Definition:
Fixed costs are the indirect production costs that fixed in total although the volume of products is increased or decreased. However, fixed costs change in units when the productions are increased or decreased.
These costs including rental expenses, insurance expenses, depreciation expenses and are not change even though the company increases or decreases its production.
Fixed Cost and its comparison to Variable Cost
A variable cost is a cost that is related to the number of goods and services that the company produces, whereas fixed costs do not vary with the volume of production.
A fixed cost does not change with the increase or decrease in the number of goods and services produced; however, a company’s variable cost increases and decreases with the amount of production.
If production goes up, variable costs will also increase, and if production is slowed down, variable costs decrease. On the contrary, fixed cost remains the same even when the company produces no goods or services.
Fixed costs are inevitable, and there is no way that a company could avoid them. These are expenses that have to be paid by a company, independent of any specific business activities.
Example of Fixed Costs:
- Indirect labor: The salaries paid to indirect labor are fixed. Such costs are paid to employees like guards and supervisors every month irrespective of the number of hours worked.
- Rent: This is a periodic payment to the landlord for using his land or property and is fixed by him.
- Property taxes: It is the fixed amount of tax that is charged to the business by the government on the fixed property owned by the company.
- Interest Expense: This is an expense that has to be paid every month for a loan taken by the business. It is a fixed cost if a fixed rate is incorporated.
- Insurance: This is a periodic charge and is fixed by an insurance contract.
- Depreciation: This annual reduction in the value of the asset is fixed if calculated through the straight-line depreciation method.
- Amortization: Gradual reduction in the cost of the intangible asset.
Moreover, fixed costs can also be discussed through a numeric example. For instance, a company has a fixed cost of 10,000 dollars per month for the rent of the machine it uses to produce equipment.
If the company doesn’t produce any equipment for the whole month, it still has to pay the fixed cost of 10,000 dollars for renting the machine.
On the other hand, if it produces 1000 parts, the fixed cost remains the same irrespective of the quantity.
Financial Statement Analysis:
The more fixed costs a company has the more revenue it needs to meet breakeven.
Therefore, the company needs to increase its production and sell more products since these costs occur regularly and do not change in the short run.
Fixed costs per unit, however, decrease. It can contribute to better economies of scale because when a company produces larger quantities, the fixed cost per unit will decrease and may become minimal.
Fixed costs are also included in the expenses section of the income statement, which computes the operating profit for us.
Depreciation and salaries payable to the management are the most common fixed costs that are included here as an indirect expense as well as interest payments.
All costs are then summed up and deducted from the gross profit to arrive at the net profit for the year.
Fixed costs are also included in the statement of financial position as well as the cash flow statement.
On the balance sheet, they might be treated as short or long-term liabilities and any cash paid for the expenses of the fixed cost will be shown in the cash flow statement.
