Cost Behaviour: Fixed, Variable and Semi-variable costs

Costs can be classified in a number of ways
One way to classify costs is by behaviour
This involves determining how certain costs will vary according to the organisation’s level of activity
For example how rentals change when the organisation produces say 500 units compared to 1000 units
This knowledge would be essential for decision making
Often managers do what if analysis:
- What would happen if the business increased it’s output to 3000 units
- How many kilograms do we need to sell in order to break even at the current price
- What if we reduced the price by 10% what would be the overall effect on things
All this would not be possible without classifying costs by behaviour
When it comes to classification by behaviour all costs are traditionally divided into three:
1. Variable Costs
2. Fixed Costs
3. Semi-variable costs

Variable Costs

Variable cost refer to costs that vary in proportion to the level of activity
That is these costs increase whenever the level of activity (units produced etc) increases
For example if output is doubled the expectation is that variable costs will double
For this reason if a total variable cost graph were to be created it would be a linear graph with a constant gradient much like the one shown above
This means that the variable costs per unit is constant i.e. fixed
Examples of variable costs include:
Labour for example when assembly line workers are paid per unit produced ( Piece Rate System)
Direct materials i.e. the cost of raw materials used in production
Let’s say each table produced requires wood worth $50
If the business in question produces 1000 tables the cost of wood would be $50 000
If they produce double the number of tables they would need 20000 x $50 = $100 000 worth of materials
As can be seen the cost of direct materials varies with the level of activity,
The more is produced the higher the costs and vice versa

Fixed Costs

Fixed Costs are those costs that remain constant over wide ranges of activity for a specified time period
They are not affected by the changes in levels of activity
When plotted on a graph as shown above you get a straight line that is parallel to the x-axis
Examples of fixed costs include:
Depreciation of machinery,
Salaries of supervisors
Leasing costs for equipment e.g. Delivery vehicle leasing costs
Fixed Costs per unit decrease as the level of activity increases
With each unit produced they approach zero
Consider a company that leases a truck for $3 000 per year to use when making deliveries
If they produce 0 tables they still have to pay the leasing company $3 000
If they produce 1 000 tables they still have to pay $3 000
In fact it does not matter if they produce 2 000 tables for whatever they produce they still are required to pay the leasing fee of $3 000
However on a per unit basis if they produce 1 000 tables the fixed cost attributable to each table would be:
$\dfrac{\$3 000}{1000}$
That is $3 per table
If the business produces 30 000 tables the fixed cost attributable to each table becomes:
$\dfrac{\$3 000}{30000}$
That is 10 cents per table
As already pointed out the fixed cost per unit approaches zero as the level of activity increases
In mathematical terms the graph of fixed cost per unit would produce a curve that is asymptomatic to the x-axis

Semi Variable Costs

In the real world there are costs that are neither variable nor fixed
There are costs for example that remain constant within the borders of certain levels of activity
When the level of activity is increased beyond a certain level the costs increase but not in a linear fashion
Such costs usually increase in a stepped fashion as shown in the graph above
An example would be warehouse rental costs
A company could pay $1 000 to rent a warehouse which would be adequate to store between 0 and 5 000 units
Any increase in units produced and stored in this warehouse would within these confines would not affect the payable rentals
However any increase to 5 0001 units might require the business to rent an additional warehouse with a capacity to store up to 5 000 more units for an additional $1 000 bringing the total warehouse rentals to $2 000
Another example would be supervisor salaries at some point if the level of activity is increased an additional supervisor would be necessary
All these costs are examples of semi fixed/ semi variable costs

The distinction between fixed and variable costs is made in the short run
Short run- is a period period during which only some factors or variables can be changed because there is not enough time to change the others
In the long run all costs are can be varied
The exact duration of what constitutes the short run varies from entity to entity depending on the entity’s nature of operations as well as other factors

To access more topics go to the Cambridge AS/A level page

Cost Behaviour: Fixed, Variable and Semi-variable costs- Updated 2024