What is a variable cost?

Dec 22, 2014

What is a variable cost? That seems like such a simple question, and I am sure many of you reading this right now are thinking really. Of course a variable cost is simply a cost that increases as production increases and decreases as production decreases. I’m sure many of you are thinking this time of year my patience and available time are pretty variable too! I know I sure wish there were more hours in a day right now with all the holiday preparations yet to be done!

var vs fixedA fixed cost is a cost that does not change regardless as to the level of production. Fixed costs are things like rent and insurance. Even if you only produce one widget you will still have to pay the same amount in rent and insurance, as well as several other items. However; fixed is only within a relevant range. Most likely over a certain period of time the rent you are paying will increase, or the insurance premiums will increase. Notice I did not say decrease-I’m not living in a dream world! If you have a three year lease, then your rent is fixed within those three years. Outside if that time it would not be, as it will most likely change, or vary.

Some people argue that all costs are variable-it just depends on the time-frame, because in the long-run all costs vary. Although that may be true, it is vital to classify costs correctly as fixed or variable. If you classify a variable cost as fixed, depending on your level of production you will have either over or under accounted for that cost, this can be catastrophic. Some costs are more difficult to classify, such as, supervisor costs. You may have to add another shift, which would add another supervisor that you had not expected. If you were just looking at this supervisor cost as fixed you will most certainly under recover this cost.

Direct, or variable costs, are directly related to production. These are things like material and production labor. These costs will in theory, only be incurred if production occurs. The recovery of those costs are directly related to their production. Fixed costs have to be recovered over production regardless as to how much or how little you produce.

There are statistical techniques, like regression, available to determine how dependent a cost is on production to determine if it is variable or not. These techniques can be quite helpful especially if you are unsure as to the classification of a cost. In the end the answer to what is a variable cost is not always black and white, but is very important.

Categories: Cost Accounting