Question

Discuss what fixed, variable, and mixed costs are and the high-low method for dealing with mixed costs

Answer 1

1. FIXED COSTS

• Fixed costs are costs that do not change in total despite wide changes in volume.
• Although fixed cost per unit decreases with increases in activity levels, total fixed cost is not affected by changes in the activity level within the relevant range (i.e., total fixed cost remains constant even if the activity level changes.
• Total fixed cost graphs are always flat lines with no slope
• The flat (horizontal) line intersects the y-axis at the level equal to the fixed cost

2. VARIABLE COSTS

• Total variable costs change in direct proportion to changes in volume.
• Although variable cost per unit remain constant, total variable cost increases and decreases in proportion to changes in the activity level.
• Total variable cost graphs always begin at the origin (if volume is zero, total variable costs are zero)
• Total variable costs can be expressed as:

y = vx    

Where:

Y = total variable cost

V = variable cost per unit of activity

X = volume of activity

3. MIXED COSTS

• A mixed cost has both a variable and a fixed component.
• Total mixed costs increase as volume increases because of the variable cost component
• Total mixed cost graphs slope upwards but do not begin at the origin; they intersect at the y-axis at the level of the fixed costs
• Total mixed costs can be expressed as a combination of the variable and fixed cost equations:       

Total mixed costs = variable cost component + fixed cost

Y = vx + f

Where

Y = total mixed cost

V = variable cost per unit of activity

X = volume of activity

F = fixed cost over a given period of time

High – Low Method

The high-low method determines the fixed and variable portions of a mixed cost by using only the highest and lowest levels of activity and related costs within the relevant range.

The variable cost element V in above formula is computed as follows:

The fixed portion of a mixed cost is found by subtracting total variable cost from total cost (high or low level).