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SAMPLE TEXT on Cost Behavior

Costs are usually classified based on how they behave when there are more units to get produced. Cost behavior may be based on the total cost or the cost for a single unit. When thinking about how a cost behaves, you should think about the total cost whenever possible. Total fixed costs would stay the same in total even if more items are produced and sold. Total variable costs, on the contrary, would increase when more items are produced, and would decrease when fewer items are produced.

Product costs would include all costs that are deem necessary to get products/services delivered. For companies that manufacture products, this would include materials, labor, and manufacturing overhead. Materials and labor are variable costs because the total cost of materials and the total costs of labor would increase when more products are produced. Some manufacturing overhead costs are variable costs, while some others are fixed.

When measuring product costs, full costing is also known as absorption costing or GAAP costing. It is required by GAAP for external reporting purposes. Under full costing, inventory costs will have to include ALL product costs, both fixed and variable. Variable costing, in contrast, is primarily used for internal reporting and management purposes only. Under it, inventory costs would only include variable product costs. In other words, materials, labor and variable manufacturing overhead costs are included. However, as period costs such as administrative and selling costs are never part of the inventory, they would never be considered as product costs.

Important: Variable Costing is also called Direct Costing. It is an alternative method that treats direct manufacturing costs and variable manufacturing overhead as product costs. It also treats fixed manufacturing overhead as a period expense. It makes the assumption that fixed costs are unrelated to production as these costs are incurred in the short-run even when nothing is produced.


SAMPLE TEXT on Cost Estimation

To estimate cost behavior, you generally need to make certain assumptions. Firstly, the number of units produced is equal to the number of units sold. Secondly, the cost behavior needs to be linear. And thirdly, the level of activity must occur within the relevant range.

A relevant range refers to the range of activity within which cost behavior holds true. It is basically the normal range of production or sales that can be expected. Total variable costs tend to vary in direct proportion to volume. Total variable cost will turn to zero when no units are produced. Total fixed costs would stay the same in total as volume fluctuates. More units produced would have no effect on the total amount of total fixed costs.

Unit fixed costs may vary inversely when more or fewer units are produced and sold. If total production and sales increase, unit fixed costs would decrease. On the contrary, if total production and sales decrease, unit fixed costs would increase.

Fixed costs may be broken into discretionary and committed costs based on whether one can quickly eliminate a particular fixed cost in the short run. With Discretionary Fixed Costs, one may easily change discretionary fixed costs in the short run by spending more or less on the particular cost item. Generally, in the short run a business will not be adversely affected if costs such as these got eliminated. On the other hand, one would not be able to easily change committed fixed costs in the short run.
 

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