CAT / FIA FMA Syllabus A. The Nature, Source And Purpose Of Management Informa - Different types of cost behaviour - Notes ^{6 / 9}

Types of Cost Behaviour

Costs can be classified according to the way that they behave within different levels of activity. 

Cost behaviour tends to classify costs as:

• Variable cost

• Fixed cost

• Stepped fixed cost

• Semi-variable cost

A variable cost varies directly with output. (The more you make the more the cost - IN TOTAL)

However, the variable cost PER UNIT remains constant.

Direct costs are variable costs (Eg Raw materials, Labour and direct Overheads)

Graph 1: Total variable costs

Variable costs in total change in direct proportion to the level of activity.

Graph 2: Variable cost per unit

The cost per unit of variable costs remains constant.

A Fixed cost (within certain activity levels) remains constant (In total)

However that also means the more the output - the Fixed Cost PER UNIT will fall

Eg Salaries, Rent,  Straight line depreciation

Graph 3: Total Fixed Costs

Total fixed costs remain constant over a given level of activity.

Graph 4: Fixed Cost per unit

The fixed cost per unit falls as the level of activity increases but never reaches zero.

A stepped fixed cost is only fixed within certain levels of activity.

The depreciation of a machine may be fixed if production remains below 1,000 units per month. If production exceeds 1,000 units, a second machine may be required, and the cost of depreciation (on two machines) would go up a step.

Other stepped fixed costs include rent of warehouse (more space required if activity increases) and supervisors’ wages (more supervisors required if number of employees increase).

Graph 5: Stepped Fixed Costs

Fixed costs increase in steps as activity level increases beyond a certain limit.

Semi-variable Costs (semi-fixed/mixed)

Semi-variable costs contain both fixed and variable components and are therefore partly affected by changes in the level of activity.

Examples of semi-variable costs includes

• Electricity and gas bills

  Fixed cost = standing charge                                                 
  Variable cost = electricity / gas used

• Salesman's salary

  Fixed cost = basic salary                                          
  Variable cost = commission on sales made

• Costs of running a car

  Fixed cost = road tax, insurance                                                 
  Variable costs = petrol, oil, repairs

Graph 6: Total semi-variable costs

Graph 7: Semi-variable costs per unit

High-low method

This method analyses semi-variable costs into their fixed and variable elements.

Always select the period with the highest activity level and the period with the lowest activity level.

1. Step 1: Find the variable cost per unit (VC/unit)

   Total cost at high activity level - Total cost at low activity level
   -----------------------------------------------------------------------
    Units at high activity level - Units at low activity level

2. Step 2: Find the fixed cost (FC)

   TC at high activity level – (Units at high activity level × VC/unit)

3. Step 3: Find the Total cost (TC)

   TC = FC + VC/unit x Activity level

Illustration 1

What is the Total cost of 3,000 units?

Solution:

1. Step 1: Variable cost per unit

   VC per unit = ($31,400 - $26,810) / (6,400 - 4,360) = $2.25

2. Step 2: Fixed cost

   TC = FC + VC
   $26,810 = FC + ($2.25/unit x 4,360 units)
   FC = $17,000

3. Step 3: Total cost of 3,000 units

   TC = $17,000 + (3,000 units x $2.25/unit)
   TC = 23,750

Graph 8: Other cost behaviour patterns

This graph represents a cost which is variable with output, subject to a minimum (fixed) charge.