Fixed cost

Fixed cost

Overview
In economics, fixed costs are business expenses that are not dependent on the level of goods or services produced by the business. They tend to be time-related, such as salaries or rents being paid per month, and are often referred to as overhead costs. This is in contrast to variable costs, which are volume-related (and are paid per quantity produced).

In management accounting
Management accounting
Management accounting or managerial accounting is concerned with the provisions and use of accounting information to managers within organizations, to provide them with the basis to make informed business decisions that will allow them to be better equipped in their management and control...

, fixed costs are defined as expenses that do not change as a function of the activity of a business, within the relevant period.
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Encyclopedia
In economics, fixed costs are business expenses that are not dependent on the level of goods or services produced by the business. They tend to be time-related, such as salaries or rents being paid per month, and are often referred to as overhead costs. This is in contrast to variable costs, which are volume-related (and are paid per quantity produced).

In management accounting
Management accounting
Management accounting or managerial accounting is concerned with the provisions and use of accounting information to managers within organizations, to provide them with the basis to make informed business decisions that will allow them to be better equipped in their management and control...

, fixed costs are defined as expenses that do not change as a function of the activity of a business, within the relevant period. For example, a retail
Retail
Retail consists of the sale of physical goods or merchandise from a fixed location, such as a department store, boutique or kiosk, or by mail, in small or individual lots for direct consumption by the purchaser. Retailing may include subordinated services, such as delivery. Purchasers may be...

er must pay rent and utility bills irrespective of sales.

In marketing
Marketing
Marketing is the process used to determine what products or services may be of interest to customers, and the strategy to use in sales, communications and business development. It generates the strategy that underlies sales techniques, business communication, and business developments...

, it is necessary to know how costs divide between variable and fixed. This distinction is crucial in forecasting the earnings generated by various changes in unit sales and thus the financial impact of proposed marketing campaigns. In a survey of nearly 200 senior marketing managers, 60 percent responded that they found the "variable and fixed costs" metric very useful.

Areas of confusion


Fixed costs are not permanently fixed; they will change over time, but are fixed in relation to the quantity of production for the relevant period. For example, a company may have unexpected and unpredictable expenses unrelated to production; and warehouse costs and the like are fixed only over the time period of the lease.

By definition, there are no fixed costs in the long run. Investments in facilities, equipment, and the basic organization that can't be significantly reduced in a short period of time are referred to as committed fixed costs. Discretionary fixed costs usually arise from annual decisions by management to spend on certain fixed cost items. Examples of discretionary costs are advertising, machine maintenance, and research & development expenditures. it can be expensive.
In business planning and management accounting, usage of the terms fixed costs, variable costs and others will often differ from usage in economics, and may depend on the intended use. Some cost accounting
Cost accounting
Cost accounting information is designed for managers. Since managers are taking decisions only for their own organization, there is no need for the information to be comparable to similar information from other organizations...

 practices such as activity-based costing
Activity-based costing
Activity-based costing is a special costing model that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each...

 will allocate fixed costs to business activities, in effect treating them as variable costs. This can simplify decision-making, but can be confusing and controversial.
In accounting terminology, fixed costs will broadly include almost all costs (expenses) which are not included in cost of goods sold
Cost of goods sold
Cost of goods sold refers to the inventory costs of those goods a business has sold during a particular period. Costs are associated with particular goods using one of several formulas, including specific identification, first-in first-out , or average cost...

, and variable costs are those captured in costs of goods sold. The implicit assumption required to make the equivalence between the accounting and economics terminology is that the accounting period is equal to the period in which fixed costs do not vary in relation to production. In practice, this equivalence does not always hold, and depending on the period under consideration by management, some overhead expenses (e.g., sales, general and administrative expenses) can be adjusted by management, and the specific allocation of each expense to each category will be decided under cost accounting
Cost accounting
Cost accounting information is designed for managers. Since managers are taking decisions only for their own organization, there is no need for the information to be comparable to similar information from other organizations...

.