ADMS 2510 Lecture Notes - Variable Cost, Income Statement, Fixed Cost

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Chapter6
Cost structure- The relative proportion of fixed, variable, and mixed costs found in an organization.
Activity base- A measure of whatever causes the incurrence of a variable cost. For example, the total cost of X-
ray film in a hospital will increase as the number of X-rays taken increases. Therefore, the number of X-rays is
an activity base for explaining the total cost of X-ray film. (a.k.a cost driver)
Step-Variable cost- A cost (such as the cost of a maintenance worker) that is obtainable only in large chunks
and that increases and decreases only in response to fairly wide changes in the activity level.
Curvilinear costs-A relationship between cost and activity that is a curve rather than a straight line.
The relevant range is that range of activity within which the assumptions made about cost behavior
are valid.
Committed fixed costs-Those fixed costs that are difficult to adjust and that relate to the investment in
facilities, equipment, and the basic organizational structure of a firm.
Discretionary fixed costs- Those fixed costs that arise from annual decisions by management to spend in
certain fixed cost areas, such as advertising and research.
Key difference between committed and discretionary fixed costs are: discretionary is for short term
and can be cut without much impact on the organization.
In summary, we cannot provide a clear-cut answer to the question “Is labour a variable or fixed cost?”
The fixed portion of a mixed cost represents the basic minimum cost of just having a service ready and
available for use. The variable portion represents the cost incurred for actual consumption of the
service. The variable element varies in proportion to the amount of service that is consumed.
Account analysis: A method for analyzing cost behaviour in which each account under consideration is
classified as either variable or fixed based on the analyst's prior knowledge of how the cost in the account
behaves.
Engineering approach: A detailed analysis of cost behaviour based on an industrial engineer's evaluation
of the inputs that are required to carry out a particular activity and of the prices of those inputs. It is used
where no past experience is available.
Dependent variable: A variable that responds to some causal factor; total cost is the dependent variable, as
represented by the letter Y, in the equation Y a + bX.
Independent variable: A variable that acts as a causal factor; activity is the independent variable, as
represented by the letter X in the equation Y a + bX.
Linear cost behavior: Cost behaviour is linear when a straight line is a reasonable approximation for the
relationship between cost and activity.
High low method: A method of separating a mixed cost into its fixed and variable elements by analyzing the
change in cost between the high and low levels of activity.
Contribution approach: An income statement format that is geared to cost behaviour in that costs are
separated into variable and fixed categories.
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