Cost Behavior
Cost Behavior
Cost behavior is term for describing whether a cost changes when the level of output changes. The cost can vary proportionately with the changes in the level of activity or unaffected by changes in the level of activity. Costs can be variable, fixed, or mixed. A cost that does not change in total as output changes is a fixed cost. A variable cost, on the other hand, increases in total with an increase in output and decreases in total with a decrease in output. Understanding how costs behave in a particular situation is crucial for the decision-making process in an organization. Cost behavior information allows managers:
To prepare budgets
To predict cash flows
To plan dividend payments
To establish selling prices [1]
1) Variable cost:
Total costs that change in direct proportion to changes in productive output (or any other measure of volume). Variable costs are costs that in total vary in direct proportion to changes in output within the relevant range. It be described by the equation: Total Variable Cost = Total Quantity of Output x Variable Cost per Unit of Output. The total variable costs fluctuate with changes in Volume but the variable cost per unit remains constant. [2]
2) Fixed cost:
A fixed cost is costs that in total are constant within the relevant range as the level of output increases or decreases. Fixed costs are those that stay the same in total regardless of the number of units produced or sold. Total fixed costs remain constant but fixed costs per unit changes as fewer or more units are produced. [2] Fixed unit costs vary inversely with activity or volume. If more units are produced than anticipated, the fixed costs are spread over more units, thus decreasing the fixed cost per unit; if fewer units are produced than anticipated, the fixed costs are spread over fewer units, thus increasing the fixed cost per unit.
3) Mixed costs:
Mixed costs or semi-variable costs have properties of both fixed and variable costs
Cost behavior is term for describing whether a cost changes when the level of output changes. The cost can vary proportionately with the changes in the level of activity or unaffected by changes in the level of activity. Costs can be variable, fixed, or mixed. A cost that does not change in total as output changes is a fixed cost. A variable cost, on the other hand, increases in total with an increase in output and decreases in total with a decrease in output. Understanding how costs behave in a particular situation is crucial for the decision-making process in an organization. Cost behavior information allows managers:
To prepare budgets
To predict cash flows
To plan dividend payments
To establish selling prices [1]
1) Variable cost:
Total costs that change in direct proportion to changes in productive output (or any other measure of volume). Variable costs are costs that in total vary in direct proportion to changes in output within the relevant range. It be described by the equation: Total Variable Cost = Total Quantity of Output x Variable Cost per Unit of Output. The total variable costs fluctuate with changes in Volume but the variable cost per unit remains constant. [2]
2) Fixed cost:
A fixed cost is costs that in total are constant within the relevant range as the level of output increases or decreases. Fixed costs are those that stay the same in total regardless of the number of units produced or sold. Total fixed costs remain constant but fixed costs per unit changes as fewer or more units are produced. [2] Fixed unit costs vary inversely with activity or volume. If more units are produced than anticipated, the fixed costs are spread over more units, thus decreasing the fixed cost per unit; if fewer units are produced than anticipated, the fixed costs are spread over fewer units, thus increasing the fixed cost per unit.
3) Mixed costs:
Mixed costs or semi-variable costs have properties of both fixed and variable costs
References: Upper Saddle Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2003). Managerial accounting. New York: McGraw-Hill/Irwin. Weiss, D. (2010). Cost behavior and analysts ' earnings forecasts. The Accounting Review, 85(4), 1441-1471.