COST BEHAVIOUR
Cost behaviour is the way in which costs are affected by changes in the volume of output.
Management decision will be based on how costs and revenue vary at different activity level
Examples of decision are as following:
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What should be planned activity level be for the next period?
Should the selling price be reduced in order to sell more units?
Should a particular component be manufactured internally or bought in?
Should a contract be undertaken?
Cost behaviour and cost control
An accountant should know the level of costs which should have been incurred as a result of organisation
activities in order to control
Cost behaviour and Budgeting
Knowledge of cost behaviour is essential for the tasks of budgeting decision making and control
accounting.
Cost behaviour and level of activity
The factors which may influence cost are volume of output of level of activity
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Number of units produced
Value of items sold
Number of items sold
Number of invoices issue
Number of units of electricity consumed
Cost behaviour principles
The basic principle of cost behaviour is that the level of activity rises, costs will usually rise
Cost Behaviour patterns.
Note the following Graphs below:
Graph 1 relates to fixed Costs
Graph 2 relates to Curvilinear or Non liners costs
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GRAPH 1: FIXED COSTS
A fixed cost is a cost which tends to be unaffected by increase or decrease in volume of output. Fixed
costs are a period charge, fixed cost always have a variable element. Fixed cost don’t change with
volume
Example
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Straight line depreciation of single machine
Fuel for aircraft is fixed and the number of passenger varies.
Weekly payroll
Rental for office space or store front
Salaries
Leases
insurance
Non- linear or curvilinear variable costs – Refer to graph 2 above
Curvilinear cost also called a nonlinear cost is an expense that increase at an inconsistent rate as
production.
Each extra unit of output causes more than proportionate increase in cost.
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Learning curve - few items as produced are difficult, flawed and expensive, low unit s will be
produced.
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The cost of a piecework scheme for individual workers with differential rates could behave the
curvilinear fashion. The rates increase by small amounts at progressively higher output level.
STEP COSTS
Step Costs is a cost which is fixed in nature but only with certain levels of activities.
See the graph below
Examples
1. Rental is a step cost in situations where accommodation requirements increase as output levels
gets higher e.g Warehousing.
2. Basic pay of employees is nowadays usually fixed, as output rises, more employees (direct
workers, supervisors, manages and so on are required.
3. Royalties (Royalties are payment for the right to use intellectual property like copy rights patents
and trademarks). Example in music performance royalty art and online use of image stock
photography, book royalty paid to the author.
VARIABLE COSTS
Variable Costs are a cost which tends to vary directly with the volume of output. The variable cost per
unit is the same amount for each unit produce.
The cost directly related to the sales volume of your business. Toed to volume
Examples of variable costs
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Sales commission is variable in relation to volume or value of sales.
Delivery / shipping charges
Advertising and publicity
Product material
Commission
Credit card fees
Product supplies
Bonus payment productivity to empoyees
SEMI- VARIABLE COSTS
Semi – Variable costs (or semi fixed costs or Mixed costs) is a cost which contains both fixed and
variable components and so is partly affected by changes in the level of activity.
The Graphs Below depict semi- variable costs
Electricity and gas bills
i)
ii)
Fixed cost
= Standing Charge
Variable cost = Charge per unit of electricity used
Salesman’s salary
i)
ii)
Fixed Cost = basic salary
Variable cost = Commission on sales made
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Costs of running a car
i)
ii)
Fixed cost
=
Variable cost =
road tax, insurance
petrol, oil, repair (which vary with miles travelled)
Determining the fixed and variable elements of semi variable costs
Analysis costs
The fixed and variable elements of semi – variable costs can be determined by the high- low method.
The high- low method
The following steps should be used to estimate the fixed and variable elements of semi variable
costs
Review records of costs in previous periods
 Select the period with the highest activity level
 Select the period with the lowest activity level
Determine the following
 Total cost at high activity level
 Total cost at low activity level
 Total unit at high activity level
 Total units at low activity level
Calculate the following
Total cost at high activity level – Total cost at low activity level
Total units at high activity level – Total units at low activity level
Step 1
Step 2
Step 3
= variable costs per units
Step 4
The fixed cost can be determined as follows. (Total cost at high activity level)
– (total units at high activity level X variable cost per unit)
Assignment
Explain the distinction between:
a)
b)
c)
d)
Direct and indirect cost
Fixed and variable costs
Production and non- production cost
Committed and discretionary costs
(2 marks)
(3 marks)
(2 marks)
(3 marks)
Exercise
Classify the following items of expenditure according to their behavior i.e. as fixed, variable, semi
variable or stepped fixed costs.
(1) Monthly rent
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(2) Council tax charge
(3) Bank loan interest
(4) Petrol
(5) Electricity bill
(6) Telephone bill
(7) Annual salary
(8) Depreciation of one, two and three factory machines
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