Labor hours

Labor hours

An activity base (also called a cost driver) is a measure of what causes the incurrence of variable costs. As the level of the activity base increases, the total variable cost increases proportionally.

 

Units produced (or sold) is not the only activity base within companies. A cost can be considered variable if it varies with activity bases such as miles driven, machine hours, or labor hours.

 

Fixed Cost

Your monthly contract fee for your cell phone is fixed for the number of monthly minutes in your contract. The monthly contract fee does not change based on the number of calls you make.

 

 

 

Number of Minutes Used Within Monthly Plan

Monthly Cell Phone Contract Fee

A fixed cost is constant within the relevant range. In other words, fixed costs do not change for changes in activity that fall within the “relevant range.” For example, your monthly contract fee for your cell phone is a fixed amount for a certain number of minutes. The monthly contract fee does not change based on the number of calls you make.

 

Of course, if you go over your monthly minutes allotment, you have exceed the relevant range for your monthly contract and will be charged above and beyond your monthly contract fee.

Fixed Cost Per Unit

Within the monthly contract portion, the average fixed cost per cell phone call made decreases as more calls are made.

Number of Minutes Used Within Monthly Plan

 

 

Monthly Cell Phone Contract Fee

 

However, when expressed on a per unit basis, a fixed cost is inversely related to activity—the per unit cost decreases when activity rises and increases when activity falls. For example, the average fixed cost per cell phone call made decreases as more calls are made in the month.

 

Examples

Advertising and Research and Development

Examples

Depreciation on Buildings and Equipment and Real Estate Taxes

Types of Fixed Costs

Discretionary

May be altered in the short-term by current managerial decisions

Committed

Long-term, cannot be significantly reduced in the short term.

One type of fixed cost is known as committed fixed costs. These are long-term fixed costs that cannot be significantly reduced in the short term. Some examples include depreciation on buildings and equipment and real estate taxes on factory property.

 

Another type of fixed cost is known as discretionary fixed costs. These fixed costs may be altered in the short-term by current management decisions. Some examples of discretionary fixed costs include advertising and research and development costs.

 

A cost may be discretionary or committed depending upon management’s strategy. For example, some construction companies may layoff workers during months with minimal customer demand. However, other construction companies may opt to retain their workers all year.

Fixed Costs and the Relevant Range

Fixed costs would increase in a step fashion at a rate of $30,000 for each additional 1,000 square feet.

For example, assume office space is available at a rental rate of $30,000 per year in increments of 1,000 square feet.

For example, assume office space is available at a rental rate of $30,000 per year in increments of 1,000 square feet.

 

Fixed costs would increase in a step fashion at a rate of $30,000 for each additional 1,000 square feet.

 

Relevant range

The relevant range is the range of activity within which assumptions about variable and fixed cost behavior are valid.

It is the range where the fixed cost remains constant.

 

Cost Classifications for Predicting Cost Behavior

It is helpful to think about variable and fixed cost behavior in a 2 by 2 matrix, as illustrated here. Take a few minutes and review this summary of cost behavior for variable and fixed costs.

Mixed Costs

Mixed Costs (also called semivariable costs).

A mixed cost contains both variable and fixed elements.

Consider the example of utility cost.

 

Mixed Costs

The mixed cost line can be expressed with the equation Y = a + bX. This equation should look familiar, from your algebra and statistics classes.

 

In the equation, Y is the total mixed cost; a is the total fixed cost (or the vertical intercept of the line); b is the variable cost per unit of activity (or the slope of the line), and X is the actual level of activity.

 

In our utility example, Y is the total mixed cost; a is the total fixed monthly utility charge; b is the cost per kilowatt hour consumed, and X is the number of kilowatt hours consumed.

Mixed Costs – An Example

If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your monthly activity level is 2,000 kilowatt hours, what is the amount of your utility bill?

Y = a + bX

Y = $40 + ($0.03 × 2,000)

Y =

$100

Read through this short question to see if you can calculate the total utility bill for the month.

The total bill is $100. How did you do?

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