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It is necessary when making decisions to classify costs by behaviour as you need to know how costs and revenues vary with different levels of activity/volume.
- Variable costs change with the level of activity. For example, doubling volume would double the variable costs. An example of a variable cost would be direct labour, direct materials within manufacturing.
- Fixed costs remain the same over a wide range of activity for a specified time period. An example of a fixed cost is rent, supervisors' salary, insurance, etc.
- Step-Fixed costs are costs which are fixed within specific activity levels. For example, if a supervisor can only supervise 100 people when there are more than a 100, then another supervisor needs to be hired. This can be a step increase or decrease depending on the change in activity levels.
- Semi-Variable costs (Mixed costs) have a variable and a fixed component. For example, telephone line may have a fixed line rental with a variable metered call.
Therefore, knowing the differences between the costs can allow you to calculate future costs and revenues relevant to different decisions.
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How do you classify cost based on Nature?
How do you classify cost based on Nature
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