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In: Accounting

Comment on the following statement, “Simplification of all costs into only fixed and variable costs distort...

Comment on the following statement, “Simplification of all costs into only fixed and

variable costs distort the actual cost behavior pattern of a firm. Yet businesses rely on

this method of cost classification.”

Solutions

Expert Solution

Cost behavior states the way in which various types of costs involved in production change when there is a change in level of production. Mainly there are three types of cost behavior:

  1. Fixed costs - costs that remain constant even due to change in level of production
  2. Variable costs - costs that change with change in level of production
  3. Mixed costs - some proportion of such costs is fixed in nature while some portion is variable in nature.

However, it has been found that mixed cost are not useful in their raw form. Many times it becomes difficult for managers to determine the activity level up to mixed cost will be fixed in nature and requires them to implement statistical and other techniques to determine the fixed proportion and variable proportion of mixed costs. This process proves to be hard for many managers and becomes time consuming. Therefore, they choose to simplify all costs into only fixed and

variable costs though it distorts the actual cost behavior pattern of a firm (as it fails to know the actual cost behavior). They prefer to rely on this method of cost classification to save time and reduce complexity.

ekkarill92 answered 2 years ago
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