Question

Please explain the characteristics of a variable cost and fixed cost and as activity increases how is the cost per unit impacted (increase, decrease, remain the same). Please explain the characteristics of a mixed cost and how the High-Low Method is used to calculate variable cost per unit and fixed costs. How can the High-Low Method be used to predict variable costs and fixed costs given a certain level of activity. (please type out answer)

Answer 1

FIXED COST cost includes expenses that remain constant for a period of time irrespective of the level of outputs, like rent, salaries, and loan payments

Fixed costs are predetermined expenses that remain the same throughout a specific period. These overhead costs do not vary with output or how the business is performing. To determine your fixed costs, consider the expenses you would incur if you temporarily closed your business. You would still continue to pay for rent, insurance and other overhead expenses.

Some examples of fixed costs include:

• Rent
• Telephone and internet costs
• Insurance
• Employee Salaries
• Loan Payments

Any small business owner will have certain fixed costs regardless of whether or not there is any business activity. Since they stay the same throughout the financial year, fixed costs are easier to budget. They are also less controllable than variable costs because they’re not related to operations or volume.

VARIABLE COSTS are expenses that change directly and proportionally to the changes in business activity level or volume, like direct labor, taxes, and operational expenses.

Variable costs, change over a specified period and are associated directly to the business activity. These are based on the business performance and the volume of services the business generates.

Some examples of variable costs include:

• Direct labor
• Commissions
• Taxes
• Operational expenses

Since they are changing continuously and the amount you spend on them differs from month-to-month, variable expenses are harder to monitor and control. They can decrease or increase rapidly, cut your profit margins and result in a steep loss or a whirlwind profit for the business.

IMPACT OF VARIABLE AND FIXED COSTS

As the activity increases the fixed cost per unit decreases while the overall variable cost increases with the substantial rise in activity

MIXED COST

have both fixed and variable characteristics. A mixed cost contains a fixed portion of cost incurred even when the facility is idle, and a variable portion that increases directly with volume. Electricity is an example of a mixed cost.

Definition of Mixed Costs

In accounting, the term mixed costs refers to costs and expenses that consist of two components:

• A fixed component, the total of which does not change as the volume of activity changes
• A variable component, the total of which changes in proportion to the change in the volume of activity

A mixed cost is also referred to as a semivariable cost.

A mixed cost is expressed by the algebraic formula y = a + bx, where:

• y is the total cost
• a is the fixed cost per period
• b is the variable rate per unit of activity
• x is the number of units of activity

HIGH FLOW METHOD AND ITS USES IN CALCULATING VARIABLE COST AND FIXED COST

the high-low method is a way of attempting to separate out fixed and variable costs given a limited amount of data. The high-low method involves taking the highest level of activity and the lowest level of activity and comparing the total costs at each level.

If the variable cost is a fixed charge per unit and fixed costs remain the same, it is possible to determine the fixed and variable costs by solving the system of equations.

Variable Cost = HAC - Lowest Activity Cost HAUS - Lowest Activity Units where: HAC = Highest activity cost HAUS = Highest activity units Variable cost is per uit Next, use the following formula to determine the fixed cost component: Fixed Cost = HAC-(Variable Cost X HAUS) Use the results of the first two formulas to calculate the high-low cost result using the following formula: High-Low Cost = Fixed Cost + (Variable Cost XUA) where: UA = Unit activity