Fixed costs are costs which are not proportional to the volume of activity.
Note that this definition does not imply that fixed costs do not vary; just that they do not vary in proportion of the volume of activity. Whether they can vary over the period considered distinguishes between committed fixed costs, which we address in this page, and the discretionary fixed costs which we address in the next page.
Committed fixed costs are costs related to resources that are acquired or contracted for in advance of when the actual work is done.
Committed fixed costs are difficult to change on the short-term because managers are often locked-in by contractual agreements. Therefore, they remain the same, in total, regardless of the activity level. The magnitude of a committed cost is determined by the amount of resource capacity acquired, not the amount of resource capacity actually used. For this reason committed fixed costs are also often called capacity related costs and are driven by planned activity levels rather than actual activity levels. Typical examples are the costs of long term assets (e.g. depreciation or lease of large equipment, buildings). Moreover, these costs are modelled by a constant for a period:
It is tempting to consider that committed fixed costs are step fixed costs with very large steps. There is however another important difference between the two: committed fixed costs cannot be easily adjusted on the short term, even with very large changes in volume of activity, because of a commitment (due to a contract or to ownership). By contrast, step fixed costs can be adjusted on the short term if changes in activity justify it.
Since the total committed fixed cost does not change, as volume increases this amount is divided by a greater number of units and therefore the unit committed fixed cost continuously decreases:
However, fixed cost in general, and committed fixed costs in particular, are extremely misleading when they are expressed per unit. It creates the false impression that fixed costs are variable and results in a meaningless fluctuation in unit costs, and this is why proponents of variable costing are strongly opposed to their inclusion in unit production costs.
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