An understanding of cost behavior is important to be able to manage and control operations. Managers use this understanding of the relationship among costs to be able to plan, budget, and make decisions. The primary function of managers is to increase their profitability, thus any decisions that they make must be carefully analyzed to determine its effect on the company’s overall profitability.
Cost incurred by manufacturing companies on their finished goods can be classified as fixed or variable costs. These cost basically changes in relationship to how the production activity changes. Fixed cost is “the cost that remains the same in total over a wide range of volume” (Dominiak & Louderback, 1998). This means that regardless of the volume of production in a given period, total amount of fixed cost remains the same. Fixed cost that can be classified as part of the finished product’s cost may include utilities, insurance, or property taxes. Variable cost on the other hand “changes in total in direct proportion to changes in volume” (Dominiak & Louderback, 1998). Variable cost is a cost estimate of a products cost on a per unit basis, thus total amount of variable cost changes in proportion to the volume of production.
Classifying cost as either fixed or variable cost means classifying product cost according to behavior. Not all cost can be considered relevant for decision making. In a manufacturing concern, some fixed cost may be considered irrelevant such as depreciation expense, utilities, or insurance cost, since these cost are incurred by the company periodically despite their peak or lean period of production. Within a certain range of production volume, managers can plan and budget the cost and selling price of a product. Analyzing cost through their behavior can also be helpful for businesses planning to develop and introduce a new product since it can determine how much the company would spend to manufacture a product and their desired profit.
Dominiak, G., & Louderback, J. (!998). Managerial accounting. Profit planning (pp. 30-35). South-Western College Publishing