Cost Behavior and Relevant Costs Chapter 4 Cost Behavior and Relevant Costs

Introduction What is the nature of costs and how are they used in decision making? Do they increase or decrease as production volume changes? Do they remain stable?

Introduction The concept of predictable cost behavior based on volume is very important to the effective use of accounting information for managerial decision making. As production volume changes, costs may Increase Decrease Remain the same

The Behavior of Fixed Costs Fixed costs remain the same in total, but may vary per unit when production volume changes. Examples: Rent, Depreciation, Salary of a Plant Manager, Insurance, Property Taxes Fixed Cost Per Unit $ $ Total Fixed Costs 4 10 2 1.33 25 50 75 25 50 75 Volume Volume

The Behavior of Variable Costs Variable costs vary in direct proportion to changes in production volume, but are fixed when expressed as per-unit amounts. Examples: Direct material, direct labor, and other unit-level costs like factory supplies $ Total Variable Costs Variable Cost Per Unit $ 150 100 20 50 25 50 75 25 50 75 Volume Volume

Relevant Range Within the relevant range, fixed costs are constant in total and vary per unit, and variable costs vary in total and are constant per unit.

Step Costs Step Costs remain constant within a relevant range of production. Example: Janitorial services within a company that manufactures desks 0-7,500 desks 7,501-15,000 desks 1 Janitor 2 Janitors $25,000 $50,000

Mixed Costs Fixed and Variable Components of Delivery Van Expense Fixed: lease payment each month Variable: Gas, oil, maintenance costs, etc., that vary with the number of deliveries made (and miles driven)

Relevant Costs and Cost Behavior It can be misleading to always view variable costs as relevant and fixed costs as not relevant.

Taxes and Decision Making Managers must consider the impact of taxes when making decisions.