The Difference Between Fixed Costs And Variable Costs You Should Know

In a business world, costs are one of the most important things in management accounting and cost accounting. The objectives obtained from the cost information, can be used as a process of planning, controlling and decision making.

The concept of cost is defined as the cash or cash equivalent value sacrificed to obtain goods or services, which are expected to provide current or future benefits to the organization.

However, in general, in management accounting, there are 2 (two) categories of costs, namely fixed costs and variable costs. Fixed costs and variable costs have some differences.

Variable costs and fixed costs are the two main costs that companies have when producing goods and services.

So it is important for companies to be able to distinguish the types of fixed costs and variable costs because they are related to the calculation and the way the company makes decisions. These costs will be incurred in the stages of the production process.

In order to achieve targets such as how many products are made or what equipment is used in the production process, the role of fixed costs and variable costs is needed in carrying out this activity.

Before issuing certain financing, the company needs to make an estimate of how much is needed, adjusted to production needs.

Definition of Fixed Costs

The definition of fixed costs are costs incurred by a company in a constant state or generally do not change even though there is an increase or decrease in the number of goods or services produced.

So it can be said that fixed costs are not affected at all with the business activities or regardless of changes in business activities carried out by the company.

In a fixed cost, there are 2 types of fixed costs themselves, namely committed fixed costs and discretionary fixed costs. Some examples contained in fixed costs are building rental costs, employee salaries, taxes, insurance costs, excise fees (if the product is shipped overseas), loan payments, and so on.

In a fixed cost that is always constant does not mean the fixed costs will always be constant. However, fixed costs may change at any time in the future.

Examples of fixed costs include:

  • Depreciation in accounting is the gradual and systematic assignment of the cost of tangible assets (such as production equipment) over their useful lives.
  • Insurance is a periodic fee based on an insurance contract.
  • Interest Expenses, what is meant by interest expense is the cost of funds lent to the company by the lender. However, this interest expense is classified as a fixed cost if a fixed interest rate is included in the loan agreement.
  • Property Tax, a property tax is a tax levied on a company by the local government, which is based on the cost of its assets.
  • Rent (Rental Fee), rental fee referred to here is a periodic fee for the use of other people’s real estate (offices, factories, warehouses) used by the company in carrying out its operations.
  • Salary, salary is a fixed amount of compensation paid to employees.
  • Utility (Utilities) examples of utility costs are the cost of electricity, gas, telephone and so on. In this cost has a variable element, but mostly fixed.

Based on its function, then fixed costs can be interpreted as the costs that are always be constant until a certain period. A period during which costs can be increased or decreased by the parties concerned but the changes occur in a fairly long period of time.

Definition of Variable Costs

Variable costs are that are always changing in the production process. This change in cost depends on the volume of goods or products produced by a company.

The greater the volume of products produced by a company, the greater the costs that must be incurred to produce these products. But vice versa, if the volume of product produced is small, the costs incurred are also small.

And it can be said that variable costs depend on fluctuations in business activity in producing goods by a company.

The examples contained in variable costs are:

  • Direct Material

    Materials related to the direct production process or commonly referred to as raw materials. Direct materials can change according to the number of products that have been produced.

  • Direct Labor

    Labor directly involved in the production of a product. Labor will be paid when it produces a product. However, only temporary workers whose wages are included in variable costs.

  • Fulfillment of Production Equipment Needs

    Materials needed for the running of the production process equipment. Like oil for production machines, or electricity for machines.

  • Labor Overtime Wages

    Labor overtime wages calculated from the number of hours spent by workers for overtime while working will be calculated as a variable cost.

  • Commission

    The commission is calculated for every successful sale of a product with a certain amount, because it changes based on the number of production and sales.

Difference between Fixed Cost and Variable Cost

As mentioned above regarding the meaning of fixed costs and variable costs, it is important to know what is the difference between fixed costs and variable costs. This is related to budgeting and calculating various other needs. The differences between fixed costs and variable costs are as follows:

  • Based on Understanding

    You can see the difference based on the understanding of fixed costs and variable costs, fixed costs are costs that remain the same amount, regardless of the volume of production or services produced. That is, when the volume is high or low, the required cost remains the same. Fixed costs are not affected by momentary fluctuations that may occur. While variable costs are costs that also change. These changes go hand in hand with changes in output or production output.

  • Based on Assessment

    Meanwhile, based on the assessment, fixed costs are related to time. However, variable costs are related to volume. This assessment will determine the amount of fixed cost and variable costs when the production process is carried out.

  • Occurrence Time

    The difference between fixed costs and variable costs can be seen based on the time of occurrence of the two costs. Considering the fact that the fixed costs do not change or the amount remains the same. So, the nature of fixed costs is definite. Even if no units are produced, the costs will remain the same.

    On the other hand, variable costs will only be incurred when there is a production process. If there is no production process, the company may not incur variable costs at all.

  • Based on Unit Cost

    Unit costs for fixed costs can change the unit price of each unit produced. If the production process produces many units, the fixed costs will decrease per unit.

    And vice versa, if the units produced are few, fixed costs can rise. In fixed costs, the unit cost is inversely proportional to the number of units produced.

    While in variable costs, the amount will remain the same in terms of production per unit. Regardless of the number of units produced, variable costs will run like this.

  • Behavior Based

    For fixed costs, the behavior or nature remains constant for a certain period of time. Meanwhile, for variable costs, there will be changes in line with the rise and fall of the level of production or output carried out.

Cost Composition

In fixed costs, there are compositions such as fixed production overhead, fixed selling costs, distribution overhead, to fixed administrative costs.

While variable costs involve expenditures for direct labor, direct materials, direct costs, sales variables, production overhead variables, to distribution overhead. You can see from the example, it is clear that there is a difference between fixed costs and variable costs.

  • Factory Overhead Cost

    What is meant by factory overhead costs are all production costs other than direct material costs and direct labor costs. This material cost consists of indirect material costs, indirect labor costs and all costs that cannot be directly assigned to products or jobs.

    Or rather all production costs which are included in indirect material costs, indirect labor costs and other production costs that are not easily identified or distinguished directly in a production process.

    Goods (Items) factory overhead costs are very much, so that when viewed from the behavior of costs, classification can be arranged as fixed costs and variable costs. And although basically there are semi-variable costs that contain criteria as variable costs and fixed costs.

    So to facilitate cost calculation and cost control, the semi-variable cost classification is further broken down into fixed costs and variable costs. These costs have a very important role in the survival of businesses and companies.

  • Production cost

    Production costs are an activity to transform the factors of production, so that they can increase or add the form, time and place of an item or service to meet human needs obtained through exchange.

    And it can be interpreted that production is a process of converting inputs into outputs so that the value of these goods increases. inputs can consist of goods or services used in the production process, while outputs are goods or services produced from a production process.

    So production does not have to mean a process of changing other goods, as is the case in a factory. So the service of transporting or shipping and storing goods is also an example of a production process because both add value. The person who performs this process is called the producer.

    The goal of the company is to maximize profit. This is the background why production costs are important. Those of you who are trying to start your own business can find out the profit or loss of the company by comparing the production costs with the income or net income obtained.

    In addition, by understanding the concept of production costs, you will be easy to make short-term decisions. Short-term decisions such as the need to purchase raw materials. The second is determining the price of goods when they are sold.

As a business owner, it is very important to track and better understand how various costs change with changes in volume and levels of output. The breakdown of these costs determines the price level of the service and helps in many other aspects of the overall business strategy.

This type of both fixed and variable costs is also a key ingredient for the various costing methods used by businesses, including job order costing, activity-based costing and process costing.

But from some of the things mentioned above, it is clear that the two costs are very opposite and have differences from each other, and they are not the same in any way.

So it is important for you to know the difference between these two things for the development of your business. In addition, in recording these two costs, you can also use financial recording software to make it easier.

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