Accounting Business Reporting for Decision Making

422 Accounting: Business Reporting for Decision Making

Activity Activity

$ $

Total xed costs Fixed costs per unit

FIGU R E 10.1 Fixed cost behaviour

The traditional definition of fixed and variable costs relates to the concept of the relevant range. The

relevant range is the range of activity over which the cost behaviour is assumed to be valid. If the

activity level goes outside the relevant range, then the expected behaviour of costs may change — for

example, fixed costs can no longer be assumed to be fixed as the entity may be able to renegotiate con-

tracts or change the level of resources required to support operating activities.

Activity Activity

$ $

Total variable costs Variable costs per unit

FIGURE 10.2 Variable cost behaviour

Of course, the classification of costs as fixed or variable is not simple. Indeed, some costs may appear

to possess fixed and variable characteristics, in which case the costs would be classified as mixed costs

(sometimes referred to as ‘semi-fixed costs’ or ‘semi-variable costs’ — see reality check ‘Mixed costs in

practice’). The mixed cost relationship is evident in figure 10.3, which illustrates a mixed cost for tele-

vision advertising based on a fixed amount of $10 000 to generate the advertisement and a $500 charge

each time it is aired.

In order to split costs into their fixed and variable components, there are a number of techniques that

are available, ranging from an approach where managers can use their business knowledge to split costs

to the use of more complex statistical analysis. To gain an understanding of how costs can be separated

let’s consider the following example.