Final answer:
The overhead budget shows expected costs of production excluding direct materials and direct labor, mainly consisting of fixed costs or overhead. As more units are produced, the fixed costs are spread out, decreasing the average fixed cost per unit, demonstrating the concept of 'spreading the overhead'. The correct option is A.
Step-by-step explanation:
The overhead budget shows the expected costs of production except for direct materials and direct labor. This includes things like rent, utilities, management salaries, and other costs that do not change with the level of production.
These are known as fixed costs or overhead. An overhead budget may include fixed and variable overhead costs, but not the costs directly associated with creating a product such as raw materials (direct materials) and manufacturing labor (direct labor).
For example, if a company has a fixed cost (overhead) of $1,000, the average fixed cost curve will show a decline as the quantity of output increases. This is because the $1,000 is spread over more units of output. This concept of distributing the fixed costs over a larger number of units is referred to as spreading the overhead. Graphically, this would be shown as a hyperbola starting at $1,000 when production is zero and approaching zero as production volume increases.
As production increases, we add variable costs to fixed costs, and the total cost is the sum of the two. The total cost curve includes both fixed and variable costs and illustrates how total production costs change with the quantity of output produced.