Average Fixed Cost

The concept of fixed cost in management accounting and economics is very important. Fixed costs are a part of total costs, while we discuss them, we should also be aware of what are the variable costs. If any one of these concepts is clear to the students of accounting, then understanding the other would not be a big challenge. So, before we get to know how to find average fixed cost, let us first get ourselves acquainted with the difference between fixed costs and variable costs in the next paragraph.

Difference Between Fixed Costs and Variable Costs

For any product manufacturing company, dealing with fixed costs and variable costs is quite common. Any firm would take a decision on increasing or decreasing its production considering the demand for its products in the market. Though the quality of products of a company may be appreciated by the market, the demand may not be that high, if the consumption pattern itself has undergone change. Fixed costs are those costs which do not change despite a change in the levels of production. This means that even if the production changes drastically, whether up or down, the fixed costs will remain the same. Exactly opposite to this is the concept of the total variable costs which changes with the change in production levels. These costs will generally rise with increased production and go down significantly with a decrease in production levels.

Fixed costs can be quite a burden for a company when it is not performing well on the sales front. Low sales mean low revenues and, despite the revenues going down, this cost does not change and cannot be changed. It will have to continue spending on such costs and they are almost unavoidable. The companies which are able to effectively manage this burden emerge as market leaders and future winners. The average fixed cost and variable cost concepts will become more clear with good examples of the two. Indirect materials, depreciation on machinery, overtime paid to workers, payroll taxes of the employer or the company, lubricant costs for machines, cost of tools and labor and machine costs are the best examples of variable costs. On the other hand, depreciation on building, insurance to be paid, rent paid to owner, salary of the manager of the plant, electricity and power expenses and employee payroll and salaries are the examples of fixed costs. If you wish to plot the average fixed cost curve, then the quantity of products is on the X axis, whereas the cost or price will be on the Y axis. This curve when plotted systematically, helps us understand it in different situations.

Computation

Average fixed cost = Fixed cost of production / Quantity of output produced.

While computing the average fixed costs, you will need the annual reports or the quarterly results of a company, and a calculator. You can look at the account statement and note down the costs which have not changed over the quarters or years. These will be fixed costs. You can add this amount of two successive years and then divide the addition by two which will give you the average fixed cost for that particular period.

The above content information will help you to analyze the financial position of a company, and arrive at conclusions, regarding its operational efficiency. So, hoping that you will make use of this information in the right way, I would like to sign off here. All the best!