Methods of Cost Variability

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Methods of Cost Variability
The Methods
* The Comparison Method
* High and Low Point or Range Method
* The Equation Method
* The Average Method
* The Graphic Method (Scatter diagram)
* The Method of Least Squares
* The Analytical Method or Degree of Variability Method

Illustration
From the following month-wise information in respect of semi-variable costs of a firm, segregate the cost into fixed and variable elements: Months2009| Production (Units)| Semi Variable Cost (Rs.)| January| 200| 2,000|

February| 150| 1,750|
March| 250| 2,250|
April| 300| 2,500|
May| 400| 3,000|
June| 500| 3,500|

The Comparison Method
Under this method, the quantum of output at two different levels of activity is compared with corresponding amount of semi-variable costs. As fixed cost remains constant, variable cost is determined by applying the following ratio: Variable cost per unit = Change in the amount of Semi-Variable Costs/Change in volume of Output Taking the level of activity of any two months, say April and May, the variable and fixed elements of cost may be calculated as follows: Variable cost per unit = Change in the amount of Semi-Variable Costs/Change in volume of Output =500/100= Rs. 5 per unit

Therefore, Variable Element of Cost= 300*5 =Rs.1,500 (for April) And, Fixed Element of Cost = Rs. 2,500-Rs. 1,500 =Rs. 1,000 (for April) Similarly, Variable Cost for May=400*5=Rs.2 000 and Fixed Cost for May=3,000-2,000= Rs. 1,000

Month2009| Production (Units)| S.V. Cost| Variable Element(Rs.)| Fixed Element (Rs.)| April| 300| 2,500| 1,500| 1,000|
May| 400| 3,000| 2,000| 1,000|
Change| 100| 500| | |

The High and Low Point or Range Method
This method is similar to the comparison method except that the data relating to the highest and lowest level of activity are considered. The data of June (highest) and February (lowest) is considered: Variable cost per unit = Change in the amount of Semi-Variable Costs/Change in volume of Output = 1,750/350 =Rs. 5 per unit

Variable Element for February= 150*5 =Rs. 750
And Fixed Element = 1750- 750= Rs. 1,000
And Fixed Cost = 3,500-2,500= Rs. 1,000

Month| Production (Units)| S.V. Cost (Rs.)| Variable Element (Rs.)| Fixed Element (Rs.)| February| 150| 1,750| 750| 1,000|
June| 500| 3,500| 2,500| 1,000|
Change| 350| 1,750| | |

The Equation Method
Under this method, the costs are segregated by means of straight line/equation method. y = mx + c
Where,
y = Total semi-variable cost
x = Output (in units)
m = Variable cost per unit
c = Fixed cost
Putting the figures of January and February in the equation: 2,000 = 200m + c ……… (i) for January
1,750 = 150m + c ……… (ii) for February
Subtracting (ii) from (i), we get, 250 = 50m or m=Rs. 5 = Variable cost per unit Now, substituting the value of ‘m’ in equation (i) 2,000 = 200*5 + c; or c = 1,000; or Fixed cost = Rs.1,000

The Average Method
First the average of the data relating to the two selected levels of activities is calculated and then The equation or range method is applied.

The Graphic Method
(Scatter Diagram)
All relevant data given are plotted on a scatter graph
The volume of production is plotted on the horizontal axis and the semi-variable cost on the vertical axis Corresponding to the volume of production, points of semi-variable costs are drawn A line of best fit is then drawn from the plotted points in such a way that the fair average relationship between volume of production and cost is established. Points falling far away from the line of best fit are abnormal and hence, should be ignored. The point where the line of best fit intercepts the vertical axis is the fixed cost. From this point, a line parallel to the horizontal axis is then drawn to show the fixed cost line. The slope of the total semi-variable cost line known as the line of best fit determines the variable element. The variable cost...
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