How does not separating fixed from variable costs lead to poor decisions?

Expert Solution

--Not separating Fixed cost from variable cost leads to poor decision because of different nature of these two cost elements.
>Fixed Cost remains fixed and constant in totality, while changing 'per unit'. [Example $ 20000 per month]
>Variable cost remains fixed and constant per unit [Example $ 10 per unit] while they change in totality when units increases or decreases.

--Certainly, since their nature is different, if they are not separated, decision based will be poor.

--For example, lets that that costs are not separated and cost of producing 10,000 units is total $ 20000 (fixed + variable).
In this case per unit cost is $ 2 per unit.Now assume that sale price is $ 3 per unit.
Say that business is considering a decision to make further 1000 units. The additional units will not lead any additional benefit and will seems to earn same $1 per unit.

>However, if variable and fixed were separated from $ 20000, and variable cost came around $ 1.5 per unit and so fixed cost will be $ 5000. Additional sale of 1000 units will tend to actually bring in $ 1.50 per unit ($3 - 1.5 variable cost). instead of $ 1 that was wrongly analysed earlier.

ekkarill92 answered 1 year ago

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