Cost Behaviour Flashcards
Cost Behaviour
Refers to how costs change in relation to volume or activity.
Some costs vary with volume or operating activity.
Others remain fixed as volume changes.
Some costs exhibit characteristics between these two extremes (mixed costs).
How costs react to changes in level of business activity?
Total variable costs - change when activity changes.
Total fixed costs - remain unchanged when activity changes.
Management Cycle (3 points)
Managers use knowledge of cost behaviour to estimate future costs and the impact of operational changes on future profitability.
Managers use assumptions about cost behaviour in almost every decision they make.
Managers must understand cost behaviour patterns to anticipate cost ramifications of alternatives in order to decide correctly.
Variable Costs
Total costs that change in direct proportion to changes in productive output. (Linear relationship between activity variable and cost.)
Per unit basis
However VC remain constant as volume changes.
Total Variable Cost
Directly proportional to the activity level within the relevant range.
On graph it is the line y=x
Variable Cost Per Unit
Remains the same over wide ranges of activity.
Approximately constant.
On graph it is line y=constant.
Variable Costs Examples
Direct Materials
Direct and Indirect Labour (hourly) - not salary labour (fixed).
Operating supplies - machinery, for services - documents used.
Sales commisions
Variable Costs for retailers
Cost of goods sold
Variable Costs for service organisataions
Supplies and travel
Variable Costs for manufacturers
Direct material, direct labour and variable manufacturing overhead.
Fixed Costs
Costs that remain constant within a relevant range of volume or activity.
Can’t get rid of them easily.
Per unit basis
Fixed costs vary inversely with changes in volume.
Fixed cost per unit
Decreasing exponential graph.
Cost per unit decreases as activity level increases.
Total fixed cost
Remains constant even when the activity level changes within the relevant range.
graph y=constant
y intercept is the fixed cost
Fixed cost examples
Depreciation - Devaluation of assets.
Rent - Can be negotiated over long term and changed.
Supervisory Salaries - Annual fixed.
Auditors fees - Switch and change price long term, doesn’t change with activity.
Activity Base
A measure of the event causing the incurrence of a variable cost - a cost driver.
A variable cost must vary with activity base.
The thing causing the cost to increase.
Cost may be variable w.r.t one activity base but fixed with respect to another.
Activity Base Examples
Units produced - direct materials.
Machine hours - Power of machine, units produced.
Labour hours - cost of production.
Miles driven - petrol costs.
Relevant Range
Volume range within the which the actual operations are likely to occur.
Linearity assumption and relevant range
Straight line closely approximates a curvilinear variable cost line within the relevant range.
Common FC behaviour pattern
Step pattern.
Want to increase production capacity, need to invest in fixed costs to do so.
Mixed Cost
Has both fixed and variable components.
Part of the cost changes with volume or usage and part of the cost is fixed over time.
Total Mixed Costs
Fixed costs + Variable costs
Can be expressed as an equation -
y=a+bx
y - the total mixed cost
a - the total fixed cost (y intercept)
b - variable cost per unit of activity (gradient)
x - level of activity
Mixed Costs example
Electricity
Telephone
Heating
Types of Fixed Costs
Committed and Discretionary
Committed Fixed Cost
Long term, cannot be reduced in the short term.
Changing them would impact organisation.
eg depreciation on buildings and equipment.
Discretionary Fixed Cost
Mat be altered in the short term by current managerial decisions.
eg advertising and R&D.
Trends towards fixed costs
Increase automation.
Increase in salaried knowledge workers who are difficult to train and replace.
Implications - managers are more locking in with fewer decision alternatives. Planning becomes more crucial as fixed costs are difficult to change with current operating decisions.
Contribution Format/ Contribution Profit Statement
Costs organised by behaviour - contribution margin format - covers fixed costs and provides for profit.
Used primarily by managers.
Total and Unit columns
Sales Revenue - Variable Costs = Contribution
Contribution - Fixed Costs = Net Profit
Traditions Profit Statement
Primarily used for external reporting.
Fixed costs not separated out.
Costs organised by function.
Sales - Costs of goods sold = Gross margin
Gross margin - other expenses = Net profit
