Question

(Related to the Apply the Concept on page 376 ) For jill Johnson's pizza restaurant, explain whether each of the following is a fixed cost or a variable cost. a. The payment she makes on her fire insurance policy b. The payment she makes to buy pizza dough c. The wages she pays her workers d. The lease payment she makes to the landlord who owns the building where her store is located e. The \(\$ 300\) -per-month payment she makes to her local newspaper for running her weekly advertisements

Short answer

a. The payment Jill makes on her fire insurance policy is a fixed cost. b. The payment for buying pizza dough is a variable cost. c. The wages paid to workers can be either fixed or variable depending on the specifics. d. The lease payment is a fixed cost. e. The payment for weekly advertisements is a fixed cost.

Step-by-step solution

Identify Fixed and Variable Cost for fire insurance policy

The payment Jill Johnson makes for her fire insurance policy is a fixed cost. This is because it remains the same regardless of how many pizzas are made and sold in her restaurant.

Identify Fixed and Variable Cost for purchase of pizza dough

The payment Jill Johnson makes to buy pizza dough is a variable cost. This depends on the quantity of pizzas she plans to produce and sell in a given time period.

Identify Fixed and Variable Cost for wages to workers

The wages she pays her workers could be fixed or variable costs depending on their employment status. If they are salaried employees, then it's considered a fixed cost as it doesn't change with the number of pizzas sold. If they are paid per hour or per pizza made, then it's a variable cost.

Identify Fixed and Variable Cost for lease payment

The lease payment she makes is a fixed cost, as it remains the same regardless of the number of pizzas sold at her restaurant.

Identify Fixed and Variable Cost for advertisements

The $300-per-month payment she makes to her local newspaper for running her weekly advertisements is a fixed cost because it is not affected by the volume of pizzas sold.

Key concepts

Cost Structure in Business

Understanding the cost structure in business is critical for any entrepreneur or manager. It refers to the distribution of different types of costs that a company incurs from its operations. The two primary categories of costs are fixed and variable. Fixed costs are expenses that remain constant regardless of the company's level of production or sales. These costs are incurred even if the business activities are at a standstill. In contrast, variable costs fluctuate with the level of production or service provision. As production increases, so do the variable costs, and they decrease when production slows down. The balance between fixed and variable costs impacts the financial stability and flexibility of a business.

Fire Insurance Policy as a Fixed Cost

A fire insurance policy typically represents a fixed cost for a business. This is because the premium paid for the insurance coverage doesn’t change with the number of goods produced or sold. For instance, Jill Johnson's pizza restaurant pays a regular amount for its fire insurance policy, preserving financial predictability in this aspect regardless of the restaurant’s sales performance. Fixed costs like this are essential to plan for since they must be paid whether the business is booming or in a slump, and they help in risk management and loss prevention.

Purchasing Raw Materials as a Variable Cost

Costs for purchasing raw materials, such as the pizza dough for Jill Johnson's restaurant, are an example of variable costs. These costs will vary in direct proportion to the restaurant’s production level. If the demand for pizzas increases, Jill will need more dough, resulting in higher expenses for raw materials. On the other hand, if demand for pizzas decreases, she will spend less on these materials. This variability is the hallmark of such costs, making them inherently different from fixed costs.

Employment Wages and Labour Costs

Labour costs can be complex, as they can be either fixed or variable. For example, if Jill's employees are salaried, their wages do not change with the number of pizzas sold, making these labour costs a fixed expense. On the other hand, if workers are paid hourly or based on production volume (like per pizza), their wages would be considered a variable cost, fluctuating with how busy the restaurant is.
Understanding the nature of labour costs is crucial for businesses to effectively manage payroll expenses in relation to their operational output.

Lease Payments

Lease payments, such as the rent Jill pays for the building where her pizza restaurant is located, is another instance of a fixed cost. The monthly lease payment is usually agreed upon in the lease contract and does not change with the level of the restaurant's activities. As a fixed cost, it lends a measure of predictability to Jill's budgeting, enabling her to plan future expenses confidently.

Advertising Expenses

While some advertising expenses can vary, many, such as monthly advertisement arrangements, are fixed costs. Jill's decision to spend $300 per month on local newspaper advertisements represents a fixed cost because it does not change with the number of pizzas she sells. Some advertising strategies might involve variable costs, but any prearranged fixed payment agreements for advertising space or time slots fall into the category of fixed expenses.