Economics
Fixed Costs
Fixed costs are expenses that do not vary with the level of production or sales, such as rent, salaries, and insurance. These costs remain constant regardless of the company's output, making them essential for a business to operate. In economic analysis, understanding fixed costs is crucial for determining a company's break-even point and overall profitability.
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11 Key excerpts on "Fixed Costs"
eBook - PDF- Cecile Laurin, Tage C. Tracy, John A. Tracy, John A. Tracy(Authors)
- 2023(Publication Date)
- For Dummies(Publisher)
Fixed versus variable costs If your business sells 100 more units of a certain item, some of your costs increase accordingly, but others don’t budge one bit. This distinction between variable and Fixed Costs is crucial: » Variable costs: Variable costs increase and decrease in proportion to changes in sales or production level. Variable costs generally remain the same per unit of product or per unit of activity. Manufacturing or selling additional units causes variable costs to increase in concert. Manufacturing or selling fewer units results in variable costs going down in concert. » Fixed Costs: Fixed Costs remain the same over a relatively broad range of sales volume or production output. Fixed Costs are like a dead weight on the business. Its total Fixed Costs for the period are a hurdle it must overcome by selling enough units at high enough margins per unit to avoid a loss and move into the profit zone. (Chapter 15 explains the break-even point, which is the level of sales needed to generate enough margin to cover Fixed Costs for the period.) CHAPTER 16 Accounting for Costs 313 The distinction between variable and Fixed Costs is at the heart of understanding, analyzing, and forecasting profit, which we explain in Chapter 17. Relevant versus irrelevant costs Not every cost is important to every decision a manager needs to make — hence the distinction between relevant and irrelevant costs: » Relevant costs are costs that should be considered and included in your analysis when deciding on a future course of action. Relevant costs are future costs — costs that you would incur or bring upon yourself depending on which course of action you take. For example, say that you want to increase the number of books that your business produces next year to increase your sales revenue, but the cost of paper has just shot up.
eBook - PDFPushing the Numbers in Marketing
A Real-World Guide to Essential Financial Analysis
- David L. Rados(Author)
- 1992(Publication Date)
- Praeger(Publisher)
But in language, usage is all. How to Use Variable Costs 1. Make sure you have an estimate of variable costs of your product, brand, or whatever before you analyze a marketing decision. 2. Watch out for allocations of Fixed Costs that show up under variable costs. Calling a fixed cost variable doesn't make it variable. Fixed Costs These costs don't change, in total, over a period of time, over some normal range of operations. These are important qualifications because few costs can be changed in the short run, say one day, and all costs can be changed in the long run, over years. Also, Fixed Costs may well in- crease if production increases sharply, say, from 60 to 95 percent of capacity. Examples of Fixed Costs for a manufacturer would include depreciation of plant and equipment, real estate taxes, equipment leases, interest pay- ments, most of the managerial and supervisory payroll, most of the costs of the maintenance crew. Like variable costs, Fixed Costs do not exist in the absolute. Costs that appear to be given, to be beyond a manager's control, may turn out to be controllable, at least partially, under a different cost control system. If managers are not charged for office space, they will tend to use more of it. If the firm has the opportunity of renting part of its office space to out- siders and charges the foregone rent to the manager, that manager may well find it possible to reduce the space required. What is fixed for one decision may be variable in another. The costs of running a sales branch are fixed for most day-to-day decisions concerning the sales force, but when consideration is given to closing or consolidating the branch these costs are no longer fixed. Such costs, that is, can not prudently be assumed to be fixed. If the decision is important enough, the assumption must be verified. Fixed Costs go by other names. They are non-variable costs to some, capacity costs to others.
eBook - ePub- John A. Tracy, Cecile Laurin(Authors)
- 2019(Publication Date)
- For Dummies(Publisher)
However, a decision alternative being considered might involve a change in Fixed Costs, such as moving out of the present building used by the business, downsizing the number of employees on fixed salaries, spending less on advertising (generally a fixed cost), and so on. Any cost, fixed or variable, that would be different for a particular course of action being analyzed is relevant for that alternative. Furthermore, keep in mind that Fixed Costs can provide a useful gauge of a business’s capacity — how much building space it has, how many machine-hours are available for use, how many hours of labour can be worked, and so on. Managers have to figure out the best way to utilize these capacities. For example, suppose your retail business pays an annual building rent of $200,000, which is a fixed cost (unless the rental contract with the landlord also has a rent escalation clause based on your sales revenue). The rent, which gives the business the legal right to occupy the building, provides 15,000 square feet of retail and storage space. You should figure out which sales mix of products will generate the highest total margin — equal to total sales revenue less total variable costs of making the sales, including the costs of the goods sold and all variable costs driven by sales revenue and sales volume. Actual, budgeted, and standard costs The actual costs a business incurs may differ (though we hope not too unfavourably) from its budgeted and standard costs: Actual costs: Actual costs are based on actual transactions and operations during the period just ended, or going back to earlier periods. Financial statement accounting is mainly (though not entirely) based on a business’s actual transactions and operations; the basic approach to determining annual profit is to record the financial effects of actual transactions and allocate the historical costs to the periods benefited by the costs
eBook - PDF- Raymond S. Schmidgall, David K. Hayes, Jack D. Ninemeier(Authors)
- 2003(Publication Date)
- Wiley(Publisher)
By this definition, “cost” is the same as “expense.” PROFIT MARGIN An overall measure of management’s ability to generate sales and control expenses; profit mar- gin is calculated by dividing net income by total revenue. Costs and Sales Volume One way to consider costs is to think about how they change when there are changes in the activity (sales) of the restaurant. Costs can be seen as fixed, vari- able, or mixed (partly fixed and partly variable). Fixed Costs. Fixed Costs remain constant in the short run even when sales volume varies. For example, food sales may increase by 5% or beverage sales may decline by 10%; in both cases a fixed cost such as interest ex- penses remains constant. Figure 7.1 shows a graph that tracks costs and revenue volume. It shows that total Fixed Costs remain the same even when sales volume increases. Common examples of Fixed Costs include salaries, rent and insurance ex- pense, property taxes, depreciation expense, and interest expense. Fixed Costs are sometimes classified as either capacity or discretionary. Capacity Fixed Costs re- late to the ability to provide goods and services. For a restaurant, capacity Fixed Costs relate to the number of seats in the dining area and include depreciation, property taxes, interest, and certain salaries. There is a quality dimension related to capacity Fixed Costs. For example, if the restaurant were to eliminate its air conditioning system, it could still serve the same number of guests, but at a lower level of service. 157 U N D E R S TA N D I N G C O S T C O N C E P T S A N D B R E A K - E V E N Fixed Costs Costs that do not vary in the short term even when sales volume varies; examples include salaries and interest expense. CAPACITY Fixed Costs Charges relating to the prop- erty or its capacity to pro- vide goods and services. Total Fixed Costs Per Unit Fixed Costs 0 Sales Volume Costs Figure 7.1 Total and Per Unit Fixed Costs
eBook - PDFCost & Management Accounting N5 SB
TVET FIRST
- T Lakhan(Author)
- 2015(Publication Date)
- Macmillan(Publisher)
of units produced Fixed cost Fixed Costs are those costs which remain constant no matter how many units are produced. For example, if the rent expense is R10 000 per month, it does not matter if the business produces 1 unit or 1 000 units, it must still pay its landlord R10 000 rent for the month. Variable cost Variable costs are those costs that vary or change in direct proportion to the number of units produced. Example 1.8 Wood (direct material) valued at R10 is needed to make 1 desk. Required: Calculate the direct material cost if 50 desks are produced. Suggested solution Direct material cost for 50 desks = R10 × 50 desks = R500 Notice how the cost varied or changed when the number of units changed. When 1 unit was produced, the variable cost was R10. When the number of units increased to 50, the variable cost increased 50 times. 21 Unit cost and total cost It is important to understand how fixed and variable costs behave both in total and per unit. Think about total cost. When you find the total of something, does it become more or less? Now, do you think you would need to multiply or divide to calculate the total cost? Obviously you must multiply. What about unit cost? Unit means ONE, so you are calculating the cost of producing one unit. Is one the bigger or smaller number? So, when you are performing a calculation, would you multiply or divide to make the answer smaller? Obviously you must divide. Total cost Example 1.9 The following information relates to Summer Ltd: Required: Calculate the total cost. Suggested solution Total cost = Total fixed cost + total variable cost = R100 000 + R50 000 = R150 000 Total, and unit, fixed and variable costs The table below summarises how fixed and variable costs behave, both per unit and in total.
eBook - PDF- Kumar, K Nirmal Ravi(Authors)
- 2021(Publication Date)
- Daya Publishing House(Publisher)
This ebook is exclusively for this university only. Cannot be resold/distributed. Similarly, the depreciation on machinery is considered as a fixed cost, but in the long run, the farmer may sell away that machinery thereby, he will not incur that fixed cost. Same is the case in case of hired labour. If the labour are paid on annual basis, he may be regarded as permanent labour and hence, the wages paid to him by the farm manager falls under Fixed Costs. On the other hand, if the labour are hired for a specific purpose for only a limited period of time, they fall under casual labour and their wage payment falls under variable costs. These examples clearly indicate that, the categorization of a particular input as a fixed cost or variable cost is thus closely intertwined with the particular period involved. In the long run, since all the factors are variable (machinery example as quoted above), there are only variable costs and Fixed Costs are completely absent. However, in short run (say, during crop season), some factors are fixed (land, machinery etc) and some are variable (fertilizers, pesticides etc). Over a very short period of time, say, in about two to three weeks, i.e ., within a single production season, all costs can be considered as fixed. Thus, the categorization of costs of the inputs into fixed cost or variable-cost can be made only with reference to the length of the production period. The greater is the production period, the lower is the distinction between fixed and variable costs; and the shorter is the production period, the greater is the distinction between fixed and variable costs or the proportion of Fixed Costs to variable costs increases. That is, the proportion of Fixed Costs to variable costs decreases, as the length of the production period increases. Considering the length of the production period, there are two types of production programmes viz ., short run and long run and these two are already discussed in-detail through Chapter 2 .
eBook - PDF- Rhona C. Free(Author)
- 2010(Publication Date)
- SAGE Publications, Inc(Publisher)
Finally, if a new student scores exactly at the class average, the aver-age will remain unchanged. Short-Run Costs A firm's costs are directly related to its ability to pro-duce goods and services. Consider Figure 10.2, panel (a). In the short run, a firm's total costs are separated into fixed and variable costs. Fixed Costs are associated with inputs and other items that are held constant and do not vary with output. Examples of Fixed Costs include the lease or rental fee a firm may pay for the use of capital equipment and the mortgage it owes on property that it owns. The key point is that these costs do not vary with the firm's level of output and must be paid even if the firm produces nothing. Hence, the total fixed cost curve is drawn as a horizontal line. Whether the firm removes 1,500 pieces of luggage from the plane or shuts down and produces nothing, these costs remain fixed—in this case, at about $1,200. Fixed Costs are an important part of determining the profitability of a firm and cannot be ignored, but they are less helpful in determining exactly how much output the firm should produce. For this, marginal cost is much more useful. Just as marginal product measures the incre-mental changes in output when, ceteris paribus, the uti-lization of a single input is changed, marginal cost calculates the additional cost associated with producing a little more (or less) output. Like marginal product, marginal cost is the same thing as the slope of its associated total and is based on the following equation: MC = ATC/AQ. Because the firm is operating in the short run, we can assume that labor is the firm's only variable input. If the wage rate (w) that the firm pays is fixed, or if the firm's effect on the wage rate is negligible, as would be the case if the firm were one of many firms hiring workers, the numerator of the marginal cost equation can be written as ATC = w(AL).
- Kumar, K Nirmal Ravi(Authors)
- 2021(Publication Date)
- Daya Publishing House(Publisher)
Cannot be resold/distributed. irrespective of the level of output. That means, whatever may be the level of output or even at zero output level, TFC remains same. So, when there is zero production, TC is equal to TFC. These Fixed Costs are the costs related to fixed resources only. The distinction between Fixed Costs and variable costs will arise only in short run because, in the long run, all the resources are variable and hence, all costs are variable costs in the long run. But, the recovery of the Fixed Costs is considered important in the long run and not in the short run. Hence, Fixed Costs are also called as long run costs. To an Economist, the Fixed Costs are Overhead costs and to an Accountant, they are Indirect costs. Firms have no control over Fixed Costs in the short run. For this reason, Fixed Costs are sometimes called as Sunk costs. They are also called as On-costs or Supplementary costs. TFC curve is a straight line parallel to X-axis because, irrespective of the level of output, TFC remains same ( Figure 15.3 ). When the output goes up, the fixed cost per unit of output comes down, as the TFC is then divided between larger number of units of output. Examples include, depreciation, interest on loan amount, land revenue etc. Figure 15.3 : Traditional theory – Short run absolute cost curves in production of paddy. As the name indicates, this cost varies with the level of output. So, when output is zero, variable cost is also zero and when output increases, variable This ebook is exclusively for this university only. Cannot be resold/distributed. cost also increases. These costs are related to variable resources only and they increase, but not necessarily in the same proportion as the increase in output. In order to increase output, the farmer must increase the quantity of variable factors of production that he employs. Therefore, as farm output increases, the farm’s variable costs must also increase.
eBook - PDFCost Accounting
With Integrated Data Analytics
- Karen Congo Farmer, Amy Fredin(Authors)
- 2022(Publication Date)
- Wiley(Publisher)
Illustration 2.12 shows that while the cost of the entire pizza is fixed in total, the cost per slice varies with the activity level, that is, the number of units or slices. As we spread Fixed Costs over more units, the fixed cost per unit decreases—a fundamental management insight. $10.00 $2.50 $2.50 $2.50 $2.50 $10.00 $1.67 $1.67 $1.67 $1.67 $1.67 $1.67 ILLUSTRATION 2.12 Fixed Costs per slice decrease as the number of slices increases 2-18 CHAPTER 2 Refresher on Cost Terms Managing Fixed Costs Managing Fixed Costs is quite different from managing variable costs. Since we incur Fixed Costs to obtain capacity, cutting Fixed Costs means cutting capacity. Exactly which Fixed Costs enable our capacity? The same Fixed Costs as the MOH items we listed previously: • Depreciation on the factory if you own it. • Rent on the factory if you don’t own it. • Depreciation on factory machines and equipment. • Property taxes on the factory. • Insurance on the factory. • Factory supervisors’ salaries. Since Fixed Costs are so intertwined with capacity, reducing Fixed Costs can’t usually be done overnight. It’s messy and interrupts operations. Therefore, managing Fixed Costs means: • Not paying for larger facilities than the organization needs, thereby keeping excess capacity—and unnecessary Fixed Costs—to a minimum. This logic applies with housing costs. Retirees (and empty-nesters) commonly downsize their housing. Why? This reduces capacity and related Fixed Costs. • Spreading existing Fixed Costs over the most units possible, given the lesser of two natural limits: (1) market demand and (2) existing capacity. To reduce Fixed Costs to zero means going out of business. Let’s see how fixed and variable costs impact profits in the next example. Nana Nancy makes decadent coconut cream cakes. The local high school asked Nana to bake a very large cake for a fundraising bake sale. Preet, the student body president, paid $250 for it.
eBook - PDFEconomics
Theory and Practice
- Patrick J. Welch, Gerry F. Welch(Authors)
- 2016(Publication Date)
- Wiley(Publisher)
Total fixed cost is the same regardless of how much is produced; total variable cost increases as output increases. Average total cost is the cost per unit of output at a given level of production and is found by dividing total cost by the number of units of output produced. Marginal cost is the change in total cost resulting from the production of an additional unit of output. 6. In the short run, total cost increases slowly at low levels of output and rapidly at high levels of output. Average total cost decreases and then increases, as does marginal cost. These patterns are the result of the way in which variable factor usage increases as production increases. At low levels of output, small amounts of variable factors are needed with the fixed factors, and at high levels of output, large amounts of variable factors are needed to compensate for the limits imposed by the fixed factors. 7. Underlying the patterns of short‐run costs is the Law of Diminishing Returns, which says that as a variable factor of production is added to fixed factors, beyond some point the additional product from each additional unit of the variable factor will decrease. 8. Long‐run average total cost illustrates the pattern of costs in the long run. The shape of the long‐run average total cost curve is the result of economies of scale that occur in the early stages of long‐run production and cause the cost per unit of output to drop, constant returns to scale where average total cost stays the same, and diseconomies of scale that occur in the late stages of long‐run produc- tion and cause the cost per unit of output to increase. Summary Review Questions 327 1. What is a producing sector? Give some examples. How does this differ from the industry classification? 2. A friend believes that, as far as the costs of operating a business are concerned, short‐run costs are the costs that are incurred within the current year and long‐ run costs are those spread over more than a year.
eBook - PDF- Peter C. Weiglin(Author)
- 2002(Publication Date)
- SAGE Publications, Inc(Publisher)
Essentially, we have to consider three kinds of costs, depending on how they vary as production levels change. They are variable costs, Fixed Costs, and semivariable costs. Variable costs are directly affected by the number of units produced. If no units are produced, the cost is zero. For each unit produced, there is a materials component and a labor component. For example, we may calculate that each unit involves $3 worth of material and $20 worth of labor to produce. That’s a variable cost of $23 per unit. Ten units would have a total variable cost of $230, 20 units $460, and so on. Fixed Costs do not go up or down as we produce more or fewer units. Examples are the CEO’s base salary, the rent or mortgage on the factory, and the costs of the front office. Those costs would be there even if no units are produced, as long as the business is open. In between fixed and variable costs are semivariable costs . These costs go up in large steps with different production quantities. The best example is a factory that installs a second (or third, or fourth) machine to handle increased production. Up to 100 units, one machine can handle the job. But for the next 100 units, a second machine will be required, and a third for the 100 units after that, and so on. The costs are not fixed, but there is a definite jump in cost between the 100th unit and the 101st unit produced because of the semivariable cost of the new machine. The total cost is therefore the sum of all of the three types of costs appli-cable to the units produced. Figure 7.1 is like Figure 6.2, but it is a bit more detailed. It shows a graphic representation of the total cost and its com-ponents and how the costs vary with rates of production. Although they are helpful as training aids, the mischief in Figure 7.1 is that it shows a straight line for variable costs.
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