Costs Behavior | Variable and Fixed Costs Analysis

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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:

Units produced (Loud Model-10)	Direct Materials Cost per unit	Total Direct Material Cost
5,000	$10	$50,000
10,000	10	100,000
15,000	10	150,000
20,000	10	200,000
25,000	10	250,000
30,000	10	300,000

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.

Variable cost behavior

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. The fixed costs are costs that continue the same in their total even if the level of activity changes. As an example, assume that Hana Inc. produces and distributes cheese pies at its plant in Los Angeles, USA. The general 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. The salary of Vincent is a fixed cost that does not vary with the number of units produced. Regardless of the number of cakes produced between the range of 50000 to 300000, Vincent receives a salary of $ 75000.
Even if the fixed cost remains unchanged when the number of cakes produced changes, the fixed cost by cake changes. The more cakes are produced, total fixed costs are distributed among more cakes, and then lowers the cost per cake. This relationship can be seen in the wage example of $75,000 of Vicente Fernandez shown below:

Cakes Produced	V. Fernandez Total Salary	Salary per cake produced
50,000	$75,000	$1.500
100,000	75,000	0.750
150,000	75,000	0.500
200,000	75,000	0.375
250,000	75,000	0.300
300,000	75,000	0.250

Seen in graphics would be as follows:

Fixed cost behavior