Much of all we've done so far in managerial accounting has been to introduce you to new terms. This video'll be much of the same because there are important terms we need to understand in order to understand how costs behave and impact decision-making.
There are two ways cost can behave they can either be variable or they can be fixed.
When activities combine both variable and fixed costs we call it mixed costs.
Variable costs change in total in direct proportion to changes in volume. As volume increases total variable costs increase.
Fixed costs stay constant in total over a wide range of volume levels so as volume changes fixed costs do not. Fixed costs are generally grouped into two categories:
Committed fixed costs and discretionary fixed costs. Committed fixed costs can't be changed due to past management decisions. An example might be entering into a lease.
Discretionary fixed costs usually can be changed just not in the short run. An example might be advertising expense prepaid for an advertising campaign. Once the campaign is over management can choose whether not to continue the expenditure.
Mixed costs increase as volume increases but not in proportion to the change in volume.
This is what a variable cost looks like when its graphed, the movement is upward as volume increases. However, variable cost is constant per unit. Make sure you understand this concept - it increases in total but is fixed per unit.
For example, McDonald's has many variable costs one would be the cost of hamburger patties. As more hamburgers are sold more patties are used so the cost and hamburger patties go up.
Let's say the cost per patty is $1.00.
Sell one hamburger, hamburger patties' cost is $1.00. Sell 10 hamburgers, hamburger patty cost is now $10.00.
Sell 100 hamburgers, the cost is now $100.
But the cost per patty has remained consistent at $1.00 per patty.
That's the big idea you should take away from this example.
Now are let's look at what fixed costs look like when it's graphed. The movement is flat as volume increases.
However fixed costs per unit change as volume increases.
For example, McDonald's they rented building and let's say the cost to do that is $1000 per month. This is the fixed costs because it's 1000 and it doesn't depend on how many hamburgers they sell. But the rent cost per burger decreases as volume increases.
If they sell a hundred hamburgers the rent cost per burger is $10.00.
If they sell 1000 hamburgers, the rent cost per unit is now $1.00.
This is what the graph of mixed costs look like.
Notice that at zero volume the line isn't starting at the origin. This is because fixed costs are incurred regardless of volume, so the total cost line starts at the fixed costs and increases as variable costs increase.
Finally, an example of a mixed cost is a salesperson's salary, which might include a fixed salary as well as a commission which is a variable cost.