Written by Cost behaviour is the study of how different costs change in response to changes in the level of activity or output.
It refers to the way and manner in which different costs change as the level of production changes.
Cost behaviour shows 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 costs that do not change with the level of activity or output within a relevant range.
They are the costs of providing the basic operating capacity of a company.
Fixed costs do not change in response to changes in business activity within a relevant range.
They remain fixed in total amount with an increase or decrease in the volume of output or productive activity.
Within relevant ranges or definable limits, fixed costs tend to be unaffected by fluctuations in the volume of output.
Examples of fixed costs are the cost of rent and depreciation expenses.
Characteristics of fixed costs
- Total fixed costs remain constant within a relevant range.
- Fixed costs are represented graphically as a horizontal straight line.
- Fixed costs (per unit) vary inversely with activity level. That is, they decrease as output increases.
- Fixed costs per unit are downward-sloping.
- Fixed costs are usually not considered in decision-making because they are regarded as irrelevant costs.
Variable Costs
Variable costs are costs that vary in direct proportion to the level of activity or output.
That is, they are directly proportional to the level of production.
You must note that variable cost 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 or decrease 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.
Characteristics of Variable Costs
- Total variable cost increases(or decreases) directly proportionally to the change in activity level. That is, if output increases by 20%, the variable costs also increase by 20%.
- Variable costs per unit are indifferent to the level of activity. That is, variable cost per unit remains constant as output increases.
- The curve of variable cost( in total) is upward-sloping.
- The curve of variable cost( per unit) is a horizontal straight line.
- Variable costs are called relevant costs since they are considered in decision-making.
- They are often used in break-even analysis.
Mixed costs
Mixed costs are costs that have both a variable and a fixed component.
They are partly variable and partly fixed.
According to the Chartered Institute of Management Accountants (CIMA), “mixed costs are costs containing both fixed and variable components and which is thus partly affected by a change in the level of activity”.
Mixed costs change in response to changes in output but not in direct proportion to the changes in output or activity.
They are sometimes called semi-fixed costs or semi-variable costs.
An example of a mixed 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 Mixed Costs
- Mixed costs increase as the activity level increases.
- Unlike variable costs which increase proportionally to output, mixed costs do not necessarily increase in direct proportion to output.
- The semi-variable cost ( per unit) is not remain fixed like the variable cost per unit. It may Increase or decreases as production increases.
Stepped-fixed costs
Stepped-fixed costs are costs that remain constant over a fixed range of activities but jump to a different amount for activity levels outside the range
Stepped-fixed costs are fixed in nature but only within certain levels of activity. They “step up” once the relevant range is exceeded.
To illustrate, suppose you run a bakery and you need to hire one baker for every 100 loaves of bread you produce per day.
The baker’s salary will be called stepped-fixed cost because it stays the same if you produce between 0 and 100 loaves, but increases if you produce between 101 and 200 loaves, and so on.
Stepped-fixed costs should not be confused with variable costs.
While variable costs change proportionally with the level of activity, stepped-fixed costs only change when the activity level has exceeded the relevant range.
One important concept to understand when dealing with stepped-fixed costs is the relevant range.
The 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, in our bakery example, the relevant range for the baker’s salary is 0 to 100 loaves per day.
If we produce more than 100 loaves per day, we need to hire another baker and our salary cost will step up.
