Final answer:
Depreciation expense is recorded as an asset depreciates over time. Fixed costs, or overhead, do not change with production levels and include items such as rent and machinery costs. 'Spreading the overhead' refers to allocating fixed costs over the units produced, thus reducing average fixed cost per unit as production increases.
Step-by-step explanation:
As a fixed asset depreciates, a portion of its cost should be recorded as an expense. This periodic expense is called depreciation expense. In the world of business and accounting, costs are often categorized into two main types: fixed costs and variable costs. Fixed costs, sometimes known as overhead, are the expenditures that do not change regardless of the level of production. Examples include rent on a factory, machinery, research and development, and advertising costs.
Fixed costs are important because they must be paid whether a little or a great deal is produced. The concept of spreading the overhead refers to the practice of allocating fixed costs across the quantity of output produced. This allocation process leads to the concept of average fixed cost, which is calculated by dividing the total fixed cost by the quantity of output produced. As production increases, the average fixed cost per unit decreases, hence 'spreading' the overhead over more units.
Understanding how fixed costs, and in particular the depreciation of assets, impact financial statements is essential for business students and professionals alike, ensuring accurate reporting and financial analysis.