4: Cost Classification II

Question 1

What is Cost Behaviour?

Answer 1

Refers to how a certain cost responds to the changes in the level of business activities

Has 3 behavioural patterns

Fixed (fixed costs)

Variable (variable costs)

Mixed/SEMI(mixed costs)

Question 2

What is Fixed Cost?

Answer 2

Does not change with the changes in the level of activities

Rather remains fixed with a relevant range

The total costs remain fixed, fixed cost per unit changes

With increased productivity, per unit fixed costs decrease

Example; depreciation, rates, rent, salaries, insurance payment

Also called Capacity Cost

Question 3

Types of Fixed Costs

Answer 3

Committed fixed cost =

Long term in nature

Cannot be reduced to zero even in the short term without seriously impairing the profitability or long term goals of the organisation

Examples; investment in equipment, salaries of skilled professional employees

Once cost is committed = continues irrespective of production

Discretionary fixed cost =

Usually short term in nature
Arises from the annual decision of the managers to spend on certain issues such as advertising, employee development, and internship programs

Also called Managed Fixed Costs

Can be reduced to zero in the short term without harming the company’s operations

Question 4

What is a Variable Cost?

Answer 4

This is the cost that varies in direct proportion to the changes in the level of activities

Measured against activity base such as labour hour, machine hour, units produced and units sold

Can change with the activity levels - but remains fixed at per unit level

Examples; direct materials, direct labour, wages, packaging, electricity, gas and transport costs

Question 5

Equation

Answer 5

Total Cost = Fixed Cost + Variable Cost

Question 6

What is a Semi-Variable Cost?

Answer 6

The variable cost that has both fixed and variable elements

Example; home phone -

Might have a home phone agreement, says you pay £15 per month for your phone. This is the fixed element. you pay this amount whether you use or not the phone.

On top of this, you pay for each call at a certain rate. This is the variable element. You pay only if you make calls.

Could also be electricity bills, wages (commision), gas, and maintenance

Needs to be separated because it has both fixed and variable elements

Separated using this method - Y = a + bX

Separation helps in the prediction of costs

Allows preparing profit and loss statement in contribution margin approach

Contribution Margin approach presents cost behaviours more visibly

Contribution Margin enables cost-volume-profit analysis