Cost Behavior Mark fieldingPritchard mefielding com 1 The

Cost Behavior Mark fielding-Pritchard mefielding. com 1

The Activity Base Units produced Machine hours A measure of what causes the incurrence of a variable cost Miles driven mefielding. com Labor hours 2

True Variable Cost Example Total Long Distance Telephone Bill A variable cost is a cost whose total dollar amount varies in direct proportion to changes in the activity level. Your total long distance telephone bill is based on how many minutes you talk. mefielding. com Minutes Talked 3

Variable Cost Per Unit Example Per Minute Telephone Charge A variable cost remains constant if expressed on a per unit basis. The cost per minute talked is constant. For example, 10¢ per minute. mefielding. com Minutes Talked 4

Extent of Variable Costs The proportion of variable costs differs across organizations. For example. . . A public utility with large investments in equipment will tend to have fewer variable costs. A manufacturing company will often have many variable costs. A service company will normally have a high proportion of variable costs. A merchandising company usually will have a high proportion of variable costs like cost of sales. mefielding. com 5

Examples of Variable Costs 1. Merchandising companies – cost of goods sold. 2. Manufacturing companies – direct materials, direct labor, and variable overhead. 3. Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing. 4. Service companies – supplies, travel, and clerical. mefielding. com 6

True Variable Cost Direct materials is a true or proportionately variable cost because the amount used during a period will vary in direct proportion to the level of production activity. mefielding. com Volume 7

Step-Variable Costs Cost A resource that is obtainable only in large chunks (such as maintenance workers) and whose costs increase or decrease only in response to fairly wide changes in activity is known as a step-variable cost. mefielding. com Volume 8

Step-Variable Costs Cost Small changes in the level of production are not likely to have any effect on the number of maintenance workers employed. mefielding. com Volume 9

Step-Variable Costs Cost Only fairly wide changes in the activity level will cause a change in the number of maintenance workers employed mefielding. com Volume 10

The Linearity Assumption and the Relevant Range Total Cost A straight line Economist’s closely Curvilinear Cost approximates a Function curvilinear mefielding. com variable cost line within the relevant range. Relevant Range Accountant’s Straight-Line Approximation (constant unit variable cost) Activity 11

Total Fixed Cost Example Monthly Basic Telephone Bill A fixed cost is a cost whose total dollar amount remains constant as the activity level changes. Your monthly basic telephone bill is probably fixed and does not change when you make more local calls. mefielding. com Number of Local Calls 12

Fixed Cost Per Unit Example Monthly Basic Telephone Bill per Local Call Average fixed costs per unit decrease as the activity level increases. The fixed cost per local call decreases as more local calls are made. mefielding. com 13 Number of Local Calls

Types of Fixed Costs Committed Discretionary Long-term, cannot be significantly reduced in the short-term. May be altered in the short-term by current managerial decisions Examples Depreciation on Buildings and Equipment and Real Estate Taxes Advertising and Research and Development mefielding. com 14

The Trend Toward Fixed Costs The trend in many industries is toward greater fixed costs relative to variable costs. As machines take over many mundane tasks previously performed by humans, “knowledge workers” are demanded for their minds rather than their muscles. mefielding. com Knowledge workers tend to be salaried, highly-trained and difficult to replace. The cost to compensate these valued employees is relatively fixed rather than variable. 15

Is Labour a Variable or a Fixed Cost? The behavior of wage and salary costs can differ across countries, depending on labor regulations, labor contracts, and custom. In France, Germany, China, and Japan, management has little flexibility in adjusting the size of the labor force. Labor costs are more fixed in nature. In the United States and the United Kingdom, management has greater latitude. Labor costs are more variable in nature. mefielding. com 16

Rent Cost in Thousands of Dollars Fixed Costs and Relevant Range mefielding. com 90 Relevant 60 Range 30 0 0 Total cost doesn’t change for a wide range of activity, and then jumps to a new higher cost for the next higher range of activity. 1, 000 2, 000 3, 000 Rented Area (Square Feet) 17

Fixed Costs and Relevant Range The relevant range of activity for a fixed cost is the range of activity over which the graph of the cost is flat. Example: Office space is available at a rental rate of $30, 000 per year in increments of 1, 000 square feet. As the business grows, more space is rented, increasing the total cost. mefielding. com 18

Fixed Costs and Relevant Range How does this type of fixed cost differ from a stepvariable cost? mefielding. com Step-variable costs can be adjusted more quickly and. . . The width of the activity steps is much wider for the fixed cost. 19

Mixed Costs A mixed cost has both fixed and variable components. Consider your utility costs. Total Utility Cost Y t d l a t o xe i m s co T Variable Cost per KW Activity (Kilowatt Hours) mefielding. com X Fixed Monthly Utility 20 Charge

Analysis of Mixed Costs Account Analysis and the Engineering Approach Each account is classified as either variable or fixed based on the analyst’s knowledge of how the account behaves. mefielding. com Cost estimates are based on an evaluation of production methods, and material, labor and overhead requirements. 21