Final answer:
In product costing, fixed cost or 'overhead' is a constant expense regardless of production levels, not directly tied to production quantities like direct materials or labor. The average fixed cost curve, which represents the spread of overhead across output, is hyperbolic, showing that average fixed cost per unit decreases as production levels rise.
Step-by-step explanation:
A common term for fixed cost in the context of product costing is 'overhead'. The Cost Flow Diagram for product costing should include all aspects of cost associated with producing a product, but it usually does not include fixed manufacturing overhead in the same category as direct costs such as direct materials or direct labor. This is because fixed overhead remains constant regardless of the level of production.
The concept of 'overhead' is particularly important when considering the total costs incurred by a business; at zero production, fixed costs like rent, insurance, depreciation, and salaries of permanent staff are still incurred. Regardless of the output, these fixed costs stay the same, making them a critical component of a business's cost structure. Let's imagine we have a fixed cost of $1,000. If this fixed cost is divided by the quantity of output produced, it results in the average fixed cost. Graphically, the average fixed cost curve is represented as a hyperbola when plotted with the quantity of output on the horizontal axis and the average fixed cost on the vertical axis. This is due to the nature of average fixed cost declining as the quantity of output increases.
The term 'spreading the overhead' refers to allocating the fixed overhead costs over a greater number of units as production increases. This means that the overhead cost per unit decreases, making each unit more cost-efficient as production volume increases.