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Knowing the behavior of costs is very useful in the management of a company for a variety of purposes. For example, know how costs behave, enables managers or administrators predict profits when sales volume and production changes. Knowing the behavior of costs is also useful for estimating costs. In turn, the estimated costs affect various decisions of the administration, like for example, if it should use machinery exceeded capacity to produce and sell a product at a reduced price.
The behavior of a cost refers to the manner in which a cost changes at the time that a related activity changes. To understand the behavior of costs, the following two factors must be considered: First, the activities that is believed that cause the cost to be incurred mues be identified. These activities are called activity bases (or activity drivers). Second, the activity range on which changes in the cost are of interest must be specified. This activity range is called relevant rank.
VARIABLE COSTS BEHAVIOR
When the activity level is measured in units produced, direct material and labor costs are generally classified as direct variable costs. The variable costs are costs that vary in proportion to the total change in the level of activity. For example, assume that the company Sound, Inc. produces sound systems under the brand name "Loud". The parts for the sound system are purchased from external suppliers for $10 USD per unit and are assembled at the plant Sound, Inc. in San Benito, USA. The direct materials costs for the model Loud-10 in a relevant range are from 5000 to 30000 units of production are shown below:
The variable cost per unit is the same, while the total variable cost changes in proportion to changes in the basis of activity. For model Loud-10, for example, the cost of direct materials for 10,000 units ($100,000) is twice the cost of direct materials for 5,000 units ($50,000). The total cost of materials varies in direct proportion to the number of units produced because the direct cost of materials per unit ($10) is the same for all levels of production. Then, producing 20,000 additional units of product Loud-10 would increase the cost of direct materials by $200,000, to produce 25,000 additional units would increase the cost by $250000 and so on.
FIXED COSTS BEHAVIOR
When units produced
is a measure of activity, examples of fixed costs include the
depreciation of equipment in a straight line of a factory, plant's
machinery and equipment insurance, supervisors salaries, etcetera.
costs are costs that continue the same in their total even if the level
of activity changes. As an
that Hana Inc. produces and distributes cheese pies
plant in Los Angeles, USA. The
production supervisor at the plant in Los Angeles is Vicente Fernandez,
who is paid a salary of $ 75,000 USD per year. The
relevant range of activity for a year is 50000 to 300000 cheese cakes.
salary of Vincent is a fixed cost that does not vary with the number of
units produced. Regardless
number of cakes produced between the range of 50000 to 300000, Vincent
receives a salary of $ 75000.
Seen in graphics would be as follows:
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