Variable vs Fixed Costs Definition
In accounting, a distinction is often made between the variable vs fixed costs definition. Variable costs change with activity or production volume. In comparison, fixed costs remain constant regardless of activity or production volume.
In accounting, all costs are either fixed costs or variable costs. Variable costs are inventoriable costs. That means accountants allocate fixed costs to units of production. Then they are recorded in inventory accounts, such as cost of goods sold. Fixed costs, on the other hand, are all costs that are not inventoriable costs. All costs that do not fluctuate directly with production volume are fixed costs. Fixed costs include indirect costs and manufacturing overhead costs.
Comparing Fixed Costs to Variable Costs
When comparing fixed costs to variable costs, or when trying to determine whether a cost is fixed or variable, simply ask whether or not the particular cost would change if the company stopped its production or primary business activities. If the company would continue to incur the cost, it is a fixed cost. If the company no longer incurs the cost, then it is most likely a variable cost.
Variable vs Fixed Costs Examples
To further help explain these costs, find a couple variable vs fixed costs examples below.
For example, if a telephone company charges a per-minute rate, then that would be a variable cost. A twenty minute phone call would cost more than a ten minute phone call. A good example of a fixed cost is rent. If a company rents a warehouse, it must pay rent for the warehouse whether it is full of inventory or completely vacant.
Other examples of fixed costs include executives’ salaries, interest expenses, depreciation, and insurance expenses. Examples of variable costs include direct labor and direct materials costs.
Variable vs Fixed Costs and Decision-Making
When making production-related decisions, should managers consider fixed costs or only variable costs? Generally speaking, variable costs are more relevant to production decisions than fixed costs.
For example, if a manager is deciding between keeping production levels constant or increasing production, then the primary factors in this decision will be the variable or incremental costs of the production of additional units of output. It would not be the fixed costs related to the operations that cannot be altered and will not change with the level of production. Therefore, in most straightforward instances, fixed costs are not relevant for production decision, and incremental costs, or variable costs, are relevant for these decisions.
If you want to utilize your unit economics to add more value to your organization, then click here to download the Know Your Economics Worksheet.
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