Important Keyword: Fixed Costs, Income from Business & Profession, Income Tax Act.
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Classifying Costs: Fixed vs. Variable
In the realm of financial management, costs can be categorized in various ways, with one of the most common methods being classification according to fixed cost and variable cost. Unlike variable costs, which fluctuate based on the production or output of goods and services, fixed cost remains constant regardless of production levels. Additionally, fixed costs are often associated with specific time periods and typically do not undergo changes over time.
What is a Fixed Costs?
Understanding Fixed Cost in Business
In the realm of business management, fixed costs represent expenses that remain constant regardless of changes in production volume within a certain range. Unlike variable costs, which fluctuate based on operational activity, fixed cost remains stable as long as operations stay within a specific size. These costs are less controllable by an organization since they are not tied to volume or operational changes.
For instance, consider the rent on a building: regardless of the level of activity within that building, the rent amount remains unchanged until the lease term expires or is renegotiated. Similarly, other examples of fixed costs include insurance premiums, depreciation expenses, and property taxes. Fixed costs typically recur on a regular basis, making them period costs.
Furthermore, in marketing endeavors, it becomes crucial to discern between variable and fixed costs to comprehend how costs fluctuate based on their nature. This differentiation also holds significance in forecasting earnings, preparing financial reports, and drafting budgets for organizational operations.
Difference Between Fixed Cost and Variable Cost?
| Fixed Costs | Variable Costs | |
| Meaning | Fixed cost are expenses that remain constant for a period of time irrespective of the level of outputs. | Variable cost are expenses that change directly and proportionally to the changes in business activity level or volume. |
| Incurred when | Even if the output is nil, fixed costs are incurred. | The cost increases/decreases based on the output |
| Also known as | Fixed costs are also known as overhead costs, period costs or supplementary costs. | Variable costs are also referred to as prime costs or direct costs as it directly affects the output levels. |
| Nature | Fixed costs are time-related i.e. they remain constant for a period of time. | Variable costs are volume-related and change with the changes in output level. |
| Examples | Depreciation, interest paid on capital, rent, salary, property taxes, insurance premium, etc. | Commission on sales, credit card fees, wages of part-time staff, etc. |
Understanding the Nature of Fixed Cost
Fixed cost, although termed “fixed,” are not entirely immutable; rather, they exhibit variations over time. They are regarded as fixed within a specific contractual or relevant period. Take, for instance, a company’s warehouse costs, which may encounter unforeseen and irregular expenses unrelated to production activities.
Within the realm of fixed cost, there exist two distinct categories: fixed committed costs and discretionary fixed costs. Fixed committed costs pertain to expenses such as investments in infrastructure that cannot be significantly reduced within a limited timeframe. Conversely, discretionary fixed costs are contingent upon management decisions and can be adjusted as needed.
Examples of discretionary fixed cost encompass expenditures on advertising, insurance premiums, machine maintenance, and research and development initiatives. The management’s decisions regarding these discretionary costs can have a substantial impact on the company’s financial health and operational efficiency.
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Official Income Tax Return filing website: https://incometaxindia.gov.in/
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