Cost behavior refers to the change in costs (increase or decrease) as the output level changes, i.e. as we increase output, are the costs rising, dropping or remaining the same.
Cost Behaviour can be used to produce various classifications of costs such as:
Variable Costs Vs. Fixed Costs
- Variable costs:
Are costs that increase or decrease proportionately with the level of activity , i.e. that portion of the cost of an activity that changes with the level of output.
Note that with variable costs, the cost level is zero when production is zero. The cost increases in proportion to the increase in the activity level, thus the variable cost function is represented by a straight line from the origin. The gradient of the function indicates the variable cost per unit.
Semi variable costs
Are costs with both a fixed and variable cost component. The fixed component is that portion which is constant irrespective of the level of activity. They are variable within certain activity levels but are fixed within other activity levels.
- Fixed Costs
Are costs that do not change with of the level of output. It is also called autonomous cost, as it remains the same irrespective of the activity level .
The classification of cost into fixed and variable costs would only hold within a relevant range beyond which all costs are variable. The relevant range is the activity limits within which the cost behaviour can be predicted.
- Semi Fixed Costs
Are costs with both a fixed and variable cost component. The fixed component is that portion which is constant irrespective of the level of activity. They are variable within certain activity levels but are fixed within other activity levels, as shown below:
- Direct Vs. Indirect costs
Recall that direct costs are costs that can be traced specifically to the end product of the production process while indirect costs cannot be so traced.
- Direct costs consist of costs that can be directly attributed to a specific output, product or level of activity. Direct costs include direct raw materials and direct labour also called prime costs in aggregate.
PRIME COST = Direct Material Cost + Direct Labour Cost
- Indirect costs are costs that will not be directly attributable to a specific product. They are regarded as overheads. Identification of overheads to specific products is done through cost allocation and apportionment. They include supervisors’ salaries, rent, electricity, depreciation of building etc.
- Controllable Vs. Non Controllable costs
Controllable costs can be influenced at the level of authority at which they are being analysed while non-controllable costs cannot.
- Controllable cost; Refers to the cost which can be influenced by the actions of a person in whom authority for such control is vested, for example control of labour cost will be influenced by the method of remuneration and the degree at management control which is exercised by a certain managers.
- Non controllable cost: is cost which cannot be influenced by a person in whom authority for such control is vested for example if the trade union demands an increase in wages the increment is non controllable cost. Similarly, the depreciation of a building is a non-controllable cost to a manager as he does not have authority over depreciation!
In decision making, only controllable costs are considered because they can be changed by the decision maker. There is little or nothing that the decision maker can do about the non-controllable costs thus they are irrelevant in decision making. However, the facilities provided by the nun-controllable costs should be efficiently used.
Functional Classification of costs:
Under this classification, costs are classified according to the function they perform in an organization. Costs can functionally be classified as:
- Production costs: Are all the costs incurred in production of units during a time period e.g. raw material costs, direct labour costs and production overheads.
- Administration costs: These are all costs incurred in ensuring the smooth running of the organization so as to facilitate the production and sale of goods and services. These include: salaries for the managers, salaries for support employees (such as accountants, clerks and secretaries) etc
- Selling and distribution costs: These are costs that are incurred to enable the delivery of products and services to the actual markets and promote or complete a sale. These costs include: salesmen commission, saleswoman salaries, advertising costs, depreciation on motor vehicles used by salesmen, the cost of fuel used by vehicles used for distribution purposes etc.