cost behavior is useful in product performance evaluation.


Cost Behavior is the analysis of the effect on total costs of a change in the level of a given activity in an organization. Some costs, called fixed costs, remain relatively unaltered regardless of a change in the level of the activity. By contrast, variable costs rise or fall in proportion to a rise or fall in the level of the activity. Other costs, known as semi-variable costs, exhibit characteristics of both fixed and variable costs.



An accounting system measures costs which are later used for a number of purposes such as: (i) profit determination, (ii) performance evaluation, (iii) inventory valuation and (iv) cost control. It is, therefore, very essential to understand what cost means and how it is calculated.

Cost is something of value given up in exchange for something else. It is price paid to acquire some goods or services. It includes money, materials, labor and time. But the term “cost” conveys multiple meanings and there are different costs for different purposes. This hub aims to provide an understanding of the cost terms and concepts that are used in literature of managerial accounting.



Some costs can be traced directly and conveniently to a particular product. Often, these are result of a formula whereby one can estimate direct cost for a given product. All other costs are called indirect costs or shared cost or common cost.



In a garment factory, direct raw material and direct labor are direct costs. Some other items such as button and stitching yarn can also be traced to a particular product but it would be inconvenient besides being insignificant. So button, stitching yarn, electricity, depreciation would be indirect costs. While direct costs can be allocated straight to a product or a batch of products, some methodology is evolved for allocation of indirect costs such as machine hours, direct labor hours or raw material quantity etc.



What would be our cost next year if our production is doubled? It may remain the same or be exactly double or in between. All depends on cost behavior which refers to how a cost would respond or react to changes in production. If cost is fixed in nature as in a university, doubling the number of students would slightly increase the total cost since same teachers, same rooms, same laboratories may accommodate the additional students. But if the major cost item is the direct materials as in edible oil, doubling production would nearly double the cost. In other cases, like electric power plant, operating costs would go up while fixed cost would remain the same.



A deep understanding of cost behavior is a must for anticipating costs when the organization's level of activity changes. This facilitates cost management, planning and decision making.



There are a variety of cost behavior pattern extending from simple variable and fixed costs to more complicated patterns like curvilinear, semi-variable, step variable and step fixed. Also for control purposes, one should have a fair idea what are avoidable costs or discretionary costs. Also what are the repercussions in changing committed costs or un-avoidable costs. For example, if a company is incurring losses and wants to close down the plant, it should know before hand what are (i) shut-down costs, (ii) what are fixed costs which would continue to be paid, (iii) what are re-start cost, and finally (iv) what would affect on employees, suppliers and clients with the shutdown decision.


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