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Variable Cost

By Yuriy Smirnov Ph.D.

Definition

Managerial accounting classifies costs by fixed cost, variable cost, and mixed cost.

Variable cost changes in direct proportion to production output or business activity. In other words, the amount increases when production volume grows and declines when production volume shrinks. Variable cost is the opposite of fixed cost.

Common examples of variable cost:

Variable Cost Behavior

Per Unit Cost

The per unit amount of variable cost remains constant despite production volume fluctuations as shown in the graph below.

Variable cost per unit graph

Please note that many commodities (e.g., oil, gas, coal, metals, raw materials, food, beverages) are subject to considerable price fluctuations, so the cost of a unit in one batch can differ significantly from the cost in another one. In other words, the per unit amount of variable cost can change over time and even within the same accounting period.

Total Cost

The total amount of variable cost is in direct proportion to production volume.

Total variable cost graph

Example

Assume that it takes 200 lb. of direct materials at a price of $3.5 per lb. to produce 1 unit of finished product. At the same time, 8 hours of direct labor at an hourly direct labor rate $15 is needed. Thus, the variable cost per unit (VC) amounts to $820.

VC = 200 × $3.5 + 8 × $15 = $820

The total amount of variable cost will depend, however, on actual production volume. For example, if actual production volume is 2,000 units total, variable cost will amount to $1,640,000 (2,000 × $820), and at the production volume of 3,500 units, it will amount to $2,870,000 (3,500 × $820).

Cost-Volume-Profit Analysis

The classification of cost between fixed and variable is a part of cost-volume-profit or CVP analysis. First, the amount of variable cost is used to calculate contribution margin, and, second, it is used in break-even volume calculation.

As far as cost directly affects the operating income of a business, any managerial decision should take their behavior into account.