Fixed Vs Variable Cost

Cost analysis and understanding the nature of cost behavior are extremely important for a management accountant. These factors allow us to estimate potential costs and levels of production as we monitor current costs and productions. Costs are a major factor towards decision making within any business. How can we reduce costs and still boost revenue? Are we able to cut prices to boost worth for the consumer? All our decisions about cost are aimed towards maximizing our profit and getting the most out of our business (Atkinson, Kaplan, Matsumura, & Young, 2007).

Fixed costs are expenses which are required to be paid no matter what the flow of business. Some of our fixed costs include rent, utilities, and insurance. While the amount due may fluctuate each month, their fixed status comes from the fact that they will be due each month. In comparison, variable costs are costs which fluctuate based on production levels. These kinds of costs are relative to inventory or in Claire’s Antiques case, the purchase of flexible resources such as wood, brackets and clock mechanisms. If the product is not being made, the product would not be purchased and thus, money not spent (Atkinson, Kaplan, Matsumura, & Young, 2007).

The advantages of fixed costs include a reliable accounting structure. Our books will be neat and clean concerning cost and expense for the month. It would be easy to determine how much we need to sell to break-even or make a profit. However, should an unexpected increase in demand for one or more of our products occur, it could cause a shift in this perfectly balanced equilibrium. Dictated by fixed costs, we would be unable to create more of the product needed in an appropriate time period. In the adverse situation where sales decline for a number of weeks, Claire’s Antiques would be left holding the bag with the additional merchandise produced and left unsold. To make up for the decrease in sales, our amount needed to be sold to make a profit would be larger than the last term (Atkinson, Kaplan, Matsumura, & Young, 2007).

This is where we see the advantages of having variable costs as well. In keeping our cost of raw materials variable, we are able to produce only what is needed. Of course, this doesn’t allow for ends to be tied up as neat and easy as fixed costs would. However, variable costs would allow us to measure success and short-comings, as well as test new products more easily (CTU, 2007).

As you can see, there are pros and cons to each type of cost and monthly expense. Assuming that all expenses are variable would underestimate costs since it will not report for the cost of unused or unsold product. Assuming all costs are fixed will overestimate costs since it will not account for the flexible resources that the organization will need. It is my position that Claire’s Antiques continue with its’ current mixed cost analysis to continue with successful business (Atkinson, Kaplan, Matsumura, & Young, pg 33, 2007).

References:

Atkinson, A., Kaplan, R., Matsumura, E. & Young, S. (2007) Management Accounting. (5^th ed.) Upper Saddle River, NJ: Pearson Education, Prentice Hall.

Colorado Technical University Online. (2006) Managerial Accounting Practices: Phase 2 Course Material. Retrieved on September 8, 2007 from https://campus.ctuonline.edu/MainFrame.aspx?ContentFrame=/Classroom/course.aspx?Class=23719&tid;=39