Cost behaviour refers to the way and manner in which a company's costs change as its level of production changes.
It refers to the relationship between a cost and the level of economic activity.
There are four main cost behaviour patterns, which are fixed costs, variable costs, semi-variable costs, and step fixed costs.
Fixed costs
Fixed costs are the costs of providing the basic operating capacity of a company.
They are costs that do not change within a relevant range.
Fixed costs do not vary with output at a given range.
They remain fixed in total amount with an increase or decrease in the volume of output or productive activity.
Fixed costs accrue in relation to the passage of time.
Within relevant ranges or definable limits, fixed costs tend to be unaffected by fluctuations in the volume of output.
It should be noted that fixed costs are sometimes called capacity costs.
An example of fixed cost is the rent of the factory which remains fixed for a given range.
The cost behaviour of fixed costs is that they remain constant within a relevant range. Therefore, fixed costs are represented graphically as a horizontal straight line.
Characteristics of Fixed costs
- Total fixed costs remain constant within a relevant range.
- The per-unit of fixed costs varies inversely with activity level. That is, it decreases as output increases.
- Total fixed costs are represented graphically as a horizontal straight line.
- Fixed costs per unit are graphically represented as a downward-sloping.
- Fixed costs are usually not considered in decision-making because they are regarded as irrelevant costs.
Variable costs
Variable costs are cost that changes depending on the level of production.
These are costs that are directly proportional to the volume of output.
One thing you must note about variable cost is that it increases in total in direct proportion to the changes in activity level but remain constant per unit as production activity increases.
Stated differently, total variable costs increase proportionally to the increase in output but the variable cost per unit remains constant even as output increases.
Examples of variable costs are direct material costs and direct labour costs.
The cost behavior of variable costs is that it increases or decreases proportionally according to the level of activity.
Characteristics of variable costs
- Total variable cost increases(or decreases) directly proportionally as activity increases( or decreases). That is, if output increases by 20%, the variable costs also increase by 20%.
- Variable cost per unit remains constant as output increases.
- Graphically, the total variable cost is upward-sloping.
- The graphic representation of variable cost per unit is a horizontal straight line.
- Variable costs are considered in decision-making and as a result, are called relevant costs.
- They are often used in the calculation of the break-even point.
- Variable costs are always zero when output is zero.
Semi-variable costs
As the name might seem to suggest, semi-variable costs are costs that are partly variable and partly fixed.
According to the Chartered Institute of Management Accountants (CIMA), "semi-variable costs are costs containing both fixed and variable components and which is thus partly affected by a change in the level of activity".
Semi-variable costs change in response to changes in output but not in direct proportion to the changes in output or activity.
They are costs that are fixed for a set level of production or consumption, becoming variable after the level is exceeded.
Semi-variable costs are caused by the combined effect of the passage of time, activity, or output.
Semi-variable costs are sometimes called semi-fixed costs or mixed costs.
An example of a semi-variable cost is the cost of a salesman's salary, containing both a basic salary( fixed cost) and a commission on sales made( variable cost).
Characteristics of Semi-variable costs
- Semi-variable costs increase as activity level increases.
- Unlike variable costs which increase proportionally to output, semi-variable costs do not increase in direct proportion to output.
- The per unit of semi-variable costs do not remain constant like variable costs per unit. It may Increase as production increases.
Step fixed costs
These are costs that remain constant over a fixed range of activities but jump to a different amount for the activity levels outside the range.
Steps fixed costs are fixed in nature but only within certain levels of activity.
Step fixed costs "step up" once the relevant range is exceeded.
To understand step cost, let us take the example of the rent of a classroom with a capacity to accommodate only 50 students.
If the number of students exceeds 50, a second classroom will be required and the rent(for two classrooms) would go up or step up.
Before we conclude, I will love to talk about the concept of the relevant range.
Relevant range
Relevant range specifies the limits of cost-driver activity within which a specific relationship between a cost and its cost driver will be valid.
It is the range of production within which the assumptions of a cost being constant are valid.
If the range is exhausted, the costs of production are expected to increase or "step up".
For example, a company may have a relevant range of 0 to 100 units per week, which means that if the company produces more than 1000 units per week, its costs will increase or step up.
Thanks for reading! If you found this post helpful, make sure to subscribe to our newsletter so you can stay up-to-date on our latest content and never miss a post.