Final answer:
Companies often use activity-based costing or multiple drivers in preparing their overhead budgets, although unit-based drivers like direct labor hours are still common. Fixed overhead costs dispersed over a larger output result in a lower average fixed cost per unit, illustrating the concept of spreading the overhead.
Step-by-step explanation:
In preparing the overhead budget, many companies use activity-based costing or multiple drivers for a more accurate allocation of overhead costs. However, a unit-based driver such as direct labor hours or machine hours is still commonly used due to its simplicity. This approach ties overhead costs directly to a single measure of activity.
A common name for fixed cost is "overhead." When firms divide fixed cost by the quantity of output produced, the result is the average fixed cost. Assuming a fixed cost of $1,000, the average fixed cost curve would be a hyperbola, decreasing as output increases. This illustrates what "spreading the overhead" means: as production increases, the fixed cost per unit decreases.
Breaking down total costs into fixed cost, marginal cost, average total cost, and average variable cost provides valuable insights for the firm. For instance, it allows for better decision-making in terms of pricing and production levels by understanding the behavior of costs at different levels of output.