Fixed cost
From Wikipedia, the free encyclopedia
Decomposing Total Costs as Fixed Costs plusVariable Costs. Along with variable costs, fixed costs make up one of the two components oftotal cost: total cost is equal to fixed costs plus variable costs.
In economics, fixed costs are business expenses that are not dependent on the level of goods or services produced by the business.[1] They tend to be time-related, such as salaries or rents being paid per month, and are often referred to as overhead costs. This is in contrast to variable costs, which are volume-related (and are paid per quantity produced). In management accounting, fixed costs are defined as expenses that do not change as a function of the activity of a business, within the relevant period. For example, a retailer must pay rent and utility bills irrespective of sales. In marketing, it is necessary to know how costs divide between variable and fixed. This distinction is crucial in forecasting the earnings generated by various changes in unit sales and thus the financial impact of proposed marketing campaigns. In a survey of nearly 200 senior marketing managers, 60 percent responded that they found the "variable and fixed costs" metric very useful.[2]
[edit]Areas
of confusion
Fixed costs are not permanently fixed; they will change over time, but are fixed in relation to the quantity of production for the relevant period. For example, a company may have unexpected and unpredictable expenses unrelated to production; and warehouse costs and the like are fixed only over the time period of the lease. By definition, there are no fixed costs in the long run.[citation needed] Investments in facilities, equipment, and the basic organization that can't be significantly reduced in a short period of
time are referred to as committed fixed costs. Discretionary fixed costs usually arise from annual decisions by management to spend on certain fixed cost items. Examples of discretionary costs are advertising, machine maintenance, and research & development expenditures.[3] In business planning and management accounting, usage of the terms fixed costs, variable costs and others will often differ from usage in economics, and may depend on the intended use. Some cost accounting practices such as activity-based costing will allocate fixed costs to business activities, in effect treating them as variable costs. This can simplify decisionmaking, but can be confusing and controversial.[4] [5] In accounting terminology, fixed costs will broadly include almost all costs (expenses) which are not included in cost of goods sold, and variable costs are those captured in costs of goods sold. The implicit assumption required to make the equivalence between the accounting and economics terminology is that the accounting period is equal to the period in which fixed costs do not vary in relation to production. In practice, this equivalence does not always hold, and depending on the period under consideration by management, some overhead expenses (e.g., sales, general and administrative expenses) can be adjusted by management, and the specific allocation of each expense to each category will be decided under cost accounting.
[edit]See
also
flat rate Cost curve
[edit]References
1. ^ Dr Jake, Mitchell; Alan Price (2003). Economics: Principles in Action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 111. doi:Alex Suleman. ISBN 013-063085-3. 2. ^ Farris, Paul W.; Neil T. Bendle; Phillip E. Pfeifer; David J. Reibstein (2010). Marketing Metrics: The Definitive Guide to Measuring Marketing Performance. Upper Saddle River, New Jersey: Pearson Education, Inc. ISBN 0137058292. The Marketing Accountability Standards Board (MASB) endorses the definitions, purposes, and constructs of classes of measur
Variable cost
From Wikipedia, the free encyclopedia
Decomposing Total Costs as Fixed Costs plusVariable Costs.
Variable costs are expenses that change in proportion to the activity of a business.[1] Variable cost is the sum of marginal costs over all units produced. It can also be considered normal costs. Fixed costs and variable costs make up the two components of total cost. Direct Costs, however, are costs that can easily be associated with a particular cost object.[2]However, not all variable costs are direct costs. For example, variable manufacturing overheadcosts are variable costs that are indirect costs, not direct costs. Variable costs are sometimes called unit-level costs as they vary with the number of units produced. Direct labor and overhead are often called conversion cost,[3] while direct material and direct labor are often referred to as prime cost.[3] In marketing, it is necessary to know how costs divide between variable and fixed. This distinction is crucial in forecasting the earnings generated by various changes in unit sales and thus the financial impact of proposed marketing campaigns. In a survey of nearly 200 senior marketing managers, 60 percent responded that they found the "variable and fixed costs" metric very useful.[4]
Contents
[hide]
1 Explanation 2 See also 3 Notes
4 References
[edit]Explanation
For example, a manufacturing firm pays for raw materials. When activity is decreased, less raw material is used, and so the spending for raw materials falls. When activity is increased, more raw material is used and spending therefore rises. Note that the changes in expenses happen with little or no need for managerial intervention. These costs are variable costs. A company will pay for line rental and maintenance fees each period regardless of how much power gets used. And some electrical equipment (air conditioning or lighting) may be kept running even in periods of low activity. These expenses can be regarded as fixed. But beyond this, the company will use electricity to run plant and machinery as required. The busier the company, the more the plant will be run, and so the more electricity gets used. This extra spending can therefore be regarded as variable. In retail the cost of goods is almost entirely a variable cost; this is not true of manufacturing where many fixed costs, such as depreciation, are included in the cost of goods. Although taxation usually varies with profit, which in turn varies with sales volume, it is not normally considered a variable cost. For some employees, salary is paid on monthly rates, independent of how many hours the employees work. This is a fixed cost. On the other hand, the hours of hourly employees can often be varied, so this type of labour cost is a variable cost.
[edit]See
also
Variable Costs and Fixed Costs
All the costs faced by companies can be broken into two main categories: fixed costs and variable costs. Fixed costs are costs that are independent of output. These remain constant throughout the relevant range and are usually considered sunk for the relevant range (not relevant to output decisions). Fixed costs often include rent, buildings, machinery, etc. Variable costs are costs that vary with output. Generally variable costs increase at a constant rate relative to labor and capital. Variable costs may include wages, utilities, materials used in production, etc. In accounting they also often refer to mixed costs. These are simply costs that are part fixed and part variable. An example could be electricity--electricity usage may increase with production but if nothing is produced a factory still may require a certain amount of power just to maintain itself. Below is an example of a firm's cost schedule and a graph of the fixed and variable costs. Noticed that the fixed cost curve is flat and the variable cost curve has a constant upward slope.
