## Variable Costing Definition

Variable costing is one of approach which is used for the purpose of valuation of inventory or calculation of the cost of the product in the company where only the cost linked directly with the production of output are applied to the inventory cost or the cost of the production and other expenses are charged as expense in the income statement.

Variable cost is linked to the production of output and it is the per unit amount which is incurred as a single unit is being produced. It increases as the number of units of production increase initially as per the economies of scale.

### Examples of Variable Costs

- Direct Raw Material
- Direct labour cost
- Commissions
- Utility Costs
- Freight Expenses
- Variable manufacturing overhead

### Variable Costing Calculations

#### Example #1

Let’s us assume a company ABC who has received an order to produce 5,000 units at the total price of $2,500. The company wants to determine the cost which is associated with the production of 5000 units and also wants to know the gross profit which can be earned.

Given

- Annual Production of units – 200,000
- Raw material cost- $25,000
- Direct Labour Cost- $15,000

**Solution**

From the above information, we can easily calculate the per unit cost for the year of a single unit

- Raw material = 25,000/200,000 = 0.125
- Labour cost = 15,000/200,000 = 0.075

So, the Variable Cost associated with the production of 5,000 units can be calculated as follows,

= 5,000 * (0.125+0.075)

**= $1,000**

Therefore, gross profit can be calculated as

$2,500 – $1,000

**Gross Profit = $1,500**

#### Example #2

Let’s us assume a company ABC who has received an order to produce 7,000 units at the total price of $4,500. The company wants to determine the cost which is associated with the production of 1,000 units and also wants to know the gross profit which can be earned.

Given

- Annual Production of units – 250,000
- Raw material cost- $45,000
- Direct Labour Cost- $25,000

**Solution**

From the above information, we can easily calculate the per unit cost for the year of a single unit

- Raw material = 45,000/250,000 = 0.18
- Labour cost = 25,000/250,000 = 0.10

So the variable cost associated with the production of 5,000 units can be calculated as follows,

= 7,000 * (0.18+0.10)

**= $1,960**

Therefore, the Gross Profit can be calculated as,

= $2,500 – $1,960

**Gross Profit = $540**

#### Example #3

Let’s us assume a company ABC who has received an order to produce 5,500 units at the total price of $10,500. The company wants to determine the cost which is associated with the production of 5500 units and also wants to know the gross profit which can be earned.

Given

- Annual Production of units – 400,000
- Raw material cost- $85,000
- Direct Labour Cost- $65,000

**Solution**

From the above information, we can easily calculate the per unit cost for the year of a single unit

- Raw material = 85,000/400,000 = 0.2125
- Labour Cost= 65,000/400,000 = 0.1625

So the variable cost associated with the production of 5,500 units can be calculated as follows,

= 5,500 * (0.2125+0.1625)

**= $2,063**

Therefore, the Gross Profit can be calculated as,

= $10,500 – $2,063

**Gross Profit = $8,438**

#### Example #4

Let’s us assume a company ABC who has received an order to produce 9,000 units at the total price of $4,500. The company wants to determine the cost which is associated with the production of 9000 units and also wants to know the gross profit which can be earned.

Given

- Annual Production of units – 250,000
- Raw material cost- $35,000
- Direct Labour Cost- $30,000

**Solution**

From the above information, we can easily calculate the per unit cost for the year of a single unit

- Raw material = 35,000/250,000 = 0.14
- Direct Labour Cost = 30,000/250,000 = 0.12

So the variable cost associated with the production of 9,000 units can be calculated as follows,

= 9,000 * (0.14+0.12)

**= $2,340**

Therefore, the Gross Profit can be calculated as,

= $4,500 – $2,340

** Gross Profit = $2,160**

### Conclusion

Variable cost is a vital factor for the production business and it should be analysed carefully as we can see above that it has a direct impact on the production and the margins of the business. A company should do a complete analysis of its cost structure which in turn helps the business to improve efficiency.

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