Cost Behavior: Fixed, Variable & Mixed

Concept

Variable Costs

Variable costs change in direct proportion to activity level. Total variable cost increases as volume increases, but the cost PER UNIT remains constant. Examples: direct materials, direct labor, sales commissions.

Concept

Fixed Costs

Fixed costs remain constant in TOTAL regardless of activity level within the relevant range. However, fixed cost PER UNIT decreases as volume increases. Examples: rent, insurance, salaried managers.

Example

Illustration

A factory pays $10,000/month rent (fixed) and $5 per unit in materials (variable). At 1,000 units: total cost = $10,000 + $5,000 = $15,000 ($15/unit). At 2,000 units: total cost = $10,000 + $10,000 = $20,000 ($10/unit). Notice how per-unit cost drops as volume rises.

Key Point

Mixed Costs

Mixed costs have both a fixed and variable component. Example: a phone bill with a $30 base fee plus $0.10 per minute. The formula is Y = a + bX, where a = fixed, b = variable rate, X = activity.

Contribution Margin

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Practice Questions