Variable vs. Fixed Costs in QAD’s Enterprise Applications (MFG/PRO)

Posted on: September 16, 2008 | By: SuperUser Account | QAD Financials

Standard Costs in QAD’s Software at a basic level has five cost elements. Direct costs for a manufactured item will include the rolled up material cost of components, the total value add of direct labor for its components and the direct labor costs associated with the top level item in the bill of material and finally any outside operational costs for the part. These direct costs populate the material, labor and subcontract elements respectively. This leaves the burden element and the overhead element. How should you approach formulation of the cost to these elements.

QAD defines Burden as “the total variable overhead cost for an item, based on burden rates for labor and/or machines”. What does this mean? A classical definition of variable overhead is the following:

Variable costs are expenses that change in proportion to the activity of a business. In other words, variable cost is the sum of marginal costs. It can also be considered normal costs. Along with fixed costs, variable costs make up the two components of total cost. Direct Costs, however, are costs that can be associated with a particular cost object. Not all variable costs are direct costs, however; for example, variable manufacturing overhead costs are variable costs that are not a direct costs, but indirect costs. Variable costs are sometimes called unit-level costs as they vary with the number of units produced.

Understanding your variable overhead cost requires you define your cost driver. If your cost driver is machine hours, your variable overhead cost may be the following:

Energy
Machine Maintenance
Engineering Support
Indirect Materials
Indirect Manufacturing labor

Once you have identified this cost pool, you need to define a per unit rate. This rate can be assigned in the appropriate work center in your database.

QAD Defines overhead as “The fixed overhead cost, if any, for an item. For purchased items, overhead can be assigned to cover the expense of purchase operations, which can then be recovered as fixed overhead on all purchased items based on a percentage of their cost. Overhead cost can be maintained for each item, or by assigning it as a percentage of other cost categories”. Classically defined

Fixed costs are business expenses that are not dependent on the level of production or sales. They tend to be time-related, such as salaries or rents being paid per month. This is in contrast to Variable costs, which are volume-related (and are paid per quantity.) In management accounting, fixed costs are defined as expenses that do not change in proportion to the activity of a business, within the relevant period or scale of production.

Understanding you cost pool for fixed overhead cost is less complex than defining your cost pool for variable overhead. Depreciation expense, rent and general plant utility costs are examples of costs that can be included in this pool. Understanding your cost driver for the allocation of this cost pool is more complex. You have three options. Apply fixed overhead rate to the Overhead element based on:

Material Cost
Labor Cost
Subcontract Cost

In later versions of QAD, you can use a combination of rates and costs drivers. You can further subcategorize your rates in QAD’s “Item Overhead Cost Update” (1.4.21) based on a product line range, item number range, item type range and also purchase versus manufactured codes. If these options are not appropriate, overhead costs to specific items can be manually assigned or automated via CIMload.
If you have any questions reqarding this blog, you can contact me via email at avitullo@logan-consulting.com.

Andy Vitullo
Principal, Logan Consulting

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