Cost can be classified in several ways such as fixed cost or variable cost, depending on its nature. One of the most popular methods is classification according to fixed costs and variable costs. Unlike variable costs, fixed costs are not dependent on the production or output of goods or services. Moreover, fix costs often relate to time period, and generally do not change over time.
What is a Fixed Cost
A fixed cost is an expense that does not change as production volume increases or decreases within a relevant range. In other words, fix costs do not change as long as operations stay within a certain size. Fixed costs are less controllable by an organization because they aren’t based on volume or operations.
As an example of a fixed cost, the rent on a building will not change until the lease runs out or is re-negotiated, irrespective of the level of activity within that building. Examples of other fixed costs are insurance, depreciation, and property taxes. Fixed costs generally incur on a regular basis, and so they are period costs.
Moreover, for marketing, it is important to understand how costs vary depending upon their nature i.e. variable or fix costs. This distinction is also essential in forecasting the earnings, preparing reports and budgets.
Difference Between Fixed Cost and Variable Cost?
|Fixed Costs||Variable Costs|
|Meaning||Fixed costs are expenses that remain constant for a period of time irrespective of the level of outputs.||Variable costs are expenses that change directly and proportionally to the changes in business activity level or volume.|
|Incurred when||Even if the output is nil, fixed costs are incurred.||The cost increases/decreases based on the output|
|Also known as||Fixed costs are also known as overhead costs, period costs or supplementary costs.||Variable costs are also referred to as prime costs or direct costs as it directly affects the output levels.|
|Nature||Fixed costs are time-related i.e. they remain constant for a period of time.||Variable costs are volume-related and change with the changes in output level.|
|Examples||Depreciation, interest paid on capital, rent, salary, property taxes, insurance premium, etc.||Commission on sales, credit card fees, wages of part-time staff, etc.|
Nature of Cost
As discussed, Fixed costs are not permanently fix but they change over time. Also they are fix by contractual obligation, in relation to the the relevant period. For example, a company may have unexpected and unpredictable expenses unrelated to production, such as warehouse costs.
Some fixed costs such as investments in infrastructure can not be substantially decreased in a limited time span are referred as fixed committed costs. While discretionary fixed costs depend on management decisions.
Examples of discretionary costs include spending on advertising, insurance premiums, machine maintenance, and research & development; the discretionary fixed costs can be excessive.
Yes. Fixed costs can change if the costs of operations changes. For example, if rent goes up, the fixed costs might be re-evaluated.
Depreciation is the regular charge on tangible or intangible asset over the course of its useful life irrespective of output. Therefore, Its is considered as a fixed cost.
Advertising costs may fluctuate over time, as management may decide but advertising isn’t affected by sales or production levels so it is said to be a fixed cost.