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Fixed Cost

Reviewed by Anjaneyulu | Updated on Oct 05, 2020

Catalogue

Introduction

The fixed costs are business expenses which are not contingent on the amount of the business generated goods or services. These expenses are in contrast to variable costs, which at the beginning of the accounting year are volume-related (and payable by the quantity produced) and unknown.

For example, consider a bakery, where monthly rent for baking facilities, monthly security system, and basic telephone line payments are fixed costs, as they don't change depending on how much bread the bakery produces and sells.

Understanding Fixed Costs

Fixed costs in management accounting are defined as expenses that, within the relevant period, do not change as a function of business activity. A manufacturer, for example, needs to pay rent and utility bills regardless of the revenue.

For marketing, one needs to learn how costs vary between variable and fixed costs. This distinction is essential in forecasting the earnings generated by different changes in unit sales, and thus, the financial impact of the marketing campaigns being proposed. Most of the senior marketing executives found that the concept of "variable and fixed costs" is very useful.

Nature of the Cost

Fixed costs are not permanently fixed, but they will change over time. They are also fixed in relation to the quantity of production for the relevant period, by contractual obligation.

For example, a business may have unforeseen and unpredictable outlays that are unrelated to output, such as warehouse costs and the like being fixed only during the lease period. By definition, in the long run, there are no fixed costs, because the long run is a sufficient period for all fixed short-run inputs to become variable.

Investments in infrastructure, supplies, and the general organisation that can not be substantially decreased in a limited time span are referred to as fixed committed costs. Discretionary fixed costs tend to arise from annual management decisions to spend on certain fixed cost items.

Examples of discretionary costs include spending on advertising, insurance premiums, machine maintenance, and research & development; the discretionary fixed costs can be excessive.

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