
The necessity for classifying the overhead into fixed and variable arises for fixation of selling price, framing the budget, effective cost control, helps management decisions, marginal costing and break even charts, method of absorption of overheads. The distinction is helpful in determining the price policy of a concern. Sometimes, different prices are charged for the same article in different markets to meet varying degree of competition. However, the lowest selling price of an article is any market should at least cover prime cost plus variable overheads. The corresponding fixed overheads may or may not be recovered if it is not practical to do so. Such fixed overheads may be recovered from sales in more favorable markets. If the selling price in a market does not cover the variable overheads, it is better not to sell good in that market. Segregating the fixed overhead from the variable overhead will be helpful in framing the fixed budget for various levels of capacity utilization. The behavior of the cost will also forcefully brought out. Fixed expenses are incurred by management decision and as such can be controlled by the top management while variable expenses can be controlled by the lower level of management. By segregating these, the lower levels of management will know the types of expenditure which is with in their control. In management decision regarding the utilization of capacity , this segregation will be found useful. After all the concept of fixed or variable expenditure is in relation to a particular rate of output. For example, supervisory salary may have to be doubled, if a new shift is to be started. In such cases, the management has to see whether the production of the second shift will be able to bear such an increase in the cost of production. the technique of marginal costing, preparation of break- even charts and study of cost volume profit relationship, segregation of cost into fixed and variable is quite essential. Different methods may be adopted for determination of absorption rates for fixed and variable overheads. The fixed overheads rates serves as a measure of utilization of the facilities while the extent of idle capacity is indicated by under absorption.
In short the classification of costs into fixed and variable is not prefect as it is based on assumption that costs are influence only by volume is not true. But there are many other factors which influence cost of production specification, product mix, method of production, technology etc.
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