So you’ve just about attended the third lecture of your commerce major and the professor has already moved on to cost and revenue concepts no sooner than he has wrapped up the various economic theories (which are approximately ten, to be precise, if you are concentrating just on the major theories!). Whew! That’s fast – even for a commerce graduate like me! But then, with each progressing year, the speed of education is gaining added momentum and what used to be taught in two semesters to the previous batches are being covered in just one semester these days! So, if your professor has given you an assignment on aggregate variable cost the same day as he took whirlwind session on it, you’ve come to the right place, dear budding scholar! Let’s get into the details of total variable costs preceded by a short summary on total cost, just for the sake of recollecting the basic premises of cost.
What is Total Cost?
Total cost of production, in terms of economics, refers to the sum total of all economic costs incurred in manufacturing a product. This includes all fixed costs (costs such as rent, electricity bills, utility bills, etc. that have no bearings on and cannot be directly allocated to the production process) that must be incurred irrespective of the volume and quantity of production, variable costs (expenses such as cost of raw materials, spare parts, labor cost, etc. which are incurred for the sole purpose of production and can be directly allocated to the production process) and opportunity cost (cost of the next best alternative that was given up in favor of the chosen alternative).
In terms of cost accounting, total cost refers to the sum total of fixed and variable costs that are classified under the major elements of cost such as Material, Labor and various Overhead costs. The profit or loss figure is arrived at by calculating the difference between total costs and total sales revenue. A cost sheet is prepared to record such costs and arrive at the profit or loss figure (as the case might be).
What is Total Variable Cost?
The TVC is the sum total of all those costs that change in direct proportion to the change in the quantity or volume of production. Such costs include cost of raw materials, labor cost, cost of operations, variable overheads, packaging, etc. An increase in the volume of production results in an increase in variable costs and vice versa.
How to Calculate Total Variable Cost
There are two ways in which you can calculate TVC. The most elementary way is to add up all variable costs. The other way is to use the following formula:-
Total Variable Cost = Total Units of Outputs * Variable Cost Per Unit
You can use this formula to calculate TVC only if you have the figure for variable cost per unit. However, to calculate variable cost per unit, you can add up all the variable costs together and use that sum in the following formula:-
Total Variable Cost Per Unit = Total Variable Cost/Total Units of Output
What is a TVC Curve?
A TVC curve is the graphical representation of the relationship between total variable costs and total outputs of the manufacturing plant for a given period of time. Plotting Variable cost values on the Y-axis and Output Quantity on the X-axis, we can show the marginal returns over a given period of time. In the short run, the curve rises steeply showing increased rate of marginal returns on investment. As it progresses, the steepness of the slope of the curve decreases, tending towards a flatter rise. This denotes a decreasing rate of return on each additional unit of output.
TVC Calculation: An Illustration
ABC Pvt. Ltd. got an order for 3000 tire tubes to be delivered to J&B Tires Ltd. The various direct/ variable costs involved in producing 3000 tire tubes is as follows:-
- Raw material – $1000
- Labor – $800
- Raw Materials Carriage Cost – $180
Therefore, total variable cost = Raw Material Cost + Labor Cost + Carriage Cost = $1000 + $800 + $180 = $1,980.
If you wish to find out the variable cost per unit of output, you can calculate it as follows:-
Variable Cost Per Unit = Total Variable Cost/ Number of units of tire tube = 1, 980/3000 = 0.66.
Now, if you wish to calculate the TVC using the formula Total Variable Cost = Total Units of Outputs * Variable Cost Per Unit, you can do it as follows:-
3000 * 0.66 = 1,980 = Total variable cost as we had previously calculated by adding up all the direct costs.
Hope that helped you get your concepts clear on TVC. This brief tutorial would also help you draw up production or job cost sheets for calculating total production costs and determining selling price by calculating profit as a percentage of cost of production or sales. Well, all that is part of advanced cost accounting and I won’t confuse you with the details right now. Wish you all the best for that oncoming assignment!