Question

Why is the distinction between variable and fixed costs important when making break-even decisions and other costing/production/sales decisions? Be sure to address both total and per unit aspects of the two types of costs. How would your decisions be impacted by ignoring this distinction?

Answer 1

• Fixed Costs

---These costs are called fixed cost because of their ‘fixed’ nature.

---They are ‘fixed’ in the sense that these do not change when volume of activity increases or decreases.

---They continue to be incurred even when no production takes place (generally).

---Fixed Cost remains FIXED in totality.

---Fixed Cost changes ‘per unit’ when volume increases or decreases.

Example:

A	Units produced	5000	4000	6000	10000	8000
B	Fixed Costs	$            2,00,000.00	$        2,00,000.00	$     2,00,000.00	$      2,00,000.00	$      2,00,000.00
C=B/A	Fixed cost per unit	$                        40.00	$                    50.00	$                 33.33	$                  20.00	$                  25.00

• Variable Cost

---These costs are called variable because of their ‘ variable’ and ‘changing nature’.

---They are variable in the sense that these vary when volume of activity increases or decreases.

---These will not be incurred when no production is taking place (unlike fixed cost)

---Variable Costs remains SAME ‘per unit’

---Variable cost changes in TOTALITY.

Example:

A	Units produced	5000	4000	6000	10000	8000
B	Variable cost per unit	$                        20.00	$                    20.00	$                 20.00	$                  20.00	$                  20.00
C=Ax B	Total Variable cost	$            1,00,000.00	$            80,000.00	$     1,20,000.00	$      2,00,000.00	$      1,60,000.00

• If no distinction is made between these two, the decision would be greatly affected.

This is because, while making managerial decision regarding cost, fixed costs (that are unavoidable) are not be considered as “relevant” cost.

While Variable costs are considered. If fixed cost are also considered, the relevant cost would be overstated and decision will not be fruitful.