Business

What Are The Various Cost Behavior Patterns With Illustrations?

cost behavior

Before studying cost behavior, a manager must first comprehend the critical business activities that may impact costs. Then, management can usually specify activity levels in dollars, units, and other metrics. Furthermore, the administration should attempt to establish a link between activity levels and costs.

However, not all costs can change as a result of business activity. So, despite a change in economic activity, some expenses may remain unchanged. For example, a company must pay insurance whether or not it is in operation. In addition, some costs do not fluctuate in lockstep with changes in business operations. A company’s cost behavior is generally studied using mathematical cost functions, so let’s find out the types of cost behavior and how they work.

What Is Cost Behavior?

The way that a company and its operating expenses shift or remain consistent over a certain period is cost behavior definition. Now, Patterns might shift, especially as the company’s production or sales volume fluctuates.  

The range of sales or output based on which cost behavior patterns do not change is called the relevant range. That’s why there are three types of cost behavior patterns such as fixed cost, variable cost, and mixed cost.

What Are Different Types Of Cost Behaviour Patterns?

Any discussion of cost behavior should begin with the notion that most costs can be classified as fixed, variable, or mixed. There are also hybrid cost behaviors that don’t fit into one of these three categories because they are used in more complex accounting programs. So, understanding if a cost is a fixed cost or a variable cost is the most important because they are the cornerstone of all other cost behavior patterns. 

Fixed Cost

Fixed Cost

Fixed costs exist independent of the number of production or revenue generated by the company. Rent, insurance, and loan payments are examples of fixed costs. Property taxes, depreciation on equipment, and non-consumption services such as Internet access are also other examples of fixed costs. 

As production increases, the fixed cost per unit decreases, but it keeps the fixed cost constant. So, certain fixed costs may fluctuate depending on business activities. For example, if a company introduces a new product, its promotional expenses may rise over regular levels. But, only the company management is responsible for changing the discretionary fixed cost.

How To Calculate Fixed Cost?

Total production costs — (Variable cost per unit × Number of units produced) = Fixed Cost.

For example, a company has a total fixed cost of $30,000 for its production purpose. If they change the production per unit volume to 5,000, 10,000, and 15,000 per year, it will change the fixed cost per unit. However, the total fixed cost will remain unchanged.

Financial YearsYear 1Year 2Year 3
Total Fixed Cost$30,000$30,000$30,000
/ Units Produced5,00010,00015,000
Fixed cost per unit$6.00$3.00$2.00

Variable Cost

The totals of variable costs will alter depending on the degree of activity in the company. For example, the cost of direct materials and labor corresponding to production levels in a manufacturing process are variable cost behaviors. If you want to increase production, you’ll need more resources, machinery hours, more labor, and vice versa. 

In the same way, the variable costs in a business entity will vary depending on the goods and equipment necessary and required travel charges and support people labor costs. For a tradesman, commission fees, shipping charges, and inventory management costs are some examples of variable costs. In addition, as production increases, variable costs per unit also increase. 

How To Calculate Fixed Cost?

Cost Per Unit x Total Number of Units = Total Variable Costs.

For example, a company spends $10,000, $20,000, and $30,000 every year to buy the raw materials for its production. As they change the raw material purchase cost, their per production unit volume also changes. It shows how a variable cost can change if the business activity changes, but the per-unit cost stays constant.

Financial YearsYear 1Year 2Year 3
Total Variable Cost$10,000$20,000$30,000
/ Units Produced5,00010,00015,000
Variable cost per unit$2.00$2.00$2.00

Mixed Cost

Fixed and variable costs have traits in common with mixed costs. Therefore, a cost that includes both fixed and variable cost components is called a mixed cost. For example, assume the monthly utility bill includes water, electricity consumption, fixed-rate limits for gas, and additional penalties if those limits are exceeded. 

The costs are fixed during periods of low activity when the business does not reach flat-rate levels. However, consumption rises above the flat rate during periods of high output or sales, and overall expenses fluctuate. 

Why Should You Understand Cost Behaviour Patterns?

Depending on how they will use the cost information, different firms use the term cost in different ways in management accounting. Different judgments necessitate different cost classifications. Let’s learn about the benefits of cost behavior patterns;

  1. Recognizing and comprehending cost behavior patterns has various applications within a business. It enables management to budget appropriately, lowering expenses and increasing revenues. 
  1. Management and financial planners can create realistic production and sales goals by understanding the company’s cost behavior patterns.
  1. Furthermore, knowing a pattern allows management to determine the company’s break-even point and modify pricing tactics as needed. Management can also use the data derived from cost-behavior patterns to boost production, start new product development, or launch new services.
  1. A manager may want cost data to prepare for the following year or make judgments about whether or not to discontinue a product. 
  1. In practice, as the utilization of cost data evolves, so does the classification of costs. For example, a single cost can be characterized as a fixed cost by one company, a committed cost by another, and even a period cost by yet another. So, if you need to understand Managerial Accounting, you’ll need to understand different categories of cost behaviors and how certain costs can be employed in various ways.

FAQs

1: What Is An Example Of Cost Behavior?

Ans: Cost behavior is the change in the usual behavior of cost due to changes in operating hours or business activities. For example, the electricity cost will increase if a company increases its working hours. But, certain costs also remain unchanged despite the changes in business activities.

2: What Is The Purpose Of Cost Behavior?

Ans: A business management studies cost behavior because it wants to understand how their operating costs fluctuate if they change business activities. Some of the examples of business costs are direct labor, direct material, overhead cost, etc.

3: What Is A Cost Behavior Pattern?

Ans: If you want to define cost behavior patterns, you simply have to understand how business expenses remain intact or change corresponding to the changes in business activities. If there are varying production levels or sales volume in a company, that may change the cost behavior pattern

Sum It Up

As we have mentioned before, cost behavior patterns are an essential phenomenon in management accounting. If you understand the concept of cost behavior well, you can exercise better control over your company’s expenditures. So, if you want to know more about it, you can ask us in the comment section below. We will surely get back to you with an answer.

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