I Like Accounting

Fixed or Variable Costs

Lesson
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A lot of people think that accounting is only concerned with the quantities of money coming in and going out.

The problem is that not every expense is the same.

Some expenses are going to happen no matter when a business does. A mortgage payment will be the same no matter how many goods a business produces.

Other expenses grow and shrink based upon the number of goods being produced. Costs for labor and materials will grow as the number of items produced grows.

The concept is so important, there are even terms for it:

  • Fixed costs - The costs remain the same no matter production levels.
  • Variable costs - The costs change as production increases or decreases.

If you are confused as to whether an item is fixed or variable, ask the following question:

If you wanted to produce nothing next month, would you still have to pay for a given expense?

  • Fixed costs - You have to pay even if producing nothing.
  • Variable costs - You don't hve to pay anything.
Question
You're a cost accountant, trying to understand how your firm's costs will change as production increases.

The only relevant information you've discovered is as follows:

  • The firm must purchase inventory

Is the item labeled inventory a variable cost or a fixed cost?
Answer
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👉 Answer:

  • Inventory is a variable cost.

👩‍🎓 This is how we solve it:

  1. Ask yourself if you'd have to buy more of the inventory to produce more goods.
  2. In this case, the answer is yes.
  3. So, therefore, it must be a variable good.
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