Effects a Sales Volume Increase or Decrease Will Have on Unit Fixed Cost

Changes in sales volume should automatically cause adjustments in production quantities. Cost of materials will go up or down as production numbers change. Some costs do not fluctuate with production, and that is why they are labeled fixed cost. Some examples of fixed costs include building lease payments and machine depreciation. Fixed costs are typically included in the overhead rate applied to individual units. Temporary or seasonal fluctuations will not prompt a change in the overhead rate, but permanent production changes should cue management to adjust overhead rates.

Increasing sales volume will trigger an increase in fixed costs per unit when production capacity exceeds the ability of the current machinery or the space of the current facility. Adding a second or third shift of production will not increase overall fixed costs. Increased production will reduce the amount of fixed costs that need to be applied to each unit produced, which will reduce the company's cost per unit.

Decreasing sales volume will only decrease fixed unit costs when the quantity produced drops so low that production assets are sold or a less expensive facility is located. As long as total fixed costs do not drop with decreasing sales, the amount of fixed costs applied to each unit will increase. This will result in higher unit costs, reducing the profit earned for each unit.

Analyze production fluctuations to determine if they are short-term or long-term. Short-term changes such as seasonal fluctuations can usually be covered with overtime or temporary increases in labor force for sales increases, or, conversely, temporary layoffs or shortened work schedules during slow periods. This type of production change will not affect unit fixed costs, and should be taken into consideration when calculating the fixed overhead rate to be applied to each unit. Long-term production changes, such as new or expired contracts, need to be analyzed by management on a case-by-case basis.

Applying fixed costs to individual units is usually accomplished by using a per-minute rate of production. When the rate is calculated for the coming year it is based on forecasts of production averages and expenses for the year. Significant variances in forecast to actual numbers should prompt an adjustment of the application rate of unit fixed costs.