Which Of The Following Is True About The Changes In Fixed Cost?

MANAGEMENT ACCOUNTING CONCEPTS AND TECHNIQUES

By Dennis Caplan, Academy at Albany (State University of New York)

� Affiliate 4:� Cost Behavior

Chapter Contents:

- Introduction

- Variable costs

- Fixed costs

- Relevant range

- Mixed costs

- Cost behavior assumptions in management accounting versus microeconomics

- Exercises and problems

Introduction:

The most important edifice block of both microeconomic analysis and price accounting is the characterization of how costs change as output volume changes. Output volume tin refer to production, sales, or any other principle activity that is appropriate for the arrangement under consideration (due east.1000.: for a school, number of students enrolled; for a health clinic, number of patient visits; for an airline, number of passenger miles). The following word examines the volume of production in a factory, but the same principles utilise regardless of the blazon of organization and the appropriate measure of action.

Costs tin can be variable, fixed, or mixed.

Variable Costs:

Variable costs vary in a linear way with the production level. Nevertheless, when stated on a per unit footing, variable costs remain constant beyond all production levels within the relevant range . The following two charts depict this relationship between variable costs and output volume.

A good instance of a variable toll is materials. If one pair of pants requires $10 of fabric, so every pair of pants requires $10 of fabric, no thing how many pairs are made. The fabric cost is $10 per unit of measurement at every level of production. If i pair is made, the total fabric toll is $10; if two pairs are made, the full fabric cost is $20; and if 1,000 pairs are made, the total fabric cost is $10,000. Hence, the total cost is increasing and linear in the production level.

Fixed Costs:

Fixed costs do non vary with the product level. Total fixed costs remain the same, within the relevant range . However, the stock-still cost per unit decreases as product increases, because the same fixed costs are spread over more units. The post-obit two charts depict this relationship between fixed costs and output volume.

In this example, fixed costs are $50,000. The first chart shows that stock-still costs remain $50,000 at all production levels from 100 units to i,000 units. The second chart shows that the stock-still cost per unit decreases as product increases. Hence, when 100 units are manufactured, the stock-still price per unit is $500 ($50,000 � 100). When 500 units are manufactured, the stock-still cost per unit of measurement is $100 ($50,000 � 500).

Relevant Range:

The relevant range is the range of activity (e.one thousand., production or sales) over which these relationships are valid. For example, if the factory is operating at capacity, increasing product requires boosted investment in fixed costs to expand the facility or to lease or build another manufacturing plant. Alternatively, production might be reduced below a threshold at which indicate one of the visitor�s factories is no longer needed, and the fixed costs associated with that mill can be avoided. With respect to variable costs, the company might qualify for a book discount on fabric purchases above some product level. The relevant range for characterizing textile as a variable cost ends at that production level, because the fabric cost per unit of output is different when the factory produces above that threshold than when the factory produces below that threshold.

Mixed Costs:

If, inside a relevant range, a toll is neither fixed nor variable, it is chosen semi-variable or mixed . Following are two common examples of mixed costs.

In this case, although the total toll line increases in production, it does non laissez passer through the origin because there is a fixed cost component. An example of a toll that fits this description is electricity. A stock-still corporeality of electricity is required to run the manufacturing plant air conditioning, computers and lights. There is also a variable price component related to running the machines on the manufacturing plant floor. The fixed component in this instance is $3,000 per month. The variable cost component is $10 per unit of output. Hence, at a production level of 500 units, the total electric cost is $8,000 [$3,000 + ($10 ten 500)].

The mixed cost illustrated in the in a higher place chart is called a step part. An example of such cost behavior would be the full bacon expense for shift supervisors. If the factory runs i shift, merely one shift supervisor is required. In order for the mill to produce to a higher place the maximum capacity of a unmarried shift, the factory must add a second shift and rent a 2d shift supervisor, then that total shift supervisor salary expense doubles. If the factory runs three shifts, 3 shift supervisors are required.

Cost Behavior Assumptions in Direction Accounting Versus Microeconomics:

Microeconomic analysis usually assumes decreasing marginal costs of production, sometimes followed by increasing marginal costs of product across a certain production level. Hence, economists� graphs of the total cost of production and the average per-unit toll of production testify smooth, curved functions. Management accountants usually assume the linear relationships depicted in the previous graphs. Linearity is a more accurate description of many situations encountered by management accountants than the economists� curves, and even when linearity constitutes a simplifying assumption information technology is almost ever sufficiently descriptive for the chore at mitt.��

Go to the Finish-of-Chapter Exercises and Problems

Get to the Side by side Chapter

Return to the Table of Contents

For a printer-friendly version, contact Dennis Caplan at [e-mail protected]