How does the planning of fixed overhead costs differ from the planning of variable overhead costs?
The correct answer and explanation is:
Correct Answer:
The planning of fixed overhead costs differs from variable overhead costs primarily in terms of cost behavior and flexibility in response to changes in activity levels.
Detailed Explanation (300 words):
Overhead costs refer to all indirect costs incurred in production that are not directly traceable to specific units of output. These are generally categorized into fixed overhead and variable overhead, and each type is planned differently.
Fixed Overhead Costs Planning:
Fixed overhead costs are costs that remain constant in total regardless of production volume within a relevant range. Examples include factory rent, salaries of permanent supervisors, insurance, and depreciation on equipment.
Planning fixed overheads involves:
- Long-term decision-making, often tied to strategic goals.
- Capacity planning, such as investment in buildings or machinery.
- Cost commitment, since fixed costs are contractual or structural (e.g., leases).
- These costs are inflexible in the short term, meaning they cannot be easily adjusted with changes in production levels.
- Fixed overhead is planned based on expected capacity and not based on units of production.
Variable Overhead Costs Planning:
Variable overhead costs fluctuate with production volume. Examples include indirect materials, indirect labor, utilities, and machine maintenance that increase with usage.
Planning variable overheads involves:
- Short-term or operational planning, based on expected production volumes.
- Close coordination with production schedules, as these costs vary per unit.
- Greater flexibility and control, since they can be scaled up or down as needed.
Key Differences:
| Aspect | Fixed Overhead | Variable Overhead |
|---|---|---|
| Behavior | Constant | Changes with output |
| Planning horizon | Long-term | Short-term |
| Flexibility | Low | High |
| Examples | Rent, salaries | Indirect materials, utilities |
In summary, fixed overhead planning focuses on structural capacity and long-term commitments, while variable overhead planning is tied closely to day-to-day production changes.