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Cost Behavior Major Concept Assmt #1 Explain and give a unique example the following concepts of cost behaviors: • Cost drive

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Answer #1

1 COST DRIVERS-

Suppose you are sitting in a classroom and the electricity bill of this room is, let's say, ₹10000 per month. What do you think affects this electricity cost? Is it the number of fans, the number of desks and chair, the number of students? It is definitely the number of fans. Increase in number of fans will increase the electricity bill and vice versa. It means that fans drives the cost of electricity. Similarly, projectors, air-conditioners, lights etc. Directly drives the cost of electricity.

Cost drivers are the determinants of the cost of an activity. They can affect the cost directly or indirectly. Thus, we can say cost drivers are the linkage between activities and cost.

Proper identification of various cost drivers and their impact on the cost of activity is a major task as it helps in determining the true cost of a particular activity. A cost may or can be driven by one or more cost drivers, as provided in above example.

On successful identification of different cost drivers, a company can strategically use these drivers in order to minimize their cost.

2 VARIABLE COST AND FIXED COST

Cost are of two main types

1 Fixed cost

2 Variable cost

FIXED COST-

Fixed costs are those costs which doesn't change with the change in level of activity. It means it is the cost that remain constant throughout different levels of output.

For example - the rent of the space where classes are held is a fixed cost to the teacher as it remains same irrespective of whether class is being held or not.

Similarly, periodic insurance premium payments paid for a car is a fixed cost of car as it doesn't change with the change in number of kilometers.

Therefore, fixed costs are unavoidable and occurs even at zero level of production.

VARIABLE COST -

Variable costs are those costs which change proportionately with the change in level of output. It is zero at zero level of production. An increase in level of output will increase the variable costs and vice versa.

For example - lunch meal provided in a school is a variable cost as it depends on number of students. Increase in number of students will increase the requirement of lunch meal, therefore increasing the cost.

Similarly, in a factory, electricity is a variable cost as it varies with the level of output. Increase in production will lead to increase in electricity (a variable cost)

Variable cost is an upward sloping graph.

3 CVP ANALYSIS -

CVP analysis or COST-VOLUME-PROFIT Analysis is an analysis which shows how change in cost and volume affects the earning of a company. This analysis involves the calculation of profit/volume ratio (also known as contribution/margin ratio).

P/V ratio = (contribution/sales)*100 OR (contribution per unit/ sales per unit)*100

Contribution = sales-variable cost

For example - suppose the sales of a company is ₹600000 and it's variable cost is ₹250000

Then p/v ratio = (600000-250000/600000)*100

. = 58.3%

This analysis also involved calculation of break even point. It is a point where company earns no profit or loss.

Break even point= total fixed cost/ contribution margin per unit

For example - suppose fixed cost of a company( producing 1000 units) is ₹600000 and sales is ₹1500000 and variable cost is ₹300000

Then, contribution margin per unit = Sales per unit - variable cost per unit

=1500-300

=1200

Break even point = 600000/1200

=500 units

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