Cost behavior analysis: The process of dividing a mixed cost into its variable and fixed

components. This process, when done manually, involves:

• Determining which metric or activity drives costs. A common example in
manufacturing is “machine hours.” Using this technique, you could determine
how much each “machine hour” affects your power bill.
• Making a scatter graph of your data. When you’re plotting your data, what
you’re looking for is that a linear relationship exists between your cost driver and
your costs. If a linear relationship doesn’t exist, then it isn’t a cost driver – pick a
new metric and try again.
What is cost behavior?
• When we talk about cost behavior, we aren't referring to "good" or "bad"
behavior. Cost behavior is nothing more than the sensitivity of costs to changes in
production or sales volume.
• The way a specific cost reacts to changes in activity levels is called cost
behavior. Costs may stay the same or may change proportionately in response to
a change in activity. Knowing how a cost reacts to a change in the level of activity
makes it easier to create a budget, prepare a forecast, determine how much profit a
new product will generate, and determine which of two alternatives should be
selected.
Types of cost:
• Fixed cost
• Variable cost
• Mixed cost

Fixed cost:
Costs that is constant in total over the relevant range.
Or
Cost that remains constant in total dollar amount within relevant range of activity.
Fixed costs include things like rent, insurance premiums, salaries, depreciation and
property taxes.
Other example:
Straight-line depreciation is an example of a fixed cost. It does not matter whether the
machine is used to produce 1,000 units or 10,000,000 units in a month; the depreciation
expense is the same because it is based on the number of years the machine will be in
service.

Types of fixed cost:

Fixed cost has two types;

Committed fixed cost:

This cost relates to the investment in facilities, equipment and the basic organizational
structure of firm. Examples of such costs include depreciation of buildings and
equipments, taxes on real state, insurance and salaries of top management.

The two key characteristics of committed fixed costs are

• They are long term in nature
• They can’t be significantly reduced even for shorter period of time

Discretionary fixed cost:

This cost usually arises from annual decisions by management to spend in certain fixed
cost areas. Examples are advertising, research, public relations and internships for
students.
• Short term in nature
• It can be reduced for short period of time

Variable cost:
Variable costs vary in total with volume, but are constant per unit within the relevant
range. Total variable costs for a given situation are equal to the number of units
multiplied by the variable cost per unit. Variable costs include things like labor and
materials. Some overhead [indirect costs] such as indirect labor, supplies and some
utilities are also variable. Note that the graph of a variable cost is a straight line with
 positive slope, beginning at the origin. The slope of the variable cost line is the variable
cost per unit.

Other example:
If it takes one yard of fabric at a cost of $5 per yard to make one chair, the total materials
cost for one chair is $5. The total cost for 10 chairs is $50 (10 chairs × $5 per chair) and
the total cost for 100 chairs is $500 (100 chairs × $5 per chair).

The activity base:

For a cost to be variable, it must be variable with respect to something. That “something”
is its activity base. An activity base is a measure of whatever causes the incurrence of
variable cost. Activity base is sometimes referred to as a cost driver. Some of the most
common activity bases are direct Labour-hours, machine-hours, units produced and units
sold.
Frequently encountered variable costs:

Type of organization Costs that are normally variable with

respect to volume of output
• Merchandising company • Cost of goods sold
• Manufacturing company • Manufacturing costs
• Both merchandising company • Selling, general, and
and manufacturing companies administrative costs
• Service organizations • Supplies,travel,clerical

True variable versus step-variable costs:

These are defined as follows;

True variable costs:

A direct material is a true variable cost because the amount used during a period will vary
in direct proportion to the level of production activity.

Step-variable cost:
A resource that is obtainable only in large chunks and whose costs increase or decrease
only in response to fairly wide changes in activity is known as step-variable cost.

Mixed cost:
A mixed cost contains both fixed and variable elements. Mixed costs are also known as
semi variable costs.

The Y-intercept of a mixed cost line is the total fixed costs. The slope is the variable cost
per unit, and any point on the line represents the total cost at the indicated volume.
As mixed cost is a straight line, the following equation is used to express relation
between mixed cost and level of activity:

Y=a+bX
In this equation,
Y=The total mixed cost
a=The total fixed cost
b=The variable cost per unit of activity
X=The level of activity

Suppose total fixed cost is $25000 and variable cost per unit of activity is $3.00 and
activity level is 800 rafting parties. Then total mixed cost will be;

Y=25000+ (3.00 per rafting party) (800 rafting parties)

= $27,400

Other example:
For example, a company pays a fee of $1,000 for the first 800 local phone calls in a
month and $0.10 per local call made above 800. During March, a company made 2,000
local calls. Its phone bill will be $1,120 ($1,000 +(1,200 × $0.10)).