Question

What is the difference between a fixed and a variable cost and how is each type of

cost used in the budgeting process? What are some examples of fixed and variable cost?

Answer 1

Fixed Cost :

Fixed cost is that expenses, which will occur irrespective of level of production or sale. It does not change with the increase or decrease of the number of units produced or sold. It is the cost that the company has to pay even when there is no production. For example: Rent,machinery,salaries, insurance, property taxes, amortization, depriciation etc.

The per unit fixed cost changes with the change in level of production or sale but the total cost remains the same throughout.

Variable Cost:

Variable cost is the expenses that varies with the level of production or sale. This cost increases with increase in production or sale and decreases with decrease in production or sale of goods. For example : Material, freight, commission etc.

The per unit variable cost remains the same with the change in level of production or sale but the total cost changes with the level of production or sale.

Use of these cost in budget process: To determine the total cost both the costs are necessary.

Total Cost = Total Fixed Cost (TFC) + Total Variable Cost (TVC)

• The fixed cost will remain same at any production level. Therefore after deciding the expenses, the whole expenses can be taken at any level of production.
• The variable cost will change with the level of production, therefore it should be changed as per the decided level of production.