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Cost Behavior.docx

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ACCT 301
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Cost Behavior The knowledge of cost behavior is essential for the tasks of budgeting, decision making and control accounting, whose importance was established in the previous article. Cost behavior is the way in which costs are affected by changes in the volume of output. In other words, this article will attempt to describe the behavior of various costs with the volume of output. The principle of cost behavior is simple, as the level of activity rises, cost will usually rise, but the difficulty arises when one needs to determine the way in which cost rise and by how much as the level of activity increases. A Cost Behavior Pattern could be established for certain costs that ‘behave’ in a ‘predefined’ or ‘usual’ way, which we may illustrate graphically. In the course of this article we will discuss the cost behavior of the following items: 1. Fixed costs 2. Step costs 3. Variable costs 4. Semi-variable costs 5. Total costs and unit costs Fixed Costs these costs are not generally related to the volume of output or to the level of activity within a firm, although they do increase with time. As such, they will not follow the principle of cost behavior mentioned earlier (costs rising as level of activity rises), e.g. the salary of a managing director, or the straight line depreciation of a machine. Cost Volume of Output As you could see, fixed costs are not affected by the volume of output Fixed Costs Step Costs These costs are fixed in nature but only within certain activity levels, e.g. if you employ 100 employees their salaries would be a fixed amount of $100k per year, yet, if you increase the number of employees to 150, the fixed amount of salaries would naturally increase. Variable Costs A variable cost tends to vary directly with the volume of output. As such it is natural to expect that they have a ‘linear’ or uniform relationship with output. Cost of raw materials, direct labor and sales commission may behave in this way subject to price per unit of materials or labor is constant. Cost Volume of Output As you can see, each ex
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