Advantages of Fixed and Variable Overheads

Contents

Advantages of Classification of Overhead into Fixed and Variable

The necessity for die classification of into fixed and variable overhead arises from die following:

(1) Meaning of Ascertaining marginal cost

It presents the basis of marginal costing because the technique of marginal costing is totally dependent on Reaggregation of cost into fixed and variable.

(2) Preparation of flexible budget

This classification helps in the preparation of flexible budget. For instance, when flexible budgets are prepared for different levels of activity, the fixed cost remains constant at all levels of activity, whereas variable cost varies according to die actual level of output.

(3) Determination of production policy

As most of the problems of decision making relate to changes in volume, this classification acquires a special importance in determination of production policy.

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This is so because fixed and variable cost behave in different ways when volume of output change.

(4) Meaning of Absorption of overhead

By classifying cost into fixed and variable, separate rates of absorption of overhead may be used for fixed and variable overheads.

The under over absorption arising out of two types of overheads are different in nature and need different managerial action.

For example, under absorption of fixed overhead the existence of surplus or idle capacity so that suitable steps may be taken to effectively utilize idle capacity.

(5) What is Effective control

The classification of expenses into fixed and variable helps in controlling expenses. Fixed expenses are incurred by management decision and are incurs hence, it is more or less incontrollable.

Variable expenses vary with the volume of activity and the responsibility for incurring this expenditure is determined in relation to output.

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Difference Between Fixed Overhead and Variable Overhead

(1) Fixed overheads are incurred whether production is continued or would be closed whereas variable overheads incurred in case of production is continued.

(2) The incidence of fixed overhead on unit cost decreases as production increases and vice versa and total amount is remain same at all levels whereas variable overhead per unit is remain same and total amount is vary.

(3) Fixed overheads are related to time whereas variable are related to volume of output.

(4) Fixed overheads are usually indirect whereas variable overheads may be direct or indirect.

(5) Fixed overhead are fixed within specified limit relating to time and activity whereas variable overheads are not related to level of output.

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