Question

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Q1: What effect would an increase in volume have on total fixed costs? Explain in your own words PLEASE.

Q2: Describe what is meant by the terms cost behavior and relevant range. Provide the definition of each and explain how they are related.

Q3: What is meant by an activity base when dealing with variable costs. Give examples of activity bases.

Answer 1

Answer1

Fixed costs refer to an amount that needs to be spent irrespective of how many units are manufactured. This includes item like land, machinery, infrastructure and other factors essential to produce anything. An example would be the cost of a piece of land on which the production facility is built. If the land cost is $500000, this is fixed as $500000 has to be spent whether 10 units are manufactured using the facility or 100.

Answer 2

Cost behavior

Cost behavior refers to the way different types of production costs change when there is a change in level of production. There are three main types of costs according to their behavior:

Fixed Costs:

Fixed costs are those which do not change with the level of activity within the relevant range. These costs will incur even if no units are produced.

Variable Costs:

Variable costs change in direct proportion to the level of production. This means that total variable cost increase when more units are produced and decreases when less units are produced. Although variable in total, these costs are constant per unit.

Mixed Costs:

Mixed costs or semi-variable costs have properties of both fixed and variable costs due to presence of both variable and fixed components in them.

Relevant Range

Relevant range is a level of volume or activity within which a company is expected to operate. All the budgeting and costing exercise are conducted with relevant range as the fundamental assumption. In other words, it is the underlying assumption when we comment certain costs to be fixed or variable. Fixed costs may not be fixed and per-unit variable cost may not be variable outside the relevant range of activity or volume.

Answer 3

An activity base is a measure of whatever causes the incurrence of a variable cost. Some of the more common activity bases consist of direct labor-hours, machine-hours, units produced, and units sold. Other examples include the number of miles driven by salespersons, the number of pounds of laundry cleaned by a hotel, the number of calls handled by technical support staff at a software company, and the number of beds occupied in a hospital.