Fixed costs are expenses that remain constant regardless of changes in business activity levels or production volume. They do not vary with changes in sales, output, or other business operations and get incurred by a company at a fixed amount or periodic payment. Similarly, they are a crucial component of a company’s cost structure.
Fixed costs are a type of cost classification based on cost behaviour. However, these costs may have further subtypes, including committed and discretionary fixed costs. Before discussing the differences, it is crucial to study both individually.
What are Committed Fixed Costs?
Committed fixed costs refer to expenses that are obligations due to contractual or legal commitments. These costs remain fixed regardless of changes in business activity or production volume. Usually, they are long-term and not easily adjustable or eliminated in the short term. Committed fixed costs are binding and represent financial obligations a company must fulfill, regardless of its current performance or market conditions.
Committed fixed costs are crucial in financial planning and budgeting since they impact a company’s financial health and cash flow. Examples of committed fixed costs may include lease or rental payments for long-term contracts, loan repayments for long-term loans, insurance premiums for long-term policies, labour contracts or union agreements, and long-term service or maintenance contracts.
What are Discretionary Fixed Costs?
Discretionary fixed costs, or managed or optional fixed costs, are expenses a company can control and adjust at its discretion. These costs are not mandatory or contractual and can be modified or eliminated based on the company’s operational needs, financial constraints, and strategic priorities. One example includes advertising expenses which companies adjust according to their needs.
Unlike committed fixed costs, which are binding and cannot be easily changed, discretionary fixed costs are optional and subject to management decision-making. These costs are typically non-essential expenses that are not directly tied to the day-to-day operations of a company and are discretionary based on the company’s priorities and available resources.
Committed vs Discretionary Fixed Cost: What are the differences?
The differences between committed and discretionary fixed costs fall under the following points.
Nature
Committed fixed costs are expenses that a company must pay and are long-term and contractual. On the other hand, discretionary fixed costs are expenses a company may adjust or eliminate based on management’s decision-making.
Source
Committed fixed costs often come from external factors, such as long-term contracts, regulatory requirements, or legal obligations, and may have limited room for management discretion. In contrast, discretionary fixed costs are subject to management decision-making, and the company has more flexibility in determining the amount, timing, and necessity of these expenses.
Flexibility
Committed fixed costs are typically less flexible and adjustable in the short term. Discretionary fixed costs are more flexible and adjustable, as they can be easily adjusted or eliminated based on the company’s operational needs.
Objectives
Committed fixed costs are often essential for maintaining the day-to-day operations of the company and are typically in line with the core financial goals and strategic direction of the company. Discretionary fixed costs, on the other hand, maybe more aligned with short-term operational needs, marketing strategies, or other discretionary spending priorities of the company.
Conclusion
Committed and discretionary fixed costs are a classification of fixed costs that do not change due to activity levels. The former represents expenses that companies must pay due to past commitments. On the other hand, discretionary fixed costs are often optional and controllable. The difference between both comes from their nature, source, flexibility, and objectives.
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