Methods of extracting fixed and variable costs - it is worth knowing

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The methodology used in accounting is based on many types of cost classification. In this article, we will discuss the issue of the methods of extracting fixed and variable costs, and we will analyze some basic methods that allow to distinguish the above two categories of costs.

Cost as understood in accounting

Taking into account the accounting regulations, it should be indicated that all rules concerning the method of recognizing and qualifying costs should be laid down in the accounting policy adopted by the entity. As we can read in Art. 10 sec. 1 point 3 lit. a of the Accounting Act, the entity should have documentation describing in Polish the accounting principles (policy) adopted by it, in particular regarding the method of keeping accounting books, including the company chart of accounts setting the list of general ledger accounts, adopted rules for classifying events, rules for keeping book accounts auxiliary and their relationship with the general ledger accounts.

It is also worth referring to the definition of cost included in the Accounting Act. In art. 3 sec. 1 point 31 of the Act, we can read that:

"(...) costs and losses shall mean probable reductions in economic benefits in the reporting period, of a reliably determined value, in the form of a decrease in the value of assets or an increase in the value of liabilities and provisions, which will lead to a decrease in equity or an increase in its shortage in another way than withdrawals by shareholders or owners. " The method of separating fixed costs from variable costs should be specified in the accounting principles (policy).

Fixed costs and variable costs

Before we move on to discriminating methods, it is worth explaining first what fixed and variable costs are. In this case, the division criterion is the degree of cost dependence on the production volume and the susceptibility to its increases and decreases.

Fixed costs are those types of expenses the amount of which does not depend on the variability of the production level. Their perfect example is depreciation. On the other hand, variable costs are those expenses the level of which depends on fluctuations in the production process of the enterprise. As an example, the consumption of materials directly needed to produce the product can be mentioned here. The division into fixed and variable costs is based on the relation of their value to the production volume. Fixed costs, unlike variable costs, are independent of increases or decreases in production.

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Methods of extracting fixed and variable costs - accounting and statistical

Moving on to clarifying the issue of the methods of extracting fixed and variable costs, it should be emphasized that in this respect certain methods are in place to make such a distinction. Although we can come across various classifications, the most frequently mentioned methods are the accounting method and statistical (mathematical) methods.

The accounting method is largely based on the subjective decision of the accountant to classify certain cost items as fixed or variable. Moreover, it is based on the experience of the accountant and his knowledge. This means that it is simple to use, but at the same time it is characterized by a significant degree of free evaluation of a given item by the accountant.

However, the situation is completely different in the case of using the statistical method. Here it is assumed that the total operating costs are linearly dependent on the scale and volume of production. Therefore, an element of subjective accounting judgment is excluded, as this method is based on available historical data. It comes in three variants, as shown below.

The method of extreme quantities (two points) consists in determining two extreme quantities of production, i.e. minimum and maximum. Based on these data, the marginal cost is calculated, which is the increment of total costs between the maximum and minimum levels. On this basis, the level of fixed costs is determined, being the difference between the total cost and the cost of a given production.

Another type of statistical method is the mean subperiod method. It consists in determining the level of fixed and variable costs in a given period and according to the increasing value of the production volume and the total costs assigned to them.

The last on our list is the regression method, which involves the use of the least squares method and estimating the line describing the dependence of the total cost on the production volume. The deviation of the actual data from the straight line is measured by the sum of the squared distances between the obtained line and these data. In terms of the methods of isolating fixed and variable costs, we can distinguish the accounting method and the statistical method, which is divided into the method of extreme quantities, the method of average sub-periods and the regression method. In conclusion, we can indicate that one of the methods of cost breakdown is classification based on production volume. In the context of this criterion, we distinguish between fixed and variable costs. However, in order to isolate them, one of the available methods can be used.