Fixed costs in total do not change based on activity volume, but the fixed cost per unit of activity does fluctuate. When the activity level is higher, the fixed cost per unit is lower, and when the activity level is lower, the fixed cost per unit is higher. There are two types of fixed costs. They are committed fixed costs and discretionary fixed costs.
Committed fixed costs are fixed costs that cannot be changed easily or quickly. Some examples of these are depreciation, property taxes, pension benefits, and long-term leases. An example of trying to change a committed fixed cost would be when a business acquires a new plant in order to increase manufacturing capacity. The fixed cost of depreciation would be increased. Discretionary fixed costs are fixed costs that can be reduced or eliminated fairly quickly and easily. Some examples of discretionary fixed costs are administrative salaries, office or factory rent, research and development expenses, and advertising.
Fixed costs are included in the manufacturing overhead, which is all manufacturing costs besides direct materials and direct labor. The fixed costs included in manufacturing overhead relate to the costs for operating the production and manufacturing facilities. These are also known as capacity or occupancy costs.
A company prepares a manufacturing overhead budget for each year. The manufacturing overhead budget includes both variable and fixed overhead costs. Fixed overhead costs are estimated based on prior years’ experience and expected changes. In the fixed overhead budget, fixed costs are shown for several items, including depreciation, supervision, maintenance, insurance, property taxes, and other costs. The manufacturing overhead budget is used to compute an overhead amount per unit of production.
An important computation used in cost accounting is the break-even point. The break-even point is the level of activity where total costs equal total revenues. For break-even analysis, total costs needs to be broken down into fixed costs and variable costs, so at the break-even point total revenue equals fixed costs plus variable costs. Normally, revenue is shown as selling price per unit times the number of units sold. Also, variable cost is shown as variable cost per unit times number of units. Therefore, the break-even point is expressed as selling price per unit times number of units equals fixed costs plus variable cost per unit times number of units.
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