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Chapter 2: Problem 5

Define variable cost and fixed cost. Give an example of each.

Short Answer

Expert verified
Variable cost is a cost that changes in proportion to the amount of goods or services being produced by a business, such as the cost of raw materials. Fixed cost is a cost that remains constant and does not change with the level of goods or services being produced, like the monthly rent of a business facility.

Step by step solution

01

Definition of Variable Cost

Variable cost is the cost that changes in proportion to the amount of goods or services being produced by a business. This means that as the level of production increases or decreases, the variable cost will also increase or decrease accordingly. Variable costs are essential for a business to operate and often directly linked to the cost of materials, labor, or production.
02

Example of Variable Cost

An example of variable cost can be the cost of raw materials required to produce a product in a manufacturing unit. As the number of units produced increases, the cost of raw materials will also increase proportionally.
03

Definition of Fixed Cost

Fixed cost is a cost that remains constant and does not change with the level of goods or services being produced by a business within the relevant period. This means that regardless of the level of production, the fixed costs will remain the same. Fixed costs are often associated with the infrastructure and administrative aspects of a business.
04

Example of Fixed Cost

An example of fixed cost can be the monthly rent of a business facility. Whether the business produces one unit or one thousand units of their product, the rent stays the same and does not change with the level of production.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Variable Cost
Variable costs are those expenses that change in direct proportion to the production volume of a business. Unlike fixed costs, variable costs fluctuate based on the company鈥檚 operational activities.
For instance, if a company needs to make more products, it will likely spend more on materials and labor. The core reason for this change is that these costs are closely tied to the actual manufacturing process.
  • Basic Example: Consider a bakery that uses flour to make bread. The more bread they produce, the more they spend on flour.
  • Key Factors: Includes cost of raw materials, production supplies, and direct labor costs.
Understanding variable costs helps businesses to price their products adequately and scale operations smoothly.
Fixed Cost
Fixed costs remain unchanged, no matter how much a business produces. These are regular expenses that occur independently from production levels.
This means even if production halts momentarily, the business must still pay these expenses.
  • Typical Examples: Rent for facility space, salaries of permanent staff, and insurance.
  • Characteristic: These costs provide a financial baseline, which businesses can plan around confidently.
Fixed costs are critical for budgeting as they are predictable and easier to forecast. This stability aids in long-term financial planning and helps maintain operational consistency.
Production Cost Analysis
Production cost analysis is a comprehensive evaluation of all costs associated with manufacturing a product. This analysis helps businesses identify all expenses involved in the creation of goods and how they contribute to the overall cost structure.
It encompasses both fixed and variable costs and is critical for setting competitive pricing and boosting profitability.
  • Components: Includes direct materials, direct labor, and overhead costs.
  • Benefits: Assists in identifying areas for cost reduction and efficiency improvements.
  • Process: Involves comparing actual costs against budgeted costs to gauge performance.
Understanding production cost analysis empowers businesses to make data-driven decisions which align with their financial goals.
Business Finance
Business finance refers to the management of funds and financial activities within a company. It involves planning, directing, monitoring, organizing, and controlling of the financial resources to achieve business objectives.
Both variable and fixed costs are vital components of business finance as they affect the company鈥檚 profit margins and budget planning.
  • Core Activities: Involves investment decisions, financing decisions, and dividend decision.
  • Strategic Significance: Determines how much capital is required and how it should be acquired.
  • Financial Health: Ensures that the business can sustain and grow while meeting its obligations.
Effectively managing business finance helps ensure business stability and long-term success. It bridges the gap between technical operational plans and financial performance.

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Most popular questions from this chapter

Total and unit cost, decision making. Gayle's Glassworks makes glass flanges for scientific use. Materials cost \(\$ 1\) per flange, and the glass blowers are paid a wage rate of \(\$ 28\) per hour. A glass blower blows 10 flanges per hour. Fixed manufacturing costs for flanges are \(\$ 28,000\) per period. Period (nonmanufacturing) costs associated with flanges are \(\$ 10,000\) per period and are fixed. 1\. Graph the fixed, variable, and total manufacturing cost for flanges, using units (number of flanges) on the \(x\) -axis. 2\. Assume Gayle's Glassworks manufactures and sells 5,000 flanges this period. Its competitor, Flora's Flasks, sells flanges for \(\$ 10\) each. Can Gayle sell below Flora's price and still make a profit on the flanges? 3\. How would your answer to requirement 2 differ if Gayle's Glassworks made and sold 10,000 flanges this period? Why? What does this indicate about the use of unit cost in decision making?

Labor cost, overtime, and idle time. David Letterman works in the production department of Northeast Plastics (NEP) as a machine operator. David, a long- time employee of NEP, is paid on an hourly basis at a rate of \(\$ 24\) per hour. David works five 8 -hour shifts per week Monday-Friday (40 hours). Any time David works over and above these 40 hours is considered overtime for which he is paid at a rate of time and a half \((\$ 36\) per hour). If the overtime falls on weekends, David is paid at a rate of double time (\$48 per hour). David is also paid an additional \(\$ 24\) per hour for any holidays worked, even if it is part of his regular 40 hours. David is paid his regular wages even if the machines are down (not operating) due to regular machine maintenance, slow order periods, or unexpected mechanical problems. These hours are considered "idle time." During December David worked the following hours: Included in the total hours worked are two company holidays (Christmas Eve and Christmas Day) during Week \(4 .\) All overtime worked by David was Monday- Friday, except for the hours worked in Week 3 ; all of the Week 3 overtime hours were worked on a Saturday. 1\. Calculate (a) direct manufacturing labor, (b) idle time, (c) overtime and holiday premium, and (d) total earnings for David in December. 2\. Is idle time and overtime premium a direct or indirect cost of the products that David worked on in December? Explain.

Classification of costs, service sector. Market Focus is a marketing research firm that organizes fo cus groups for consumer-product companies. Each focus group has eight individuals who are paid \(\$ 60\) per session to provide comments on new products. These focus groups meet in hotels and are led by a trained independent marketing specialist hired by Market Focus. Each specialistis paid a fixed retainer to conductt a minimum number of sessions and a per session fee of \(\$ 2,200\). A Market Focus staff member attends each session to ensure that all the logistical aspects run smoothly. Classify each cost item (A-H) as follows: a. Direct or indirect (D o r I) costs of each individual focus group b. Variable or fixed (V or F) costs of how the total costs of Market Focus change as the number of focus groups conducted changes. (If in doubt, select on the basis of whether the total costs will change sub stantially if there is a large change in the number of groups conducted. You will have two answers (D or l; V or F) for each of the following items: Cost Item. A. Payment to individuals in each focus group to provide comments on new products. B. Annual subscription of Market Focus to Consumer Reports magazine. C. Phone calls made by Market Focus staff member to confirm individuals will attend a focus group session (Records of individual calls are not kept.) D. Retainer paid to focus group leader to conduct 18 focus groups per year on new medical products. E. Recruiting cost to hire marketing specialists. F. Lease payment by Market Focus for corporate office. G. cost of tapes used to record comments made by individuals in a focus group session (These tapes are sent to the company whose products are being tested.) H. Gasoline costs of Market Focus staff for company-owned vehicles (Staff members submit monthly bills with no mileage breakdowns.) I. costs incurred to improve the design of focus groups to make them more effective.

Total costs and unit costs, service setting. National Training recently started a business providing training events for corporations. In order to better understand the profitability of the business, the owners asked you for an analysis of costs- -what costs are fixed, what costs are variable, and so on, for each training session. You have the following cost information: Trainer: \(\$ 11,000\) per session Materials: \(\$ 2,500\) per session and \(\$ 35\) per attendee Catering costs (subcontracted): Food: \(\$ 75\) per attendee Setup/cleanup: \(\$ 25\) per attendee Fixed fee: \(\$ 5,000\) per training session National Training is pleased with the service they use for the catering and have allowed them to place brochures on each dinner table as a form of advertising. In exchange, the caterer gives National Training a \(\$ 1,000\) discount per session. 1\. Draw a graph depicting fixed costs, variable costs, and total costs for each training session versus the number of guests. 2\. Suppose 100 persons attend the next event. What is National Training's total net cost and the cost per attendee? 3\. Suppose instead that 175 persons attend? What is National Training's total net cost and the cost per attendee? 4\. How should National Training charge customers for their services? Explain briefly.

Cost of goods purchased, cost of goods sold, and income statement. The following data are for Arizona Retail Outlet Stores. The account balances (in thousands) are for 2017 . Marketing and advertising costs \(\quad\) \(\$ 55,200\) Merchandise inventory, January 1, 2017 \(\quad\) 103,500 Shipping of merchandise to customers \(\quad\) 4,600 Depreciation on store fixtures \(\quad\) 9,660 Purchases \(\quad\) 598,000 General and administrative costs \(\quad\) 73,600 Merchandise inventory, December 31, 2017 \(\quad\) 119,600 Merchandise freight-in \(\quad\) 23,000 Purchase returns and allowances \(\quad\) 25,300 Purchase discounts \(\quad\) 20,700 Revenues \(\quad\) 736,000 1\. Compute (a) the cost of goods purchased and (b) the cost of goods sold. 2\. Prepare the income statement for 2017
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