Question

Answer the following question in your own words. Your answer must have a 150 minimum word count:

• Explain the difference between fixed costs and variable costs. Describe their significance and give examples of each one.

Answer 1

Fixed costs are those which remain constant irrespective of the level of production/activity. Variable costs are those which vary in proportion to their level of activity. The understanding of the difference between fixed and variable costs is important to determine the breakeven point as well as to understand the optimum level of activity.

For example: a business unit would have various costs such as rental expenses, depreciation, etc. These costs are fixed irrespective of whether the business produces hundred units of output or 200 units of output. Even if there is zero activity, the fixed costs have to be incurred. On the other hand, there will be variable costs such as cost of material and labour, selling expenses,etc. These are the costs which vary in proportion to the quantity produced by the business. So if the cost of material is $1.00 per unit, the total material cost will be $100 if hundred units are produced and $200 if 200 units are produced.