Cost Accounting
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Fixed Cost
Fixed costs are costs that are constant from month to month. Fixed cost remains the same regardless of your level of sales. Depending on your type of business, some typical examples would be rent, interest on debt, plant and equipment expenses, and salary of permanent full-time workers. Fixed cost are cost the must be paid whether or not we open five days or seven. A fixed cost is a cost that is independent of a firm’s output level. In the short run, all firms have fixed costs even if the firm is producing nothing. There are no fixed costs in the long run. Below is the graph for fixed cost:
Fixed cost graph
The first example of a fixed cost for a car manufacturer introducing a new engine is the cost of insuring the factory that is used to manufacture the new engine. Insurance for the company is actually a promise of compensation for specific potential future losses in exchange for a periodic payment. Insurance for a factory is designed to protect the financial well-being the company in the case of unexpected loss. Agreeing to the terms of an insurance policy creates a contract between the insured and the insurer. In exchange for payments from the insured (called premiums), the insurer agrees to pay the policy holder a sum of money upon the occurrence of a specific event. In most cases, the policy holder pays part of the loss (called the deductible), and the insurer pays the rest. An insurance is a fixed cost as the company has to pay the amount stated as signed in the insurance policy and the amount is paid annually remains the same and will not vary in line with the numbers of cars produced. The second example of fixed cost for a car manufacturer introducing a new engine is the engine certification cost. There is a certain ruling where abut a company has to certify a new car engine that is produced. The engine produced must be certified by the government to make sure that it meets the requirements especially the amount of emission produced by the new engine as it is a measure that is used to protect the environment and also to make sure the engine is safe to be used. Manufacturers will incur more than the normal level of certification costs during the first few years of implementation because engines will need to be certified to the emission standards using the test procedures.
Variable Cost
Variable costs are expenses that change in direct proportion to the activity of a business. Variable costs are corporate expenses that vary in direct proportion to the quantity of output. Unlike