VCE Accounting Practice Test

The primary difference between fixed costs and variable costs lies in how they behave relative to production levels. Fixed costs are those that do not change with the level of production; they remain constant regardless of how much is produced. For example, rent for a factory, salaries of permanent employees, and depreciation of equipment are typical fixed costs that a business incurs even if it produces nothing.

On the other hand, variable costs fluctuate directly with production levels. This means that the more a company produces, the higher the variable costs will be. Examples of variable costs include materials used in production, labor costs associated with hourly workers, and utilities that increase with higher production activities.

Understanding this distinction is crucial for businesses, as it affects budgeting, financial forecasting, and overall financial management. Companies need to manage their fixed and variable costs effectively to ensure profitability, especially in varying production environments.