Fixed Cost & its importance in BEP
Meaning of Fixed Cost : A cost does not change with an increase or decrease in the Goods produced.
In General, companies can have two types of costs, i.e., Fixed Costs and Variable Costs.
Also called as Indirect cost or Overhead costs.
Examples: Lease Rentals, Salaries, Insurance, Taxes, Interest expense, Depreciation etc.
All Sunk costs are Fixed Costs. But, all fixed costs are not sunk costs.
Sunk cost: Money that has already been spent and which cannot be recovered. Examples are Machinery Cost, Lease expense, etc.
A fixed cost per unit is always variable; Whereas Variable cost per unit is always fixed.
Segregation of Total Costs into fixed Costs and Variable costs helps the Management to decide the scale of Production and Breakeven analysis.
Example: A company Produces Pens. Their fixed costs are Rs. 10000 and Variable costs are Rs. 10 per Pen. Selling price per pen is Rs. 120. Find the Total cost for 100 Pens and 200 Pens and Profit on two options.
100 Units
200 Units:
From the above, the Fixed Cost per Unit is changed from Rs. 100 to Rs.50 when Production was increased from 100 units to 200 Units. Whereas, Variable cost remained fixed though production was increased from 100 units to 200 units.
So, when change in the Production:
Fixed cost per unit is variable (though Total Fixed cost is fixed)
Variable cost per unit is fixed. (though Total Variable cost is variable)
The segregation of Total costs into Fixed Costs and Variable costs helps the firms to analyze the breakeven analysis. (Where there is no profit, no loss) and increase their profit capacity.
BEP –Break Even Point = Fixed Costs / Sales Price per Unit – Variable Cost per unit
In the above example 100 units production level, BEP is 10000/120 – 10 = 91 Units.
That means at the point of 91 units, there is no profit or no loss.
At 91 units
Profit Rs.9 is almost negligible. Hence at the production of 91 units, there is no profit, and there is no loss. So Break Even Point (BEP) is 91 units
Key Points for MCQ
BEP stands for Break Even Point
Fixed cost - other names are Overhead cost or Indirect Cost
All Sunk costs are Fixed Costs. But, all fixed costs are not sunk costs.
Sunk cost: Money that has already been spent and which cannot be recovered. Examples are Machinery Cost, Lease expense, etc.
A fixed cost per unit is always variable;
Whereas Variable cost per unit is always fixed.
BEP formula = Fixed Costs / Sales Price per Unit – Variable Cost per unit
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