Cost Behavior - Fixed and Variable
Practice As You Learn
Cost Accounting
Cost behavior revolves around the following rules (YOU MUST KNOW THIS):
1) Fixed costs do not change in total as volume/activity changes, within a relevant range (which is really a range used for planning)
2) Fixed cost per unit does change with changes in volume activity.
(constant fixed costs divided by changing activity = a cost per unit that changes)
3) Variable costs do change in total as volume/activity changes
(the same cost per unit x a changing volume = changing total cost)
4) Variable cost per unit does not change with changes in volume/activity.
A variable cost is something that is used/cost incurred each time that you do something, like make a product, or sell a product. The cost every time you do it does not change, but as you do more/less the total cost is more/less.
Important: When you are determining if a cost is fixed or variable ask yourself the following question:
Will it cost me more if I make or sell one more product
If yes – it is a variable cost – you pay every time you do one more
Other cost definitions – simplified:
Relevant Range – The range of activity that fixed costs won’t change
Sunk Cost – I can’t get my money back no matter what
Opportunity Cost – I won’t get the benefit of this because I chose to do something else
Discretionary Cost – Management can decide not to spend for this
Committed Cost – Management can’t decide not to spend for this without a big change in goals and strategy
Learn As You Practice – Problem 1.
You must be able to determine how a cost behaves.
Juffy, Inc. manufactures peanut butter and incurs costs for the following items.
Decide if the cost is a fixed cost (F), a variable cost (V), or a mixed cost (M).
_____1. Plastic jar
_____2. Cell phone for sales people
_____3. Corn syrup, an ingredient
_____4. Worker who operates the cooking machine
_____5. Peanuts, an ingredient
_____6. Utilities at the manufacturing plant
_____7. Insurance on the manufacturing plant
_____8. Janitors working at corporate headquarters
_____9. Telephone at corporate headquarters
____10. Supervisor at the manufacturing plant
____11. Worker who puts the peanuts in the machine
____12. Worker who fills the jars with peanut butter
____13. Depreciation on the machine that cooks the peanut butter
____14. Plant manager
____15. Quality inspectors of the product
____16. Salesmen travel expenses
____17. Oil and parts for the manufacturing machines
____18. Lids for the jars
____19. Shipping to customers
____20. Advertising the peanut butter
____21. Rent at the corporate headquarters
Answer
determine if the cost is fixed, variable, or mixed remember this:
1) a fixed cost will not change because you make or sell one more unit within a relevant range, it does not mean it will never change
2) a variable cost will cause you to use more/pay more every time you make one more unit.
3) Whether or not a cost is mixed depends on how you pay for the cost. If you pay a set amount and then pay more if you use more than it is mixed. You will see with the answers that some can be mixed.
Juffy, Inc. manufactures peanut butter and incurs costs for the following items.
Decide if the cost is a fixed cost (F), a variable cost (V), or a mixed cost (M).
V 1. Plastic jar
F / M 2. Cell phone for sales people
V 3. Corn syrup, an ingredient
V 4. Worker who operates the cooking machine
V 5. Peanuts, an ingredient
V / M 6. Utilities at the manufacturing plant
F 7. Insurance on the manufacturing plant
F 8. Janitors working at corporate headquarters
F 9. Telephone at corporate headquarters
F 10. Supervisor at the manufacturing plant
V 11. Worker who puts the peanuts in the machine
V 12. Worker who fills the jars with peanut butter
F 13. Depreciation on the machine that cooks the peanut butter
F 14. Plant manager’s salary
V 15. Quality inspectors of the product
V / M 16. Salesmen travel expenses
F / M 17. Oil and parts for the manufacturing machines
V 18. Lids for the jars
V 19. Shipping to customers
F 20. Advertising the peanut butter
F 21. Rent at the corporate headquarters
1., 3., 5, 18, are materials that go directly into the product (direct materials). When you make more product you must buy/use more. Therefore the costs are variable costs. The more you make the more it costs you.
4, 11, 12, 15, are costs incurred because you pay workers to make the product. The more products you make the more it costs you. Therefore, these costs are variable costs.
6. and 16. These costs could be variable or mixed. This is determined by how the costs are paid for, which is not stated. See the description above.
2. and 17. These costs could be fixed or mixed. This is determined by how the company plans to pay for the costs. If there is a set amount to be paid every month it is fixed, if it varies by units made or sold, they are variable costs.
19 Shipping to customers is a variable cost because the more you sell the more you have to ship and it costs you more each time you ship.
All others are fixed – The company will pay the same set amount and this
will not change based on how many units are made or sold.
General Rules to follow, things to notice:
1. Direct materials and direct labor are always variable costs
2. Manufacturing overhead is almost always a fixed cost.(except utilities)
3. Costs that are paid monthly/annually are almost always fixed costs.
Learn As You Practice – Problem 2.
Charlie’s Burgers sells hamburgers, fries, and drinks to the lunch crowd. In the normal course of business, costs are incurred for the following items. Determine if the costs are fixed (F), variable (V) or mixed (M). Write 1. through 15. on your paper and write the type of cost by the number.
1. Meat
2. Cashier’s wages
3. Cleaning crew wages
4. Depreciation on cooking equipment
5. Paper supplies, napkins, bags, straws
6. Rent
7. Advertisement run every Friday
8. Cook’s wages
9. Utilities
10. Depreciation on the freezer
11. Cleaning supplies, soap, etc.
12. Lettuce, ketchup, mustard, pickles, etc.
13. Buns
14. Bacon for bacon cheeseburgers
15. General liability insurance
After you have classified the costs as fixed, variable, or mixed, determine which fixed costs are discretionary and which ones are committed. Determine if there are any sunk costs.
Variable costs are neither discretionary, committed, or sunk since you incur them every time you do something one more time.
Answer
Answers to Learn As You Practice – Problem 2.
Charlie’s Burgers sells hamburgers, fries, and drinks to the lunch crowd. In the normal course of business, costs are incurred for the following items. Determine if the costs are fixed (F), variable (V) or mixed (M).
V 1. Meat
V 2. Cashier’s wages
F 3. Cleaning crew wages
F 4. Depreciation on cooking equipment
V 5. Paper supplies, napkins, bags, straws
F 6. Rent
F 7. Advertisement run every Friday
V 8. Cooks wages
M/V 9. Utilities
F 10. Depreciation on the freezer
F 11. Cleaning supplies, soap, etc.
V 12. Lettuce, ketchup, mustard, pickles, etc.
V 13. Buns
V 14. Bacon for bacon cheeseburgers
F 15. General liability insurance
For all variable costs noted above, more is spent for each hamburger made and sold. Material that is part of the product and labor to make/sell the product is always variable.
The fixed costs will not change because one more or one less hamburger is made or sold.
2. and 8. could also be mixed. The company could have to have a certain number of hours worked no matter what sales are and then add to the number of hours worked if sales are higher.
After you have classified the costs as fixed, variable, or mixed, determine which fixed costs are discretionary and which ones are committed. Determine if there are any sunk costs. (Variable costs are neither discretionary, committed, or sunk since you incur them every time you do something one more time.)
Discretionary fixed costs – 7 you can decide not to run the advertisement 3 & 11 you can decide to spend less and clean less often
Committed fixed costs – 6, 15 these costs have to be spent to run the business and management can not decide not to spend.
Sunk Costs – 4, 10 depreciation is always a sunk cost. The money has already been spent. Depreciation is always a committed cost.