Compare and contrast possible changes in cost
Question1: From the cost behaviour standpoint, explain the four common cost types: variable, fixed, mixed, and step-variable.
Cost behaviour refers to how costs change in response to changes in activity levels or volume. There are four common cost types based on cost behaviour: variable, fixed, mixed, and step-variable.
- Variable costs: Variable costs are costs that vary directly with changes in activity levels or volume. For example, the cost of raw materials used to produce a product will increase as more units are produced. Variable costs are typically expressed on a per-unit basis and can be represented by a linear equation, where the cost per unit is constant regardless of the level of activity.
- Fixed costs: Fixed costs are costs that do not vary with changes in activity levels or volume. Examples of fixed costs include rent, salaries, and insurance premiums. Fixed costs are usually expressed as a total cost rather than a cost per unit, and their unit cost will decrease as production volume increases. Fixed costs are generally considered sunk costs since they do not vary with changes in activity levels.
- Mixed costs: Mixed costs are costs that have both a fixed and a variable component. An example of a mixed cost is a phone bill, which includes a fixed monthly fee plus a variable charge based on the number of calls made. The fixed component of a mixed cost is usually a minimum cost required to maintain a certain level of activity, while the variable component increases with activity levels.
- Step-variable costs: Step-variable costs are costs that remain fixed within a certain range of activity levels, but then increase in steps as activity levels exceed a certain threshold. An example of a step-variable cost is the cost of a machine operator. A company may need to hire an additional operator once production reaches a certain level, resulting in a step increase in the cost of labour.
Question2: How changes in costs affect the process of preparing budgets.