Cost Behavior Refers to How a Cost Reacts to Changes in the Level of Operating Activity

Cost Behavior refers to how a cost reacts to changes in the level of operating activity.

Very Important!!!

Total variable costs do vary w/ volume of production.

Unit variable costs do NOT vary w/ volume of production changes.

Total fixed costs do NOT vary w/ volume of production changes.

Unit fixed costs do vary w/ volume of productions changes.

e.g.

It takes 2 boards to make a chair and costs $10/board, so it costs $20 in boards/ chair.

If you make 1 chair, it costs $20 in boards.

If you make 10 chairs, it cost $200 in boards.

So boards must be a variable cost. Total costs increase the more chairs you make. The unit cost ($20/chair) does not change w/in a relevant range.

e.g.

Rent is $300/ month.

If you make 1 chair, rent is $300/month.

If you make 100 chairs, rent is $300/month.

Unless you make 1000 chairs and need another warehouse (your relevant range changed), the rent remains constant.

Consider applying the rent to each chair made.

The more chairs you make, the cheaper the rent is per chair.

That is, if you make 1 chair, then rent/chair is $300. If you make 10 chairs, rent/chair is $30 rent/chair. If you make 300 chairs, rent/chair is $1/chair.

So rent must be a fixed cost. The total fixed cost (rent) does not change if the number of chairs produced changes (within a relevant range). The unit fixed cost decreases as the volume of chairs increases.

Note: Fixed costs (FC) Variable costs (VC)

TOTAL COSTS = FIXED COSTS + VARIABLE COSTS

Or

TOTAL COSTS = FIXED COSTS + (VC/UNIT x #UNITS)

Graphically:

TC = FC + (vc/unit x #units)

HI/Low method used to separate total costs into fixed and variable:

1st calculate vc/unit (slope) à High$ - Low$

High# - Low#

2nd pick high or low and solve for FC