Electricity Cost – Fixed or Variable?

What is a Fixed Costs?

Fixed Costs can be defined as the costs that do not vary with the level of output within the company. As a matter of fact, organizations have to incur this particular cost regardless of the level of output they are operating in.

Over the course of time, even if the level of production increases within the company, the total fixed costs still the same. However, fixed cost per unit tends to decrease with the increasing level of input within the company.

In the same manner, it is also important to consider the fact that fixed costs are also referred to as overheads.

They cannot directly be associated with individual units of output produced within the company. Some examples of fixed costs include office rent, and salaries for office, and other managerial staff.

What is a Variable Cost?

Variable Cost is the cost that changes with the level of output within the company. Factually, it is directly proportional to the level of output that the company produces. This means that the higher the total level of output within the company, the higher the variable cost.

Hence, at zero levels of output, the company has zero variable costs. However, it must be noted that with increasing levels of output, the variable cost per unit stays the same.

Some examples of variable costs for an organization include production related expenses, direct material, and direct labor for the company.

Furthermore, it can also be seen that the variable cost for the company is referred to as a direct cost because it can be directly traced down to one unit of goods produced within the company.

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Nature of Electricity Bill

During the normal course of operations, there are numerous expenses that a business has to bear in order to stay operationally active. In this regard, they mainly categorize those expenses as either fixed, or variable.

However, in certain types of expenses, there is often ambiguity regarding how they should be classified in order to depict a clear picture to the users of the financial statements.

Electricity tends to be one of such expenses that are often treated with relative ambiguity, because of the reason that it is relatively harder to bifurcate electricity-related expenses into fixed and variable.

However, it can be seen that the categorization of electricity-related costs can be broken down into several different pieces, and then subsequently tied together to get a better insight.

The electricity bill, by its very nature, is often regarded as a mixed cost. This is essential because of the cos that includes both components, fixed, as well as variable.

It normally includes a flat service charge, after which the variable charge accumulates in accordance with the number of electricity units that are consumed within the company.

Therefore, the nature of the electricity expense can be regarded as fixed. This is because it normally involves a fixed component and a variable component.

Also, it is also regarded as a fixed cost, because even if the company is not producing any goods and services, they would still be paying some fixed amount for electricity every month.  

How to Classify Electricity Bill?

Firstly, electricity is considered to be a utility that is consumed across different departments within the company. Therefore, it is relatively harder to segregate electricity strictly into either fixed or variable.

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However, this is something that can be dealt with by keeping production-related electricity costs as variable costs, and other miscellaneous costs as fixed electricity costs.

For production-related electricity expenses, it makes sense for those costs to be associated with variable costs, because they are directly proportional to the number of goods and services that are produced. Higher the production, higher the electricity costs.

Therefore, it is best to classify production-related electricity expenses as variable costs, and other miscellaneous electricity-related expenses as fixed expenses.

Regardless of the fact that holistically electricity-related costs are considered as mixed costs, yet they are normally classified as fixed costs, in the Income Statements. This is because of the fact that electricity expense in itself includes both fixed, as well as variable components.

Hence, it is regarded as a cost that cannot be individually attributed to one particular unit of product. Even though production-related electricity expenses are directly proportional to the amount that is produced within the company, yet it still cannot be attributed to one particular unit in an accurate manner. Hence, in most cases, it is classified as fixed costs only.