Module+3000+III+Explanation+and+Examples


 * III. Module 3000 Explanation and Examples rpc **

** Variable costs are costs that change in direct proportion to the changes in business volume or units produced. An example of a variable cost is the cost of materials. The more widgets you produce the more materials needed to make these widgets. The cost of this material is variable depending on volume of output. Another example of a variable cost is the amount of labor needed to produce these widgets. The more widgets you produce the more labor required. Other examples of variable costs include commissions paid to sales people, power to run the plant, and lubricants. ** ** Fixed costs are costs that **// in total //** do not change as units or volume changes within a **// relevant range //**. Examples of fixed costs are supervisors salaries, rent on building, and property taxes. To further clarify this definition of fixed costs, we must define **// in total //** and **// relevant range. //** The **// in total //** part of this definition means the supervisors salary does not change as volume increases, but the unit cost does change in proportion to the volume change. **// Relevant range //** is the range of volume in which the cost is valid. **// Relevant range //** would refer to the normal volume or level of activity of the operation. Fixed costs can and do sometimes change. An example would be if you were paying a supervisor $70,000 per year and you gave him a raise to $75,000 per year. Now the fixed cost for that supervisor becomes $75,000. \ **
 * I. What are Variable Costs? **
 * II. What are Fixed Costs? **

** A mixed cost consists of both a fixed and variable component. A good example of mixed costs could be your electric bill. You have a flat charge per month for electricity, fixed portion, and you are then charged per kilowatt (variable) x kilowatt hours used (activity driver). In the total cost of electricity you have both fixed components and variable components. In the case of your electric bill, the formula for total mixed costs is: ** ** Total Mixed Costs = Total Fixed Costs + (Variable Cost per kilowatt hour x number of kilowatt hours used). **
 * III. What are Mixed Costs? **

** Activity drivers are sometimes referred to as “cost drivers”. Activity drivers describe changes in cost by measuring activity in output or volume. Two kinds of activity drivers are **// unit-level drivers //** and **// non-unit-level drivers //**. **// Unit-level drivers // **explain changes in costs as output changes. Examples are materials, direct labor hours, and electricity to run machines.** //Non-unit-level drivers// **describe how costs change as factors other than output changes. Examples are the number of invoices prepared, number of material transfers.**
 * IV. What are Activity Drivers? **


 * V. Cost Equations **

** As stated in the introduction, the basic cost equation: ** ** y = a + b(x) where as: **

** y = total cost **

** a = fixed cost **

** b = variable cost **

** x = total units or volume **

** To put this equation to work, we must first create an example of fixed and variable costs. Let’s say you are a cost accountant for a machine shop that makes rods for electric plants. Your job is to calculate the total cost of sales. We will assume your total fixed costs are $200,000, 4 salesmen at $50,000 each, last year they sold 50,000 rods, and each salesperson earns $3 per rod commission. What is the total cost of sales? The equation would look like this **

** Y (total cost of sales) = a ($200,000 for 4 salespersons- FC) + ($3 commission VC x 50,000 rods or volume) = **

** Y = $200,000 + $3(50,000) **

** Y = $350,000 **

** From that result you can now calculate the sales expense per unit: **

** Unit sales expense = total selling cost / units sold **

** Unit sales expense= $350,000 / 50000 = **

** Unit sales expense= $7 **

** Total variable sales expense can be calculated as follows: **

** Total variable sales expense = variable rate x units sold **

** Total variable sales expense = $3 x 50,000 = **

** Total variable sales expense = $150,000 **