What is the Variable Cost? (Definition, Formula, and Example

Definition:

Variable Cost is the method that assumes the main cost of products is direct labor, direct material, and variable manufacturing overhead.

These costs are fixed in units and variable in total. In other words, it is the cost that is variably attributed to the cost of the product.

The variable Cost Concept is that not all fixed costs should be included in the costs of products. Fixed costs that include in the costs of products are those variably related to product only.

These costs are called Variable Manufacturing Overhead. Fixed Manufacturing Overhead which is not related to production, is excluded and treated as period cost.

Here is the main element of Variable Cost,

Variable Costing

Do you know why Fixed Manufacturing Overhead is excluded? The main idea is that this concept wants to make the cost of goods gold solely variable.

For example, if we want to know the cost per cloth unit, we could figure out the cost of three main elements. Those are materials used per cloth, the cost of workers spend in total to process and make cloth become finished goods.

And the final one is Others Direct Costs that could attribute directly to the cost of cloth.

We can also say that Variable Costing is the cost that depends mainly on the output or volume of productions that the company produces.

The high volume of output, a high amount of total Variable Cost. Yet, no matter how much the output of the company product, it does not affect the value of Variable Cost per unit. It affects only in total This cost is similar to direct cost.

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Formula:

Now let move the formula of variable cost, and we will explain the detail of each element in the formula,

Variable Cost Per Unit

Variable Cost Per Unit = Labor Cost Per Unit + Direct Material Per Unit + Direct Overhead per Unit

  • Labor Cost Per Unit here is the direct labor cost that directly attributes to each unit cost. The cost is usually fixed in the unit and according to the labor rate and level of expertise. Labor Cost Per Unit can be calculated by taking the number of hours to spend per product at the rate per hour. That simple right?
  • Direct Material here is also straightforward. Before knowing how much is the cost of direct material per unit, we need to know the type and amount of material used for that kind of product. Making sure that we take only material that directly use for making products. Now, we identify the type and amount of material to use in the product. We should also know the unit price of those materials, and then we could come up with the total direct material per unit.

Total Variable Cost

Basically, Total Variable Cos is calculated as follows,

Now, once we know Variable Cost Per Unit, we should know Total Variable Cost, right?

Total Variable Cos = Total Output * Variable Cost Per Unit

This formula is quite straight forward right?

Example:

For Example, ABC Company operates in cloths manufacturing for high-class people living in the modern city.

Based on data from the managerial accountant, the cost of cloth per unit is correctly calculated. And confirmed by the financial director of the company as follow:

  • Raw material per unit of cloth = $7
  • Labour cost per unit of cloth = $5
  • Fixed cost in total for the period = $500,000
  • Salary for Sales team for the period = $250,000
  • Another direct cost ( variable overhead) per unit $4
  • Total Productions = 500,000 unit of cloths
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Calculate the Variable Cost per unit and Total Variable Cost for the period?

Now, we have to pick up all of the Variable Costs per unit and then multiply it with the total cost of unit products during the period to calculate the total cost.

Here is the element of cost that is variably attributed to the unit of the cloth

  • Raw material per unit = $7
  • Labor cost per unit of cloth = $5
  • Other direct costs per unit =$4

Therefore, the Variable Cost per unit is $16 and total is 16 * 500,000 = USD 8,000,000