In cost accounting, a part of management accounting, fixed costs are expenses that do not change in proportion to the activity of a business, within the relevant period or scale of production. In Management accounting, cost accounting is that part of management accounting which establishes budget and actual cost of operations processes departments or product and Management accounting is concerned with the provisions and use of Accounting information to managers within organizations to provide them with the basis to make informed business In common usage an expense or expenditure is an outflow of Money to another person or group to pay for an item or service or for a category of costs For example, a retailer must pay rent and utility bills irrespective of sales. Unit fixed costs, called average fixed costs (AFC), decline with volume, following a rectangular hyperbola as the inverse of the volume of production: AFC = FC/N.
Variable costs by contrast change in relation to the activity of a business such as sales or production volume. Variable costs are expenses that change in proportion to the activity of a business In the example of the retailer, variable costs may primarily be composed of inventory (goods purchased for sale), and the cost of goods is therefore almost entirely variable. Inventory is a list for goods and Materials, or those goods and materials themselves held available in stock by a Business. In manufacturing, direct material costs are an example of a variable cost. An example of variable costs are the prices of the supplies needed to produce a product.
Along with variable costs, fixed costs make up one of the two components of total cost. Variable costs are expenses that change in proportion to the activity of a business In Economics, and Cost accounting, total cost (or total costs) describes the total Economic cost of production and is made up of In the most simple production function, total cost is equal to fixed costs plus variable costs. In Economics, a production function is a function that specifies the output of a firm an industry or an entire economy for all combinations of inputs
In microeconomics and business, the difference between fixed costs and variable costs (and the related terms average cost and marginal cost) is crucial, as each will influence production decisions for profit maximization differently. Microeconomics is a branch of Economics that studies how individuals households and firms and some states make decisions to allocate limited resources typically in markets In Economics, average cost is equal to total cost divided by the number of goods produced (the output quantity Q In Economics and Finance, marginal cost is the change in Total cost that arises when the quantity produced changes by one unit In Economics, profit maximization is the process by which a firm determines the Price and output level that returns the greatest Profit. In the most simple cases, fixed costs do not affect production decisions, because they cannot be changed, and management will choose to produce if sales prices are above the cost of each additional unit (marginal cost).
Fixed costs should not be confused with sunk costs. In Economics and business decision-making sunk costs are Costs which cannot be recovered once they have been incurred From a pure economics perspective, fixed costs may not be fixed in the sense of invariate; they may change, 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 these would not be considered part of variable costs.
It is important to understand that fixed costs are "fixed" only within a certain range of activity or over a certain period of time. If enough time passes, all costs become variable. Similarly, not all indirect costs are fixed costs; for example, advertising expenses or labour costs are indirect costs that are variable over a slightly longer time frame, as they may not be subject to change in the short term, but may be easily adjustable over a longer time frame. For example, a firm may not be able to vary the number of employees (and hence labour costs) in the short term due to contract obligations, but be able to lay employees off or otherwise change these costs.
In accounting terminology, fixed costs will broadly include all costs (expenses) which are not included in cost of goods sold, and variable costs are those captured in costs of goods sold. Cost of goods sold, COGS, or "cost of sales", includes the direct costs attributable to the production of the goods sold by a company 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 (such as 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. In Management accounting, cost accounting is that part of management accounting which establishes budget and actual cost of operations processes departments or product and
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. For example, costs may be segregated into per unit costs (costs of goods sold), fixed costs per period, and variable costs as a proportion of revenue. Capital expenditures will usually be allocated separately, and depending on the purpose, a portion may be regularly allocated to expenses as depreciation and amortization and seen as a fixed cost per period, or the entire amount may be considered upfront fixed costs. Depreciation is a term used in Accounting, Economics and Finance to spread the cost of an Asset over the span of several years