Cost Behavior - Fixed and Variable
Things You Must Know
Introduction to Accounting
Variable Cost: Changes in total, in direct proportion to changes in the level of activity. The total cost increases/decreases as units made increases/decreases.
Variable cost is constant if expressed on a per unit basis.
Direct material, direct labor and variable overhead
are all variable costs. Costs that vary with sales,
such as sales commission are variable costs.
It is a variable cost if it costs you more if you make or sell one more.
Fixed Cost: Total cost does not change with changes in the volume of activity (within a relevant range)
The cost per unit will change as the number of units change
Rent, insurance, administrative salaries are examples of fixed costs. These costs do not change just because you make or sell one more unit as long as you stay within the relevant range (see below).
Mixed Costs (sometimes called semi-variable):
One that contains both variable and fixed costs elements:
Fixed – minimum cost of having a service ready and available for use
Variable – cost incurred for actual consumption of the service
Total Mixed Costs = Total Fixed Cost $ + (Variable Cost $ per activity x # of the activity)
An example of a mixed cost is charges for a cell phone. The cost is $39.99 plus $0.40 for each minute used over 400 minutes
An example of a mixed cost is charges for water and sanitation. The cost is $55 per month, plus $1.25 per gallon for gallons used over 250 gallons used.
Relevant Range: The range of activity where the assumption about cost behavior is valid.
Example: The company’s fixed costs will remain fixed as long as production greater than 1,000,000 units is not required. If more than that must be produced, then a new facility with higher facility costs and overhead costs will be required.
The company’s fixed costs will change if they have to produce more than 1,000,000 units. Up to 1,000,000 is the relevant range.
Opportunity Cost: The potential benefit that is given up when one alternative is selected over another alternative. Opportunity costs are not recorded/reported because they do not occur. The cost is the benefit that you gave up.
Example: The opportunity cost of going to college is the amount of money you would have made if you were working.
Sunk Cost: Cost that is already paid for and can not be changed by a decision made now or in the future.
Example: Tuition for this semester that you have already paid and will not get back for any reason.
Committed: Investment in facilities, equipment, and the basic operations of the company
1) long term in nature
2) can’t be significantly reduced, even over short periods of time without changing the long term goals of the company
Difficult to change the cost once the commitment has been made.
Discretionary: Annual decisions made by management to spend in certain areas for certain things.
Can be cut for short periods of time with minimal damage to long term goals.
Direct and Indirect
– See Product and Period costs section