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Cost Accounting - Fixed vs Variable?
by Ujala Younis
(Chakala Scheme 3)
Q: Fixed costs are really variable, the more you produce the less they become. Do you agree? Explain?
A: Thanks for your questions Ujala.
I agree and disagree.
As production increases, ones variable costs definitely increase. When production increases even more, one's fixed costs can also increase.
For example, you run a small factory and make tables. It costs $10 for wood for one table. In the small factory you make 1,000 tables per month. Your rent, water, electricity, salaries, etc. (fixed costs) are $6,000 per month. You sell the tables for $30 a table. Assume for this example that all workers are paid fixed wages or salaries, so wages and salaries forms part of fixed costs.
Your income statement currently looks like this: Sales $30,000 Variable costs (wood) $10,000 Fixed costs $6,000 Profit $14,000
Let's say the demand for your tables increases to 1,100 tables per month. You can still produce this quantity of tables with the current staff and facilities (fixed costs remain the same).
Your income statement now looks like this: Sales $33,000 Variable costs (wood) 11,000 Fixed costs $6,000 Profit $16,000
Now let's say a short while later the tables start selling really well. Your customers demand 1,500 tables each month. You cannot produce 1,500 in the same factory and with the same number of workers. So you hire more people and move to a bigger factory.
Here's the latest income statement: Sales $45,000 Variable costs (wood) $15,000 Fixed costs $12,000 Profit $18,000
So, as you can see from this example, your variable costs always change according to production. But when the production increased to a certain point, both your variable and fixed costs would increase. Your fixed costs increase to a new higher level and stay at that level until the next point of expansion.
To give a final answer to your questions above: Yes, fixed costs can vary, but no, when production increases fixed costs would not usually decrease.