Question

Categorize the following costs incurred by a bookstore owner as fixed or variable: accountant, electricity for extra holiday hours, wages, clerks' insurance, manager's salary, purchase of books, rent, telephone.

Short answer

Fixed: Accountant, insurance, manager's salary, rent. Variable: Electricity, wages, books, telephone.

Step-by-step solution

Understanding Fixed and Variable Costs

Fixed costs remain constant regardless of the level of business activity, while variable costs change with the level of output or sales. Let's categorize each cost based on this understanding.

Analyze Each Cost

1. Accountant: Typically a fixed cost, as the fee doesn't change based on sales. 2. Electricity for extra holiday hours: Variable cost, as it changes with usage based on business activity level. 3. Wages: Typically a variable cost, but can be fixed if on a salary. Assume variable for hourly workers. 4. Clerks' insurance: Fixed cost, as insurance fees are usually constant. 5. Manager's salary: Fixed cost, as it's typically constant. 6. Purchase of books: Variable cost, as it varies with the number of books sold. 7. Rent: Fixed cost, since it's usually a set amount monthly. 8. Telephone: Variable cost, as it may vary with usage, though sometimes it can be fixed. Assume variable if usage-based pricing is present.

Categorizing the Costs

Fixed Costs: Accountant, Clerks' insurance, Manager's salary, Rent. Variable Costs: Electricity for extra holiday hours, Wages, Purchase of books, Telephone.

Key concepts

Fixed Costs

Fixed costs are expenses that do not fluctuate with changes in production or sales levels. Even if no books are sold, these costs remain constant. They're like the backbone of the business, ensuring that essential expenses are constant.
Fixed costs include expenses such as:

• Rent and Lease Payments: The bookstore must pay its rent each month, regardless of how many customers walk through the door.
• Manager's Salary: The salary of a manager is considered a fixed cost because it remains unchanged in the short term.
• Insurance: Fees associated with insurance, like Clerks' insurance, are also consistent, providing coverage over a set period.
• Professional Fees: Costs like those for an accountant are typically fixed, as they are usually not dependent on the business's performance.

By understanding fixed costs, a bookstore owner can have a clearer picture of the expenses they'll always need to cover, aiding in budgeting and financial planning.

Variable Costs

Variable costs change in proportion to the level of sales or production activity. In a bookstore, these costs fluctuate with the business's operation scale.
For instance:

• Electricity for Extra Holiday Hours: The cost increases with extended hours and additional usage.
• Wages for Hourly Workers: If employees are paid by the hour, then wages are a variable cost since they increase with more hours worked.
• Purchase of Books: Buying books to replenish stock is a variable cost, as it depends on sales and demand.
• Telephone Charges: Though often predictable, these can vary if based on usage, aligning them as variable in some models.

Managing variable costs is crucial for maintaining profitability, as they directly impact the cost structure and pricing strategies of the bookstore.

Business Expenses

Business expenses encompass all costs incurred in the process of running a bookstore. They are necessary for maintaining the operations and providing services.
These expenses can be broadly categorized into two types:

• Fixed Costs: As noted, these include rent, salaries, and insurance. They provide a sense of financial consistency.
• Variable Costs: Expenses that fluctuate with activity levels, like book purchases and utility costs.

Understanding business expenses allows a bookstore owner to manage financial planning effectively. By distinguishing between fixed and variable costs, the owner can strategize better, ensuring that both daily operations and long-term goals are financially sustainable. Maintaining detailed records of these expenses helps in budgeting, forecasting, and optimizing profit margins.