Question

This week you were introduced to managerial accounting and cost methods. Discuss the differences between fixed, mixed and variable costs by providing two examples of each type of cost. Why is it important for managers to understand the differences in these costs?

Answer 1

(a) Fixed costs – These are the costs which are incurred for a period, and which, within certain output and turnover limits, tend to be unaffected by fluctuations in the levels of activity (output or turnover). They do not tend to increase or decrease with the changes in output.
For example, rent, insurance of factory building etc., remain the same for different levels
of production.
(b) Variable Costs – These costs tend to vary with the volume of activity. Any increase in the activity results in an increase in the variable cost and vice-versa. For example, cost of direct labour, etc.

(c) Mixed cost refers to the cost and expenses that consists of two components, A fixed component the total of which does not change as the volume of activity changes. A variable component, the total of which changes as proportion to the change in the volume of activity. For example, operating license, insurance, parking etc.

It is important for managers to understand the difference in above costs as follows.

In economics, variable costs and fixed costs are two main costs a company has When producing goods and services. A variable cost varies with the amount produced, while a fixed cost remains the same, no matter how much the company produces.