As is true for every system in the world, the cost is subject to change as the factors that it depends on change. This gives rise to the concept of variable cost. In the following section, we will see what we mean by variable cost, fixed and semi-variable cost. We will also focus on solving some questions from the concepts of variable cost etc.
Variable Cost, Semi-Variable and Fixed Cost
A cost that doesn’t change in a short term, irrespective of how the volume of production or the sales may change is the fixed cost. This cost is usually a constant cost for a basic operation of businesses or in other words it is a basic operating cost of a business which is crucial and can’t be avoided. The value of fixed cost determines the cost of the product and thus the profit and loss incurred by the business.
We can understand the fixed cost with the help of many examples. For example, if you are living in a rented place, you must have negotiated the cost of the place or the rent for a term that is on the rental agreement. This cost will not change as long as the rental agreement is valid. The rent is the fixed cost here. Similarly, another example is the property tax. Fixed costs are usually incurred at regular intervals (for example monthly rent) so sometimes we call them the period costs.
These are the costs that vary as the total cost to the organization when the output (number of items or services produced by the unit/business) varies. In other words, we say that a variable cost varies in exactly the same proportion as the output varies.
Therefore, as sales increase the variable costs will increase. For example, a variable cost for a bakery would be the cost of the flour. Similarly, in other businesses, the variable cost will be determined by the raw materials and the output of the business. For example, with massage therapy, oil may be used and there may be the cost of laundering one or two towels. This will constitute the variable cost.
Thus we see that the variable costs are those costs which vary directly in proportion to change in the volume of production/output. Hence we can say that the cost which changes in the same proportion as the units produced, is the variable cost. Some of the examples of variable cost are direct expenses, direct labour, direct material etc.
This cost is a cost which has elements of both fixed cost as well as the variable cost. So a cost that contains the components of both the fixed as well as the variable cost is said to be a semi-variable cost. In other words, we say that a cost that remains fixed up to a certain level of production and changes with the change in the volume of production beyond this level is a semi-variable cost. We can see the fixed part as a base level cost that is always incurred while as the variable portion of the cost is an additional cost which changes as we change the volume of production.
Formula For Semi-Variable Costs
We can understand the concept of semi-variable cost with the help of some of the following examples. For example, a popular cellular network provides you with a certain service for a fixed nominal charge. Say, for example, you get 1 GB data per day if you subscribe to a monthly plan of ‘x’ rupees. So this ‘x’ rupees is a fixed cost which will not change unless you start to use more data than 1 GB. In case your data usage exceeds 1 GB, the same company will charge you extra money. This charge will be proportional to the amount of extra data that you use. Let this extra charge be ‘y’ rupees per unit of extra data used. Then the cost of the final bill will be:
Cost (C) = x + Ny; where ‘N’ is the number of units that you consumed apart from the 1 GB that cost you x rupees.
The semi-variable costs can thus be separated into two terms. The fixed cost portion and the variable portion. We write:
- Semi-variable cost = Fixed cost + variable cost
- Variable cost per unit = change in cost/change in output
As a result, the semi-variable cost is also called the mixed cost and a semi-fixed cost.
Solved Examples For You
Q1: The fixed costs are those costs which turn out to be ……………. at any volume of production output.
- none of the above
Answer: As we saw in the above section, “The fixed costs are those costs which turn out to be constant at any volume of production output.” Hence the correct option is a. constant.
Q2: Variable costs are those costs which vary in ……………. to change in volume of production/output.
- Direct material
- Direct labor
- Direct expenses
- none of the above
Answer: The correct answer here is b. proportion.
Q3: ……………. costs are those cost of which some portion remains fixed at the given level of production.
Answer: The correct answer is b. Semi-variable.
Practice Questions For You
Q1: Period costs are charged against the ……………. of the relevant period.
- Product costs and period costs
- Direct and indirect costs
- Semi-variable costs
Ans: d. manufacturing/work