Fixed Cost and Variable Cost

This classification is based on cost behaviour. It is one of the most useful classifications f.r the purpose of cost planning and control. Cost behaviour means how a cost will react or respond to changes in the level of business activity.

Fixed Cost. A fixed cost does not respond to changes in activity level within a limited range, called the relevant range. A fixed cost remains constant in total regardless of changes in activity; therefore, when measured on per unit basis it will react inversely to changes in activity. Depreciation of factory building, salary of plant manager, insurance of plant and machinery are examples of fixed cost

As the production increases average fixed cost per unit decreases because the same total amount is now spread over more units.

Variable Cost. A variable cost is one the total of which changes in direct proportion to changes in activity level. If production increases by ten percent, total variable costs will also increases by ten percent. It is important to note that the total amount of variable cost increases or decreases with activity level, but per unit variable cost is a constant amount. Direct materials and direct labour are good examples of variable costs.

This idea is illustrated by the following table. Assume that production of one bag of flour requires ten kilograms of wheat costing Rs. 100. Total and per unit cost of wheat under various output levels is as below:

 Number of Bags of Floor Produced Cost of Wheat Per Bag Total Cost of Wheat (Variable Cost) 10 100 1,000 Rs.                  100 Rs.                  100 Rs.                  100 Rs.                1,000 Rs.                   100 Rs.                     10

Variable cost per unit is a fixed amount, therefore, when activity level increases or decreases, the total variable cost also increases or decreases accordingly.

Semi variable Cost. A semi variable cost is composed of both fixed cost and variable cost. Semi variable cost respond to changes in activity level, but due to the presence of fixed cost it does not change indirect proportion to production volume.

Cost of electricity consumed in factory is an example of semi variable cost. Cost of electricity consumed for lighting and air conditioning purposes represents fixed portion of total cost of electricity. Electricity consumed for driving machines is variable component as it changes with the changes in activity level.

With an increase in the level of output semi variable cost per unit decreases but the negative slop of unit cost curve is not as steep as it is in case of variable cost.