Question

1. Define variable cost, fixed cost, and mixed cost.

2. Describe what happens to the net income of a company under each of the following assumptions: (a) Units sold are less than break-even units. (b) Units sold are greater than break-even units. (c) Units sold are equal to the break-even units

Answer 1

• Variable Cost

These are those cost the property of which is that they remain fixed ‘per unit’ but varies in totality as the units increase or decrease. For example, Variable cost of direct material is $10 per unit. This $10 per unit will remain fixed. However, say if 10000 units are produced, total variable cost will be 10000 units x $10 = $100000. If 5000 units are produced, total variable cost will be 5000 units x $10 = $50000.

• Fixed Cost

Unlike Variable cost, these cost remain fixed in totality no matter what and how many units are produced. For example, factory rent of $20000 per month. However, if fixed cost per unit is considered, per unit cost varies with unit, but in total Fixed cost always remains the same.

• Mixed Cost

As the name suggest, it’s a mixture of Variable cost and Fixed Cost having the properties of both the cost. Part of it remains constant, while part of it varies with production and sale. Example say that sales manager is given $2000 per month + $1 per unit sold.

• Answer 2

Part (a) If units sold are less than break Even units, the net income will be NEGATIVE, there will be Net Loss. This will be because, the contribution margin would not be able to cover all the fixed costs.

Part (b) If Units sold are greater than Break Even units, the net income will be POSITIVE. Contribution margin will be higher than the fixed cost to be covered.

Part (c) If Units are equal to the break Even units, the Net Income will be ZERO. This is because, at Break Even Level, contribution margin equals Fixed cost and there are neither profits nor losses.