Question

In: Accounting

What is the meaning of the term "cost behavior"? Why is it important to know "how...

What is the meaning of the term "cost behavior"?

Why is it important to know "how different costs behave" in the process of planning, decision-making, and control?

Solutions

Expert Solution

Cost behavior is the primary to understand for management accounting. it is associated with the learning how the cost will change with each and every level of activity changes in organizational. it is divided into two parts. one is variable cost and another is fixed cost. Variable cost is the cost which is directly associated with the production and changes proportionately for each unit of output. eg. labor, material etc. which fixed is the cost which is required to spend for setup of production and did not change directly with the changes of the output unit. eg. machinery.

It is very important to understand how a cost behaves to do planning and decision making as each factor will directly or indirectly affect the cost per unit. and if we did not consider it as per its behavior we might get the wrong cost of production which either make us lose the proposed project if we quote a higher price or end up doing us a loss from the project if we quote lower than the cost per unit produced. hence we have to treat cost as per its behavior. if a cost is variable in nature it should be calculated for each unit of production but if cost is in nature of Fixed than we will find the contribution from variable cost per unit by deducting it from selling price per unit, than we will check that did we have enough contribution from selling unit produce to recover out fixed cost or not. generally, in management costing, we treat a positive contribution as earning towards fixed cost and if we have enough production capacity left to get the project without the need to upgrade existing fixed assets or install extra fixed assets it will be viable to accept.

hence it is very important for management to understand and treat the cost as respective per cost behavior.


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