Wages are one of the common expenses for any company. When companies work in any sector, they require the services of their employees. Usually, these employees work in exchange for an hourly rate.
This rate comes from the employment contract between the employer and the employee. In this case, the employer is the company employing the individual for their services.
Companies differentiate their costs based on how they occur. This differentiation can fall into several categories. For example, companies may separate direct and indirect costs, fixed and variable costs, etc.
The costs incurred for employees also get the same treatment. Differentiating them based on direct or indirect work may be straightforward. However, determining if they are variable or fixed may require some background knowledge.
Wages can be fixed or variable costs. However, companies cannot classify them into either category before understanding how they incur those costs.
On top of that, other factors may also contribute to this process. This process falls under managerial accounting within a company. Before discussing whether wages are variable or fixed, it is crucial to understand what these costs are.
What are Fixed Costs?
Fixed costs are expenses incurred by a company that does not change based on its activity levels. These costs remain the same regardless of how much production a company undertakes.
Usually, these include items that do not relate to the activity conducted by the company. Therefore, these costs do not change over a specific period. These may still increase from one period to another, though.
However, fixed costs do not remain fixed per unit. This differentiation is crucial in understanding fixed costs better. The more a company produces, the fixed cost remains the same.
However, the per-unit fixed cost decreases. For example, a company has $10,000 in fixed costs. Regardless of whether it produces 1,000 or 10,000 units, this cost will remain the same in total. However, the per-unit fixed cost for 1,000 units will be $10. For 10,000 units, it will be $1.
Similarly, if activity levels fall, the fixed cost per unit will change. In this case, it will decrease as companies will have lesser units to distribute these costs.
That does not imply that fixed costs alter with the activity levels. The total cost will remain the same. However, it fluctuates for the per-unit cost allocated to a product.
Some of the most common examples of fixed costs include the following.
- Loan payments
What are Variable Costs?
Variable costs are the opposite of fixed costs. These costs change as the activity levels within a company fluctuate. Therefore, the more a company produces, the more variable costs will grow in total.
On the other hand, if they have lower activity levels, they will incur lesser costs. These costs change within a period and from one period to another. However, that statement assumes that activity levels will fluctuate.
However, variable costs also remain the same per unit. Assuming the underlying factors don’t vary, these costs will not change for every production unit. Instead, they will stay fixed.
For example, a company produces every product for $10. Regardless of whether it manufactures 1,000 or 10,000 units, the variable cost for every product will be the same. Nonetheless, the total variable costs will fluctuate with the changes in activity levels.
Variable costs fluctuate in total as the activity levels change. However, they stay the same per unit. These characteristics are vital in differentiating variable and fixed costs.
On top of that, variable costs may not relate to production units only. It may also have other drivers. For example, the more profits a company makes, the higher taxes it will pay.
Some of the most common examples of variable costs include the following.
- Direct labour expenses
- Direct materials
Are Wages Fixed or Variable Cost?
The answer to if wages are variable or fixed isn’t straightforward. There are several factors that companies must consider before classifying these costs. In theory, wages are a variable cost. These costs increase as the activity levels within a company increase. The more workers work, the higher the wages the company pays will be. However, wages aren’t a variable cost.
Essentially, wages can classify as a semi-variable cost. A semi-variable cost includes elements that are both variable and fixed. These costs stay the same for a specific level.
Beyond that, they become variable. In the case of wages, the same applies. Usually, employees must work for a minimum interval every period. For example, companies may require workers to complete 40 hours every week.
The costs involved with the set interval for employees every period fall under fixed costs. So, if an employee works the minimum required hours, the wages for that period will classify as such.
However, if they work longer than that period, the associated wages will become variable. For example, a worker works 45 hours a week rather than the required 40 hours. In this case, the additional 5 hours worked will be a variable cost.
On top of that, other elements associated with wages are also variable costs. These include items like commissions, overtime, bonuses, etc.
Since these items aren’t a part of the minimum period requirement, they will fall under variable costs. These items will vary based on the activity levels within a company. On top of that, they may impact the hours worked by an employee for a specific period. Therefore, they fall under variable costs.
Overall, wages include elements of both fixed and variable costs. These fall under the former category when they involve the minimum work hours required.
If employees work varied hours during a specific period, their expenses will be variable. On top of that, other factors, including overtime, commissions, etc., change the classification to variable costs. In practice, wages include both elements. Therefore, they are a semi-variable cost.
Are Wages and Salary the same?
Most of the time, people consider wages a variable cost while classifying salaries as fixed. However, they are different based on various factors.
It is crucial to understand the differences between wages and salaries to know if they are variable or fixed. Both costs are a part of the payroll expenses for an employer. However, the classification may differ.
The primary difference between salaries and wages is the fixed element. Usually, the salaries paid to workers remain fixed regardless of hours worked. This amount is a part of their employment contract.
When calculating salaries, companies do not consider how many hours an employee has worked. Therefore, they primarily constitute a fixed cost for a company.
On the other hand, wages consider the hours worked by an employee. These amounts differ based on the work put in by the employee. Therefore, they are more variable in nature.
While they remain fixed for employees that worked the same hours each period, they can still differ. When employees work more, they will receive higher wages. If they work less, they will get lower wages.
Salaries also don’t consider an employee’s performance. As stated above, these payments stay fixed regardless of the work put in by the employee.
On the other hand, wages may reflect how an employee performs during a specific period. Therefore, wages also get a variable element from this factor. Salaries, in contrast, always fall under fixed costs for a company.
Are Wage reported as cost of goods sold or administrative expenses in the income statement?
Wages paid to employees can be reported as either cost of goods sold (COGS) or administrative expenses in an income statement, depending on the type of business and the role of the employees.
COGS refers to the direct costs associated with producing and selling a product, such as raw materials and direct labor. Wages paid to production workers who are directly involved in the production process would typically be included in COGS. This is because their wages are considered a direct cost of producing the product.
On the other hand, administrative expenses refer to the indirect costs of running a business, such as rent, utilities, and salaries of administrative employees. Wages paid to employees who are not directly involved in the production process, such as office managers, would typically be included in administrative expenses.
It is important to accurately classify wages in the income statement, as this can affect the overall profit margins and ratios, and provide a clearer picture of a company’s financial performance. Additionally, proper classification of wages can also help a company comply with Generally Accepted Accounting Principles (GAAP) and other financial reporting standards.
The classification of wages in an income statement as either COGS or administrative expenses depends on the role of the employees and the type of business. Proper classification of wages is important for accurate financial reporting and analysis.
Wages are the compensation paid to employees based on their hourly work and rates. Usually, they are a fixed cost to an employer up to the minimum hours worked by an employee.
If employees exceed those minimum hours, the additional wages will become a variable cost. Essentially, wages are a semi-variable cost to the employer. It is also what differentiates them from salaries.