Cost Behavior
Illustration 9-7 shows how the fixed cost of property insurance behaves on per-unit basis as production changes.
Illustration 9-7: Unit fixed cost graph
As you can see from the graph, the per-unit fixed costs decreases as the number of DVDs produced increases.
Let us continue the lecture with some more examples of fixed costs. Illustration 9-8 below provides examples of fixed costs and their cost drivers for a variety of businesses.
Illustration 9-8: Examples of fixed costs
Type of Business |
Cost |
Cost Driver |
Manufacturing |
Equipment depreciation |
Number of units produced |
Restaurant |
Rent cost |
Number of clients |
Taxi |
Insurance |
Number of miles driven |
Hotel |
Property tax |
Number of rooms occupied |
Print house |
Advertising costs |
Number of printed out pages |
Hospital |
Property Insurance |
Number of patients |
All fixed costs can be classified as avoidable fixed costs and unavoidable fixed costs.
Avoidable fixed costs are costs that are not required to be incurred.
In other words, you will stay in business if you do not incur the cost. For instance, Friends Corporation spends $5,000 per year on advertising. This is a fixed cost. However, it is avoidable because the company can stop advertising and still stay in business (although sales volume may suffer).
Unavoidable fixed costs are costs you have to incur if you want to stay in business.
For example, the property tax, rent of the office, depreciation expenses are unavoidable fixed costs.
9.5 Step-variable Costs
In previous sections we defined two basic types of costs which are variable costs and fixed costs. Now we can talk about other cost categories. First, let us define step-variable costs.
Step-variable costs are costs that stay fixed over a range of activity, and then change after this range is overcome. In other words, these costs change in increments.
To illustrate step-variable costs, let us again return to our example with production of DVDs. One worker can supervise the production of maximum 100 DVDs per day. If it is needed to produce 320 DVDs, Friends Corporation would hire four workers. If the number of produced DVDs is increased up to 400 DVDs, four workers will still be able to cope with this load. However, for 410 DVDs, it will be required to hire an additional worker.
Illustration 9-9: Step-variable cost graph
Illustration 9-9 describes a step-variable cost, where the width of each step represents the volume of activity (number of DVDs) needed before the step-variable cost increases to the next level because additional resources (workers) are required. Once the next level is achieved, the cost of hiring workers remains constant until it increases again. Narrow width means that cost is sensitive to fairly small fluctuations in related activity.
Examples of step-variable costs and their cost drivers are provided in the Illustration 9-10.
Illustration 9-10: Examples of step-variable costs
Type of Business |
Cost |
Cost Driver |
Manufacturing |
Number of workers |
Number of units produced |
Restaurant |
Number of waiters |
Number of clients |
Hotel |
Number of housekeepers |
Number of rooms occupied |
Hospital |
Number of nurses |
Number of patients |
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