Factory Overhead Classification: Fixed vs Variable Overheads

Every factory cost number in this course rests on one prior decision: is this cost fixed, variable, or somewhere in between? The decision matters because fixed and variable costs behave differently when output changes, and a quotation that treats them as identical will be wrong in every month except the one in which it was made. A factory that classifies its costs honestly can explain its own prices, survive slow months, and negotiate with arithmetic. A factory that does not will discover its errors at month end, when the salary bill and the rent arrive regardless of what was quoted.

The definitions are simple. A fixed cost does not change with output in the short run. Rent is fixed: the landlord charges the same whether the factory makes 50,000 pieces or 150,000. Management salaries are fixed, depreciation is fixed, and loan interest is fixed. A variable cost moves with output. Direct wages move with pieces produced, piece-rate incentives move with pieces produced, and production-linked consumables such as needles, oil, and spare parts move with running hours. A semi-variable cost has both parts: electricity has a fixed standing charge plus a variable consumption charge, and maintenance has a fixed contract plus usage-linked spares.

The test for any cost head is one question: would this cost change if output halved next month? If the answer is no, the head is fixed. If it changes proportionally, it is variable. If it changes a little, it is semi-variable and must be split. Three months of ledger data usually answer the question without argument, because real costs reveal their behaviour quickly when output swings.

All figures in this example are illustrative and use the same factory and the same monthly total as the CPM lesson, so the two lessons reconcile. Shams Apparels closed the month with a total factory operating expense of BDT 12,480,000. The fixed heads are rent BDT 1,200,000, management salaries BDT 1,500,000, depreciation BDT 600,000, loan interest BDT 480,000, and fixed service contracts BDT 1,500,000. Added together they equal BDT 5,280,000. The variable heads are direct wages BDT 5,400,000, the variable portion of electricity BDT 900,000, consumables BDT 600,000, and piece-rate incentives BDT 300,000. Added together they equal BDT 7,200,000. The two subtotals add to BDT 12,480,000, which matches the ledger exactly. That reconciliation is not bookkeeping pedantry; it is the proof that no cost was lost, double-counted, or hidden between heads.

Now convert the split into CPM figures. At 80 percent target efficiency the factory's produced minutes are 4,992,000. Fixed CPM is BDT 5,280,000 divided by 4,992,000, which is BDT 1.06 per minute. Variable CPM is BDT 7,200,000 divided by 4,992,000, which is BDT 1.44 per minute. Added together they equal BDT 2.50 per minute, which matches the quotation CPM from the CPM lesson. The match is exact because both figures share the same denominator, and that shared denominator is the whole point: fixed and variable CPM figures may only be added when they are measured over the same minutes.

A common error is worth naming explicitly. If fixed CPM is computed over available minutes (6,240,000) it comes to BDT 0.85 per minute, and adding that to variable CPM over produced minutes (BDT 1.44) gives BDT 2.29, which matches nothing and understates true CPM by BDT 0.21 per minute. On a shirt with an 18-minute SMV that error alone is BDT 3.78 per piece. Whenever a split CPM total does not reconcile to the single CPM computed from the whole ledger, the denominators differ, and the split must be rebuilt.

Fixed cost per piece is where classification turns into commercial power. The fixed total does not change with volume, so the fixed cost per piece is simply the fixed total divided by pieces produced. At 80,000 pieces per month, BDT 5,280,000 of fixed cost is BDT 66.00 per piece. At 100,000 pieces it is BDT 52.80 per piece. At 120,000 pieces it is BDT 44.00 per piece. The same factory, the same costs, and a BDT 22.00 per piece difference driven entirely by volume.

Variable cost per piece behaves differently. A T-shirt with an SMV of 4.50 minutes at a variable CPM of BDT 1.44 per minute carries variable cost of 4.50 times 1.44, which is BDT 6.48 per piece, and that figure barely moves with volume as long as wage rates and consumption rates are stable. So total labour cost per piece falls with volume almost entirely because fixed cost spreads thinner, and that is the honest explanation a factory can give a buyer who asks why a 5,000-piece order costs more per piece than a 50,000-piece order.

The factory example in this lesson shows what happens when the split is ignored. A Gazipur factory entered a slow season at half its normal volume but kept quoting at the busy-season fixed cost per piece. It accepted two orders believing the margin was intact, and discovered at month end that fixed cost per piece had doubled, wiping out the margin on both orders. The fix was a monthly volume table showing fixed cost per piece at low, planned, and high volumes, published beside the CPM sheet. Quotations for slow months were repriced, the factory began declining orders that could not cover fixed plus variable cost, and the volume table became its best negotiation tool because buyers accept arithmetic they can verify.

Electricity is the classic semi-variable cost, and it deserves careful treatment because it is large enough to distort CPM if mishandled. The standing charge, the contracted minimum, and the fixed service element belong in the fixed head. Consumption above the minimum, metered in kilowatt-hours and clearly tracking running hours, belongs in the variable head. The split comes from the electricity bill itself, which separates fixed charges from consumption charges, supplemented by meter readings when the bill is ambiguous.

Maintenance follows the same pattern. A fixed annual maintenance contract, spread monthly, is fixed. Spare parts consumed in proportion to running hours are variable. The practical rule is to split by invoice type: contract invoices go to fixed, consumption invoices go to variable, and any invoice that mixes both is split by its line items. What must never happen is splitting by feel, because a guessed split moves with the guesser's mood and destroys the comparability of CPM across months.

Reclassification between months is legitimate when the underlying arrangement genuinely changes. A supervisor moved from a monthly contract to daily casual engagement changes from fixed to variable in substance, and the books should follow. But every reclassification must be documented with its reason, because an unexplained reclassification makes CPM movements unreadable. The monthly CPM review meeting is the right place to record these decisions in one line each.

The monthly overhead routine has six steps. List every expense head from the ledger. Apply the output test to each head. Split semi-variable heads from observed data. Reconcile fixed plus variable to the ledger total to the taka. Compute split CPM figures on one shared denominator. Publish the volume table beside the CPM sheet. The whole routine takes an afternoon for a mid-size factory, and it prevents the slow, silent margin erosion that kills factories that only look at their costs when a crisis arrives.

Before the split is published, run five checks. First, fixed plus variable equals the ledger total exactly. Second, both CPM figures share the produced-minutes denominator. Third, no salary head sits in variable cost unless it genuinely varies with output. Fourth, depreciation is present in fixed cost. Fifth, every reclassification from last month carries a written reason. A split that passes these checks is a safe basis for quotation, for break-even analysis, and for every volume conversation with a buyer.