Variable costs and fixed costs are two fundamental categories used in cost accounting to classify expenses incurred by a business.
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Here’s a brief explanation of each:
- Variable Costs:
- Variable costs are expenses that vary in direct proportion to the level of production or sales activity.
- These costs increase as production levels or sales volumes increase and decrease as production levels or sales volumes decrease.
- Variable costs per unit remain constant, but the total variable costs fluctuate based on the level of activity.
- Examples of variable costs include raw materials, direct labor (wages paid to production workers), commissions paid to sales staff based on sales volume, and shipping costs directly tied to the number of units sold or produced.
- Fixed Costs:
- Fixed costs are expenses that remain constant regardless of the level of production or sales activity.
- These costs do not fluctuate with changes in production levels or sales volumes within a certain range of activity.
- Fixed costs are incurred regularly over a specific period, typically monthly or annually, and do not vary based on production output or sales volume.
- Examples of fixed costs include rent or lease payments for facilities, salaries of permanent staff, insurance premiums, property taxes, and depreciation of fixed assets.
In summary, variable costs change in direct proportion to changes in production or sales activity, while fixed costs remain constant regardless of changes in activity levels. Understanding the distinction between these two types of costs is essential for analyzing cost behavior, conducting cost-volume-profit analysis, and making informed decisions regarding pricing, production levels, and profitability within a business.