Costing a Design Job
Fixed Cost
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In management accounting, 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 retailer must
pay rent and utility bills irrespective of sales.
In marketing, 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.
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. Discretionary fixed costs 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 practices
such as activity-based costing 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, 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.
Capital costs
Capital
costs are
fixed, one-time expenses incurred on the purchase of land, buildings, construction, and equipment used
in the production of goods or in the
rendering of services. Put simply, it is
the total cost needed to bring a project to a commercially operable status.
Whether a particular cost is capital or not depend on many factors such
as accounting, tax, and materiality.
Capital costs include expenses for tangible goods such
as the purchase of plants and machinery, as well as expenses for intangibles
assets such as trademarks and software development.
Capital costs are not limited to the initial
construction of a factory or
other business. Namely, the purchase of a new machine to
increase production and last for years is a capital cost. Capital costs do not
include labour costs (they do include construction labour).
Unlike operating
costs, capital costs are one-time expenses but payment may
be spread out over many years in financial reports and tax returns. Capital
costs are fixed and are therefore independent of the level of output.
- Purchase
of the land upon which the plant is built
- Permits
and legal costs
- Equipment
needed to run the plant
- Costs
involving the construction of the plant
- Financing
and commissioning the plant (prior to commercial operation)
They do not include the cost of the natural gas, fuel
oil or coal used
once the plant enters commercial operation or any taxes on
the electricity that
is produced. They also do not include the labour used to run the plant or the labour
and supplies needed for maintenance.
Government
generally provides subsidies through investments and partnerships in the initial
capital costs of research and
manufacturing infrastructure that cannot be matched by investor-owned
companies.
Variable Costs
Variable costs are expenses that
change in proportion to the activity of a business. Variable cost is the sum
of marginal
costs over all units produced. It can also be considered
normal costs. Fixed
costs and variable costs make up the two components
of total
cost. Direct Costs, however, are costs that
can easily be associated with a particular cost
object. However, not all variable costs are direct
costs. For example, variable manufacturing overhead costs are variable
costs that are indirect
costs, not direct costs. Variable costs are sometimes
called unit-level costs as they vary with the number of units produced.
Direct labour and overhead are often called conversion
cost, while direct material and direct labour are often referred to
as prime cost. In marketing, 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.
For example, a firm pays for raw materials. When
activity is decreased, less raw material is used, and so the spending for raw
materials falls. When activity is increased, more raw material is used and
spending therefore rises. Note that the changes in expenses happen with little
or no need for managerial intervention. These costs are variable costs.
A company will pay for line rental and maintenance
fees each period regardless of how much power gets used. And some electrical
equipment (air conditioning or lighting) may be kept running even in periods of
low activity. These expenses can be regarded as fixed. But beyond this, the company
will use electricity to run plant and machinery as required. The busier the
company, the more the plant will be run, and so the more electricity gets used.
This extra spending can therefore be regarded as variable.
In retail the cost of goods is almost entirely a
variable cost; this is not true of manufacturing where many fixed costs, such
as depreciation, are included in the cost of goods.
Although taxation usually varies with profit, which in
turn varies with sales volume, it is not normally considered a variable cost.
For some employees, salary is paid on monthly rates,
independent of how many hours the employees work. This is a fixed cost. On the
other hand, the hours of hourly employees can often be varied, so this type of
labour cost is a variable cost.
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