overhead is ₱4,440,000. Total variable costs amount to ₱16,927,500 for 1,000,000 units, which equals ₱16.93 per phone case.
To produce the special order of 1,000,000 cases, the total variable cost is ₱16,930,000. Thus, the contribution margin is ₱22,500,000 – ₱16,930,000 = ₱5,570,000.
The company should accept the special order based on the variable cost formula, as it will increase profits by ₱5,570,000.
The manager’s hesitation stemmed from mistakenly including fixed costs in the calculation. Since the company has enough capacity, there won’t be additional fixed costs for producing the extra 1,000,000 units. This shows how important variable cost is for decision-making.
Formula and Calculation of Variable Costs
The total variable cost is calculated by multiplying the quantity of output by the variable cost per unit:
Total Variable Cost = Total Quantity of Output x Variable Cost Per Unit of Output
Variable costing per unit can fluctuate based on the level of profit achieved. In most cases, these costs are determined by adding together the various types of variable costs described below.
Additionally, if variable cost is incurred in batches, they may need to be allocated proportionally across the products produced in that batch to ensure accurate cost distribution.
Variable Cost vs Average Variable Cost
Variable cost and average variable cost might seem similar, but they represent two distinct expense measures. Variable cost typically refers to the cost associated with producing a single product, whereas average variable cost examines production over time, comparing variable costs to the total output produced. The average variable cost is calculated as:
Average Variable Cost = Total Variable Costs / Total Output
Variable cost and average variable cost may differ due to factors such as price increases or discounts. For example, consider a long-term project. An employee’s hourly wages represent a variable cost, but if the employee was promoted last year, their current wages would increase the variable cost.
Meanwhile, the average variable cost would reflect an intermediate value between past and present wages. When plotted on a graph, average variable cost often forms a U-shaped curve. This makes it a valuable tool for companies to determine the most efficient production levels.
By analyzing average variable costs, businesses can identify the optimal point to maintain manufacturing or decide when it is more cost-effective to temporarily halt production or even close a facility in the short term.
Variable Cost vs Fixed Cost
Understanding the difference between variable cost and fixed cost is essential for managing a business effectively. Variable costing changes depending on the level of production or sales, such as raw materials, shipping fees, or direct labor.
In contrast, fixed costs remain constant regardless of output, such as rent, salaries, or insurance. While variable costs provide flexibility and directly impact the cost of each unit produced, fixed costs ensure stability in budgeting.
Balancing these two types of expenses allows businesses to optimize profitability and adapt to market changes.
Variable Costing vs Absorption Costing
Both absorption and variable costing have their respective advantages and drawbacks. Understanding these will help businesses make an informed choice for managing costs and improving decision-making.
| Variable Costing | Absorption Costing |
| Includes only variable costs (materials, labor, overhead). | Includes both variable costs and fixed costs (e.g., rent, salaries). |
| Shows how variable costs impact profits directly. | Fixed costs are not recognized until products are sold, affecting short-term profits. |
| Helps managers make quick decisions based on variable costs. | Provides a full view of all costs, supporting long-term production planning. |
| Useful for pricing special orders by focusing on variable cost. | This may lead to overpriced products if based on absorption cost (including fixed overhead). |
| Finished goods are undervalued as variable cost is included only. | Higher inventory value due to the inclusion of fixed overhead in product costs. |
| Not GAAP-compliant, so not suitable for external financial reporting. | Compliant with GAAP, suitable for external and tax reporting. |
By understanding these advantages and disadvantages, businesses can better choose the right costing method to optimize financial management and decision-making.
Automate Variable Cost Calculation with HashMicro
Tracking variable costing is crucial for managing production efficiently. Features like profit & loss vs budget & forecast and budget & realization help you compare actual spending with your budget. With HashMicro, this process becomes easier, giving you clear insights to boost your profits.
HashMicro’s Accounting Software goes beyond by providing financial statements with budget comparison, so you can stay on top of variable cost, ensuring accurate financial control. Its automated reporting saves time and helps you make smarter, faster decisions, especially when integrated with effective business budgeting software.
Need to track variable cost across branches or projects? HashMicro’s multi-level analysis lets you compare costs effortlessly. With these features, you’ll streamline cost management and boost your bottom line. Get your free demo of HashMicro Accounting Software today and see the difference!
Conclusion
In conclusion, variable costing provides a clear picture of production costs by focusing on expenses that change with production. Using the variable costing formula, businesses can make informed decisions for short-term planning. Comparing absorption and variable cost, the latter offers more flexibility for internal management.
For accurate cost control, understanding the costing formula helps managers evaluate special orders without overestimating expenses. By analyzing variable cost examples, businesses can predict how increased production impacts profitability, avoiding mistakes in decision-making.
If these methods seem complex, try HashMicro’s Accounting Software. It provides accurate financial analysis and reduces manual tasks like bookkeeping and asset depreciation. HashMicro also offers other useful features. Subukan mo na! Get your free demo today!
Frequently Asked Questions about Variable Costing
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How to use variable costing?
Variable cost is determined by adding direct labor cost, direct material cost, and variable manufacturing overhead, then dividing by the total units produced. The variable costing formula is: (Direct Labor Cost + Direct Raw Material Cost + Variable Manufacturing Overhead) ÷ Number of Units Produced.
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What is another name for variable costing?
Variable costs, also known as prime or direct costs, fluctuate based on production levels. In contrast, fixed costs are time-based and remain steady over a specific period, while variable costs adjust according to changes in output volume.
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What is the role of variable costing in decision making?
Variable costing helps in decision-making by setting targets for product sales or services. It allows us to calculate the company’s break-even point, which is essential for establishing sales goals.
