Question: come predict what will take place to profit later at Bikes Unlimited, us must know how prices behave with alters in the number of units marketed (sales volume). Some costs will not adjust at all v a adjust in sales volume (e.g., monthly rent for the production facility). Some expenses will adjust with a change in sales volume (e.g., materials for the hill bikes). What are the 3 cost behavior patterns that help organizations identify which costs will adjust and which will remain the exact same with transforms in sales volume?

Answer: The three simple cost behavior patterns are well-known as variable, fixed, and mixed. Every of these price patterns is explained next.

You are watching: Cost behavior refers to the manner in which a cost changes as the related activity changes.


Variable Costs

Question: We know that some costs vary with alters in activity. What carry out we contact this form of expense behavior?

Answer: This cost behavior pattern is called a change cost. A variable cost describes a cost that varies in total with alters in volume the activity. The activity in this example is the number of bikes produced and also sold. However, the activity can take numerous different forms depending on the organization. The 2 most common variable costs are direct materials and also direct labor. Various other examples encompass indirect materials and energy costs.

Assume the cost of straight materials (wheels, seats, frames, and also so forth) because that each bike at Bikes limitless is $40. If Bikes countless produces one bike, total variable expense for direct materials amounts to $40. If Bikes unlimited doubles its manufacturing to 2 bikes, total variable cost for direct materials likewise doubles come $80. Variable expenses typically adjust in ratio to changes in volume the activity. If volume of activity doubles, complete variable costs additionally double, when the price per unit continues to be the same. It is crucial to note that the ax variable refers to what wake up to total costs with transforms in activity, not to the price per unit.

Taking it one step further for Bikes Unlimited, let’s take into consideration all variable costs related come production. Assume direct materials, direct labor, and all other variable production costs amount come $60 every unit. Table 5.1 “Variable Cost habits for Bikes Unlimited” gives the total and per unit variable prices at three different levels that production, and also Figure 5.1 “Total variable Production prices for Bikes Unlimited” graphs the relation of full variable prices (y-axis) to units created (x-axis). Note that the slope of the heat represents the variable price per unit the $60 (slope = readjust in variable price ÷ readjust in units produced).


Table 5.1 variable Cost behavior for Bikes Unlimited

Units ProducedTotal change CostsPer Unit variable Cost
1$ 60$60
2,000120,00060
4,000240,00060

Figure 5.1 complete Variable Production prices for Bikes Unlimited


Using Different activities to measure Variable Costs

Question: at Bikes Unlimited, it is reasonable to assume that the activity, number of units produced, will influence total variable costs for straight materials and direct labor. However, companies often use a different activity to estimate total variable costs. What types of activities might be offered to estimate variable costs?

Answer: The form of task used to estimate variable prices depends top top the cost. For example, a law firm could use the number of labor hours to calculation labor costs. One airline such together American Airlines can use hours of paris time to calculation fuel costs. A mail delivery company such together UPS could use the number of packages processed to calculation labor costs connected with sorting packages. A retail keep such as Best Buy could use sales dollars come estimate expense of goods sold.

Variable costs are impacted by different tasks depending top top the organization. The goal is to find the activity that causes the variable cost so the accurate cost estimates deserve to be made.


Fixed Costs

Question: prices that differ in total with transforms in activity are dubbed variable costs. What execute we call costs that remain the exact same in complete with alters in activity?

Answer: This cost actions pattern is called a fixed cost. A fixed cost describes a expense that is fixed (does not change) in total with changes in volume that activity. Assuming the activity is the number of bikes produced and sold, instances of fixed prices include salaried personnel, structure rent, and also insurance.

Assume Bikes limitless pays $8,000 per month in rent because that its manufacturing facility. In addition, insurance because that the same building is $2,000 per month and also salaried production personnel space paid $6,000 per month. All various other fixed manufacturing costs total $4,000. Therefore Bikes countless has complete fixed costs of $20,000 per month pertained to its production facility (= $8,000 + $2,000 + $6,000 + $4,000). If just one bike is produced, Bikes unlimited still should pay $20,000 per month. If 5,000 bikes room produced, Bikes limitless still payment $20,000 per month. The fixed costs remain unchanged in full as the level of task changes.

Question: What happens to fixed prices on a every unit basis as production levels change?

Answer: If Bikes unlimited only produces one bike, the fixed price per unit would amount come $20,000 (= $20,000 full fixed prices ÷ 1 bike). If Bikes limitless produces two bikes, the fixed cost per unit would be $10,000 (= $20,000 ÷ 2 bikes). As task increases, the fixed prices are spread out over an ext units, which outcomes in a lower price per unit.

Table 5.2 “Fixed Cost behavior for Bikes Unlimited” offers the total and per unit fixed prices at three different levels the production, and Figure 5.2 “Total solved Production expenses for Bikes Unlimited” graphs the relationship of full fixed costs (y-axis) come units produced (x-axis). Note that nevertheless of the activity level, total fixed prices remain the same.


Table 5.2 solved Cost actions for Bikes Unlimited

Units ProducedTotal resolved CostsPer Unit fixed Cost
1$20,000$20,000
2,00020,00010
4,00020,0005

Figure 5.2 total Fixed Production expenses for Bikes Unlimited



United Airlines battles to regulate Costs

United Airlines is the second largest air carrier in the world. It has actually hubs in Chicago, Denver, Los Angeles, mountain Francisco, and new York and also flies come 109 destinations in 23 countries. Destinations incorporate Tokyo, London, and Frankfurt.

Back in 2002, United filed because that bankruptcy. Industry analysts reported that United had fairly high fixed costs, make it challenging for the agency to cut prices quickly in line through its reduction in revenue. A couple of years later, United arised from bankruptcy, and also in 2010 combined with Continental Airlines. Back financial information was presented separately for each company (United and Continental) in 2010, both carriers are currently owned by United continental Holdings, Inc. The complying with financial details for United Airlines is indigenous the company’s revenue statement for the year ended December 31, 2010 (amounts space in millions). Testimonial this information carefully. Which costs are likely to be fixed?



Although we cannot recognize all fixed prices with certainty, several costs likely autumn into this category: wages (for union employees, such as pilots, flight crews, and also mechanics); aircraft fuel (assuming flights space not easily canceled); aircraft rent; and also depreciation. This costs full $11.1 billion, or 60 percent of total operating expenses (rounded). Fixed costs are clearly a large component of full operating expenses, which renders it challenging for airline companies favor United Airlines come make temporary cuts in costs when revenue declines.


Committed matches Discretionary addressed Costs

Question: Organizations frequently view fixed prices as either committed or discretionary. What is the difference between these two species of addressed costs?

Answer: A cursed fixed price is a fixed cost that cannot easily be readjusted in the quick run without having a far-reaching impact on the organization. Because that example, i think Bikes unlimited has a five-year lease ~ above the company’s manufacturing facility, which prices $8,000 per month. This is a committed solved cost since the lease cannot easily be broken, and also the company is cursed to making use of this facility because that years come come. Other instances of committed fixed expenses include salaried employee with irreversible contracts, depreciation ~ above buildings, and insurance.

A discretionary fixed price is a fixed cost that have the right to be adjusted in the quick run without having a far-reaching impact on the organization. For example, i think Bikes unlimited contributes $10,000 every year toward charitable organizations. Management has the alternative of transforming this amount in the brief run without resulting in a significant impact ~ above the organization. Other examples of discretionary fixed prices include advertising, research and development, and training programs (although an dispute can be made that reducing these expenditures can have a far-ranging impact ~ above the agency depending top top the amount of the cuts).

In general, management looks to cut discretionary fixed prices when sales and also profits room declining, since cuts in this area have tendency not to have actually as significant an affect on the company as cut committed addressed costs. Difficulties arise when struggling establishments go beyond cutting discretionary fixed costs and also begin looking at cutting committed fixed costs.


Mixed Costs

Question: We have actually now learned around two types of cost behavior patterns—variable costs and fixed costs. However, there is a third type of expense that behaves differently in the both total and per unit costs readjust with changes in activity. What carry out we contact this type of cost?

Answer: This cost actions pattern is referred to as a mixed cost. The hatchet mixed expense describes a expense that has actually a mix of fixed and variable costs. For example, i think sales personnel in ~ Bikes countless are payment a full of $10,000 in monthly salary plus a the supervisory board of $7 because that every bike sold. This is a blended cost because it has a fixed component the $10,000 every month and also a change component of $7 every unit.

Table 5.3 “Mixed Cost behavior for Bikes Unlimited” offers the total and also per unit fixed prices at three various levels of production, and Figure 5.3 “Total blended Sales Compensation expenses for Bikes Unlimited” graphs the relation of total mixed expenses (y-axis) to units created (x-axis). The allude at i beg your pardon the heat intersects the y-axis to represent the complete fixed price ($10,000), and the steep of the heat represents the variable price per unit ($7).


Table 5.3 blended Cost habits for Bikes Unlimited

Units SoldTotal combined CostsPer Unit mixed Cost
1$10,007$10,007.00
2,00024,00012.00
4,00038,0009.50

Figure 5.3 total Mixed Sales Compensation costs for Bikes Unlimited


Because this cost is shown with a straight line, we can use the equation because that a right line to explain a combined cost:


Key Equation

Total mixed price = full fixed price + (Unit variable expense × number of units)

or

Y = f + vX

where

Y = full mixed expenses (this is the y-axis in number 5.3 “Total combined Sales Compensation prices for Bikes Unlimited”)f = total fixed costsv = variable price per unitX = level of task (this is the x-axis in number 5.3 “Total mixed Sales Compensation costs for Bikes Unlimited”)


For Bikes Unlimited, the mixed cost equation is Y = $10,000 + $7X. If Bikes unlimited sells 4,000 bikes (X) in one month, the complete mixed expense (Y) for sales personnel compensation would be $38,000 <= $10,000 + ($7 × 4,000 units)>.


Short ax Versus lengthy Term and also the appropriate Range

We now present two important concepts that must be considered when estimating costs: brief term versus lengthy term, and also the appropriate range.


Short term Versus long Term

Question: as soon as identifying cost habits patterns, we assume that administration is utilizing the cost information come make short-lived decisions. Why is this short-lived decision making assumption so important?

Answer: Variable, fixed, and also mixed cost concepts are valuable for short-lived decision making and therefore apply to a specific duration of time. This short-term period will vary depending on the company’s existing production capacity and the time compelled to change capacity. In the long term, all cost habits patterns will most likely change.

For example, suppose Bikes Unlimited’s manufacturing capacity is 8,000 systems per month, and management plans to broaden capacity in 2 years by renting a new production facility and hiring added personnel. This is a permanent decision that will change the cost behavior patterns established earlier. Variable production prices will no much longer be $60 every unit, resolved production prices will no much longer be $20,000 per month, and also mixed sales compensation prices will also change. Every these expenses will readjust because the approximates are accurate only in the quick term.


The pertinent Range

Question: an additional important principle we use as soon as estimating costs is referred to as the relevant range. What is the relevant variety and why is the so important when estimating costs?

Answer: The relevant range is the variety of task for i m sorry cost behavior patterns are most likely to be accurate. The variable, fixed, and also mixed expenses identified for Bikes countless will only be precise within a particular range that activity. When the certain goes exterior that range, price estimates room not necessarily accurate and often should be reevaluated and also recalculated.

For example, i think Bikes Unlimited’s combined sales compensation prices of $10,000 every month to add $7 every unit is just valid as much as 4,000 units per month. If unit sales increase past 4,000 units, administration will hire added salespeople and also the full monthly basic salary will increase beyond $10,000. For this reason the relevant selection for this mixed expense is from zero come 4,000 units. As soon as the agency exceeds sales that 4,000 devices per month, that is out of the relevant range, and also the mixed price must it is in recalculated.

We talk about the relevant variety concept in an ext detail later in the chapter. Because that now, remember the the accuracy of cost habits patterns is restricted to a particular range of task called the appropriate range.


Computer Application

Using Excel to develop Charts

Managers frequently use computer applications on a daily basis to execute a selection of functions. For example, they often use Excel to create tables, graphs, and also charts. You can use Excel to produce the charts presented in figure 5.1 “Total variable Production costs for Bikes Unlimited”, figure 5.2 “Total solved Production prices for Bikes Unlimited”, and also Figure 5.3 “Total blended Sales Compensation expenses for Bikes Unlimited”. Here’s how:

Create the chart. After girlfriend have gotten in the data, to mark the appropriate data cell (including headings and also labels) and also click top top Insert, Chart, Scatter. Select Scatter with Smooth Lines and Markers. The graph that results is attached to her data points. If you adjust the data, the chart changes, too. (In earlier versions that Excel, the graph wizard walks you with the steps essential to produce the chart.)Format the chart. currently that girlfriend have created the chart, pick it and also use Chart devices to layout it v background shading, message inserts, font size, chart size, and other much more advanced features. If you want to display the chart within some other document (e.g., a native document), you deserve to copy the (highlight the chart and also select Edit, Copy from the food selection bar) and paste it into the file (select Edit, Paste or Paste Special).

The Excel document created by adhering to these three measures would look choose the one displayed in figure 5.1 “Total variable Production prices for Bikes Unlimited”.


How Cost behavior Patterns are Used

Question: How do supervisors use cost actions patterns come make much better decisions?

Answer: accurately predicting what costs will be later can assist managers prize several vital questions. For example, managers at Bikes Unlimited could ask the following:

We mean to check out a 5 percent increase in unit sales following year. Just how will this impact revenues and costs?We are using for a loan v a bank, and also bank managers think our sales estimates are high. What happens to our revenues and also costs if we lower estimates by 20 percent?What happens to revenues and also costs if we include a racing bike to our product line?How will costs behave later if we increase automation in the production process?

The only method to accurately predict costs is to understand how prices behave given transforms in activity. To make great decisions, supervisors must know how expenses are structured (fixed, variable, or mixed). The next section explains how to estimate fixed and variable costs, and how to identify the fixed and variable components of blended costs.


Budget cut at an Elementary institution District

A institution district exterior Sacramento, California, was confronted with making budget cuts since of a reduction in state funding. To mitigate costs, the institution district’s management decided to consider closing among the smaller sized elementary colleges in the district. According to one initial estimate, closing this college would reduce expenses by $500,000 come $1,000,000 every year. However, further analysis identified just $100,000 to $150,000 in price savings.

Why walk the evaluation yield reduced savings than the initial estimate? many of the expenses were committed fixed expenses (e.g., teachers’ salaries and also benefits) and could no be eliminated in the short term. In fact, teachers and also students at the college being taken into consideration for closure were to be moved to various other schools in the district, and so no to save on teachers’ salaries and benefits would result. The just real short-term cost savings would certainly be in not having to preserve the classrooms, computer system lab, and also library (nonunion employees would certainly be permit go) and in utilities (heat and also air conditioning would be turned off).

The college district ultimately made decision not come close the school because of the large committed fixed costs involved, as well as a absence of neighborhood support, and budget cuts were make in other locations throughout the district.


Review trouble 5.1

Sierra firm is do the efforts to identify the actions of the three costs shown in the complying with table. The following price information is listed for six months. Calculate the expense per unit, and then identify exactly how each cost behaves (fixed, variable, or mixed). Define your answers.


Cost 1Cost 2Cost 3
MonthUnits ProducedTotal CostsCost per UnitTotal CostsCost every UnitTotal CostsCost per Unit
150$100$2.00$100$2.00$100$2.00
21002002.001001.001501.50
3150300_____100_____200_____
4200400_____100_____250_____
5250500_____100_____300_____
6300600_____100_____350_____

Solution come Review difficulty 5.1

As displayed in the following table, expense 1 is a change cost because as the number of units developed changes, complete costs readjust (in proportion to transforms in activity) and also per unit cost remains the same. Expense 2 is a resolved cost due to the fact that as the number of units produced changes, total costs remain the same and also per unit expenses change. Price 3 is a combined cost because as the variety of units produced changes, total cost transforms (but not in ratio to changes in activity) and per unit cost changes.

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Cost 1Cost 2Cost 3*Rounded.
MonthUnits ProducedTotal CostsCost per UnitTotal CostsCost every Unit*Total CostsCost every Unit*
150$100$2.00$100$2.00$100$2.00
21002002.001001.001501.50
31503002.001000.672001.33
42004002.001000.502501.25
52505002.001000.403001.20
63006002.001000.333501.17