Fixed and variable costs - classification of costs in the activity
Tax deductible costs are costs incurred in order to achieve income or to maintain or secure the source of income, with the exception of the costs referred to in article 1. 23 of the PIT Act. If the expenses meet this definition, are related to the business and have been properly documented (e.g. an invoice for company data), they may constitute tax costs, which can then be divided according to many criteria. One of the classifications is the division into fixed and variable costs. Let's check what are fixed costs and variable costs!
What is the breakdown of tax deductible costs?
In accounting, regardless of the type of business taxation, we can distinguish between direct and indirect costs. Direct costs are those that are directly related to obtaining income in the conducted business activity (e.g. purchase of basic materials, commercial goods). On the other hand, indirect costs are those that are not directly related to income, but relate to expenses related to the maintenance of the company (e.g. office rent, utilities, accounting services). In the case of taxpayers keeping books of accounts, in accordance with the Accounting Act, we also distinguish fixed and variable costs.
What are variable costs?
Variable costs are those costs that are directly related to production. These costs depend on the production volume, because with the change of its size, the value of variable costs also changes. Taking into account the change in production, with its increase, variable costs increase, and with its decrease - the value of variable costs decreases. Of course, variable costs are those costs that are not included in the fixed costs. In the case of production equal to 0, variable costs are at the level of PLN 0.
These types of costs include, among others:
- outlays on raw materials.
It is worth noting that variable costs are the result of short-term decisions.
In order to calculate the variable cost per production unit, the average variable cost should be used. The formula for the average variable cost is as follows:
AVC = VC / Q
AVC - Average Variable Cost
VC- variable cost
Q - production volume
We also divide variable costs into individual subcategories:
- proportional costs - with an increase in production, the unit variable cost is fixed (e.g. the cost of remuneration when employees work on piecework);
- progressive - variable costs increase with the increase in production (e.g. overtime pay);
- degressive - the unit variable cost decreases with the increase in production (eg in the case of a larger order of materials, the unit price is lower - a discount or rebate is granted);
- regressive - as production increases, the unit cost of production decreases rapidly (e.g. the cost of heating a cinema hall is lower for more people in the room than for one person).
What are fixed costs?
Unlike variable costs, fixed costs do not change with a change in production volume. This means that reducing production does not change fixed costs. Fixed costs remain the same over a wide period of time, but this does not mean that their value is always the same. These costs depend on macroeconomic conditions and therefore the costs may change, but this is not due to the level of activity.
The factors influencing the fixed costs include a change in the technology used or a change in the organization of the company. An example may also be the replacement of devices and machines with newer ones, which can be energy-saving, and therefore will constantly (for a longer period) consume less energy than previous machines. Thus, the fixed costs will decrease.
These types of costs include, among others:
- administration remuneration,
- machine depreciation write-offs,
- machinery insurance,
- rent for renting a building.
Fixed costs, in the case of a long period, may change their value (e.g. by increasing the size of the enterprise), and therefore, in a long-term analysis, they may be wrongly considered as variable costs.
Fixed costs can be divided into:
- absolutely fixed costs - they are not subject to any changes when the production volume changes (e.g. depreciation write-offs when fixed assets are settled using the straight-line method);
- abruptly constant costs - their value does not change only in the size range, after which they increase, and where they stabilize again (e.g. renting a production hall, after exceeding a certain production value it is necessary to rent an additional hall).
When we divide the fixed costs by the production volume, we get the average fixed cost:
AFV = FC / Q
AFC average fixed cost
FC- fixed cost
Q - production volume
The sum of variable costs (KZ) and fixed costs (KS) gives the value of total costs (KC), ie KC = KZ + KS. In distinguishing whether the cost is fixed or variable, the consideration should not be given to the period of time, but to whether the cost is influenced by the production volume.
A company that produces furniture, bears, inter alia, such costs as:
- machine depreciation (wood milling machines);
- consumption of materials necessary for the production of furniture (wooden boards, dowels, carpentry glue);
- the cost of electricity in the production hall.
Which of the following costs are fixed costs?
According to the definition, fixed costs include machine depreciation and the cost of electricity in the production hall. On the other hand, the consumption of materials necessary for the production of furniture is classified as variable costs, because this cost depends on the number of finished products produced.
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The production company, due to the rapidly developing industry, started producing an additional finished product. As a result, an additional production hall was rented, and therefore the costs for renting production halls increased. Is this cost a fixed or a variable cost?
Due to the fact that the cost of renting production halls is not directly related to the number of products produced, the cost of renting the halls is a fixed cost.
Fixed and variable costs and simplified accounting
In the case of simplified accounting (KPiR or Revenue Register - flat rate), there is no need to distinguish between fixed and variable costs, because according to the Accounting Act, this division is required in the accounting books. In the tax book of revenues and expenses, expenses that do not constitute costs are not entered in the book (NKUP). Therefore, taxpayers are required to read the regulations in order to correctly recognize what expenses constitute tax deductible expenses.
When maintaining the KPiR, it is also important to correctly include costs in the appropriate column of the ledger. In this case, the expenses are sorted according to the costs using the following columns:
- 10 - purchase of commercial goods and basic materials,
- 11 - purchase side costs,
- 12 - remuneration in cash and in kind,
- 13 - other expenses.