In managerial accounting, costs by their behavior are classified as fixed cost, variable cost, and mixed cost.
Fixed cost remains constant within a specified relevant range and does not change depending on business activity. In other words, the amount depends on the accounting period (e.g., month, quarter, or year) rather than the number of units produced.
Please note that the amount of fixed cost remains constant only within the relevant range and can also fluctuate over time, especially in the long run. So, it can be expected to be constant within an accounting period, such as a month, quarter, or year.
The per unit amount of fixed cost is calculated by dividing the total amount by the actual number of units produced.
|Fixed Cost per Unit =||Total Fixed Cost|
|Number of Units|
The graph below shows that within a relevant range per unit cost gradually declines as the number of units produced increases.
The total amount of fixed cost remains unchanged within a relevant period as shown in the figure below.
In managerial accounting, relevant range refers to the production volume bounded by the minimum and maximum amount when fixed costs remain unchanged. If production volume drops below the minimum amount or surges above the maximum amount, the amount of fixed cost undergoes significant changes as shown in the graph below.
Accurate identification of relevant range is very important because it affects budgeting decisions and financial planning.
Xander LLC rents warehouse space at an annual rental fee of $15,000, which allows it to keep simultaneously 20,000 units in stock. There is a possibility of renting additional warehouse space allowing it to keep 10,000 units for $5,000 per year.
The initial relevant range is between 0 and 20,000 units within a fixed cost (rental fee) of $15,000. When warehouse space reaches capacity, the new relevant range will be between 20,000 and 30,000 units, and fixed cost surges to $20,000 ($15,000+$5,000).
Common examples of fixed cost:
Classifying costs between fixed and variable is important before any break-even analysis is performed. Businesses with a higher proportion of fixed costs have a greater break-even volume in units and therefore are more vulnerable to any decreases in sales. That is the reason why cost behavior should be considered when managerial decisions are made.