Assessment Description:

Explain the difference between fixed and variable costs and give two examples of each. Can a company budget for variable costs? Explain.

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SOLUTION to ACC 240: Fundamentals of Accounting- Topic 5 DQ 1.

Hello class,

There are two broad categories of cost that businesses encounter in their operations, they include; fixed costs and variable costs. Gold et al., (2022) has classified fixed costs as those that are incurred regardless of the level of production or sales, and do not vary in the short-run in response to changes in the level of output or sales-revenue. Examples of fixed costs include rent or lease payments for facilities and salaries of permanent staff. Conversely, variable cost is defined as costs that fluctuate with the activity level, that is, costs that increase or decrease with the amount of production or sales volume (Gold et al, 2022). This implies that if the level of output increases, the variable costs also increase on the same note, if the level of output decreases, it is mirrored with the decrease in the variable costs. Some examples of variable costs include material costs which are used in the manufacturing process, and commissions that are paid to the sales agents. According to Syahputri et al. (2023) it is essential to differentiate between these two costs due to different financial analyses such as break-even analysis and cost-volume-profit analysis.

Even though companies are well aware of fixed costs since they are relatively easier to budget due to their nature, it is a fact that companies can actually budget for variable costs as well. Variable costs are usually estimated by assuming the level of production or sales for the given period and then determining the cost according to the experiences or the norms of the specific industry. This process is known as flexible budgeting and it allows companies to create budgets that adapt to different levels of activity (Syahputri et al., 2023). To control variable costs, companies apply methods such as cost-volume analysis to recognize trends and costs changes, regression analysis to define cost patterns and relations, and activity-based costing to assign costs in a more precise manner (Syahputri et al., 2023).

In regard to the information above, I believe that companies that analyze their fixed and variable costs are in a better position to control their costs and make right estimations with regards to production levels and resource allocation. On the one hand, fixed costs are predictable and certain, making them easy to budget for and incorporate into revenue predictions; on the other hand, variable costs require competent handling in as much as their adjustment best suits the changing needs or responding to challenges within the market.

References

Gold, H. T., McDermott, C., Hoomans, T., & Wagner, T. H. (2022). Cost data in implementation science: categories and approaches to costing. Implementation Science, 17(1), 11. https://doi.org/10.1186/s13012-021-01172-6

Syahputri, D. R. A., Audrine, K., Darmawan, L. V., & Muda, I. (2023). Flexible budget as a development tool for manufacturing industry. Brazilian Journal of Development, 9(12), 31340-31355.  https://doi.org/10.34117/bjdv9n12-053