Fixed Cost

Definition

Fixed cost is economic resources forgone in production of a particular product whereby the condition of forgoing such resources is based on discretionary bases. That is out of choice. This means that if the cost will be at a certain level (fixed) it is because it has been decided so by the management.

This criterion advocates that the monetary value of the cost element that comprise of a particular product may change or may not change when the production volumes change. Such that in some cases, the cost element may remain constant even when output of a product is varied or may change in a certain manner or proportion. So, in this case, it means that a cost element can be categorized as fixed cost because the management has decided so and at the same time the same type of cost may be classified to be variable cost based on the prevailing circumstances. Therefore, under this criterion, we have three categories of costs

i). Variable cost

ii). Semi-variable

iii). Fixed costs

Fixed cost is the cost element of a product that has a behavior of remaining constant or unchanging character such that when the volumes of production change, the cost element remain the same. in other words, its value is fixed. Examples are monthly salary, rent expenses etc.

NB: Many students or scholars think fixed costs are just constant. This is not true for if we consider the aspect of decision making by the management, the so referred to as fixed cost also vary based on discretion criterion.

Before we consider each category of fixed cost, let us look at the meaning of this term “Discretion”

The term “Discretion” means at one’s will. Its upon one’s judgement to make a particular decision. In other words, one is at liberty to choose to or not to. So, on this basis, fixed cost may remain fixed or vary. With this kind of criterion, fixed cost can be further classified in to three categories;

i). Committed Costs-already decided costs

ii). Discretionary Costs-costs at the mercies of the management

iii). Step Costs-have a mixture of both constant and variable movement of the cost element.

Characteristics Of Fixed Cost

1. Constant all through all levels of production or constant at some point then vary and again become constant
2. Fixed cost is fixed based on set periodic time frame.
3. Fixed costs can fall under direct costs or overheads (i.e., indirect)
4. Part of total cot f production-fixed cost are part of total cost incurred or paid for the production of a good or service.

Advantages Of Fixed Cost

1. Controllable by the management. The management is at their discretion to vary the cost as they find it more suitable
2. Convenient in times of cash flow shortages. This is because in case there may be financial crisis, the management may decide to decline consumption of such costs
3. Suitable tool for general decision-making. These types of fixed costs are a good tool to use in decision making such as allocation of economic resources especially when the resources are scanty.

Disadvantages Of Fixed Cost

1. Misappropriation of funds-sometimes the management may misuse the organization’s resources for they have a leeway of incurring such expenses as they so wish even when the profitability is not guaranteed
2. Not applicable in some cases- For example, when there is a customer in demand of a particular quantity to be produced, the aspect of fixing the exact amount to be utilized may not fit in well.