Question

. Fixed Costs, Variable Costs, Total Costs, Revenues are used to estimate profitability. This is an intersection with Economics and Accounting. Explain how they are derived and used for both disciplines.

Answer 1

In economics and accounting we use the concept of different types of cost, revenues and profitability.

In economics fixed cost is that type which do not changes with production and it remains fixed with production. For example we can say initial machinery cost, fixed rent or land cost. Variable cost is a cost which changes with production and it varies with level of production. For example we can say labour cost, raw material cost.

In economics by revenue we mean total volume of sales i.e product price or selling price multipled by total production or total output sold. We have not considered any inventory. Total production equal total sales. So specifically revenue is total monetary of selling output. It will be TR = P*Q, where TR is total revenue, P= selling price per unit, Q= Total quantity sold.

In economics profit is calculated by Total revenue minus total cost. Total cost is equal to total fixed cost plus total variable cost. So profit = TR - TC or P*Q - Fixed Cost - Variable cost.

In accounting analysis fixed cost is that cost which remains constant in business. It doesn't changes with running of business. The investment in constructing the plant and machinery cost is a type of fixed cost. All indirect cost like indirect material cost, indirect labour cost will come under this category. Different types indirect expenses like fixed rent, fixed insurance, fixed taxes will come under this.

In accounting variable cost are those cost which includes direct material cost, direct labour cost and direct expenses. This variable cost actually function of quantity of output or volume of business activity. Direct material cost are those cost of materials which are directly used or consumed in production process. In accounting this direct material cost plus direct labour cost and direct expenses are called prime cost.

In accounting total cost of production is factory cost plus office and administrative overheads. Factory cost is equal to prime cost plus factory overheads. Overhead costs are those cost which are mainly indirect cost.

Revenue in accounting analysis is the total cost of sales plus profit. Cost of goods sold is equal to cost of production plus net stock of production plus selling and distribution overhead cost. Revenue is total quantity sold multipled by selling price. Selling price per unit is equal to total sales divided by total quantity sold.

In accounting profitability analysis are done on the basis of some ratios. For example we can say net profit margin ratio, return on asset ratios. Net profit margin ratio = (Net income /sales)*100. Return on assets ratio is net income divided by total assets multipled by 100. In accounting there is also calculated gross profit margin ratio and it is equal to gross profit divided by sales multipled by 100.