Cost Behavior Patterns and Concepts DB

As an EEC’s corporate business financial analyst, one should have a clear understanding of the different types of costs such as variable, fixed, and mixed costs that a company could have. A fundamental description of the various types of cost concepts for a business will be important in understanding them. A business that wants to be successful should have a proper understanding of the different costs, it will enable managers to have better forecasting and depiction of how they would like to run their business successfully. This paper will analyze EEC’s variable, fixed, and mixed costs, how they affect sales volume and analyze absorption costing.

Review EEC’s Journal Activity

The journal activity for EEC was provided as: 

Define and identify variable, fixed, and mixed costs

A variable cost is a type of cost which varies in its total amount in the direct proportion to change in the level of an activity. Variable costs are usually expressed as a per unit and varies with the level of activity ("Variable, fixed and mixed (semi-variable) costs - explanation and examples | Accounting for Management", 2018). Examples of variable costs in a company include direct labor, direct materials, and cost of goods sold. Direct labor is an example of a variable cost because it the cost changes depending on the amount of work incurred by workers. Material costs like that of purchasing raw materials and factory supplies can also be considered as variable costs. The demand for the materials changes based on whether the level of activity of a business is increasing or decreasing. Additional variable costs that have been indicated in the journal activity include accounts receivable, accounts payable, maintenance expense, selling expenses, bad debt on expenses, retained earnings, income tax rates, and sales on net accounts. These costs are usually affected by the changes in sales and the customer. Progress and finished goods are other costs that are affected by the level of business activity.

A fixed cost is one that remains constant regardless of changes that would occur in the activity within a given range. A fixed cost is usually expressed as a constant per unit. It can also be described as costs of a business operating in a specific amount of time that would not vary if the sales vary within a specific time. Examples of fixed costs include rent for the facility and employee salaries. Fixed costs are usually constant as long as the business is in operation.

A mixed cost is one which would contain both fixed and variable cost elements. The overall number of mixed costs in the journal activity can be considered low. Sales on the account can be considered a mixed cost since there could be a fixed contract that has a fixed sales or there could some variable sales throughout the period. Factory utilities can also be considered as mixed costs as there can be a fixed rate to provide the utilities or a variable one based on business activity.

Determine what effect a sales volume increase or decrease will have on unit fixed cost, unit variable cost, total fixed cost, and total variable cost.

An increase in volume will have the following direct effect. It will cause a decrease in unit fixed costs, no change in unit variable costs, no changes in total fixed costs, and an increase in the total variable costs. Unit fixed costs usually have an inverse relationship with the level of activity and will change negatively with an increase in volume (Basu, 2018). The total fixed cost throughout a certain period does not change and the total cost would remain constant even though the volume might increase. The unit variable cost will remain the same since there will be no changes in costs per unit. The total variable cost will change and will increase because there was an increase in sales volume.

Part 2

Definition of the concept

Absorption costing was the chosen costing concept to be applied for EEC. Absorption costing is a cost method that includes all the manufacturing costs in a product hence it is also called full costing. Absorption costing includes all the fixed manufacturing overhead costs as part of the costs of the cost of work (Singh, 2018). After units have been completed, the costs are usually transferred to finished goods. It is only when the units are sold do the feature in the income statement as cost of goods sold.

Discuss how and when the concept could be used by EEC

The concept of absorption costing can be used by EEC when categorizing the income statement costs by function. Manufacturing costs can be grouped together and selling and administrative costs grouped together. Manufacturing costs will flow through the absorption costing as the cost of goods sold and all of the selling and administrative expenses could be listed separately as period expenses.

Discuss the advantages and disadvantages as it relates to EEC

Absorption costing is advantageous because it makes use of fixed overhead expenses which do not change with the level of production. A fixed cost rate can be computed at the end of every year. Some of the examples of fixed overhead expenses include insurance, wages for full-time employees, rent, and lease payment for equipment. One disadvantage with absorption costing is in its pricing decisions. When EEC evaluates each business opportunity based on absorption costing, it could reject business opportunities which provide revenues below absorption costs and accept revenues above absorption costs (Maverick, 2019). Some of the businesses which EEC could reject may contribute to additional profits for the company.

References

Basu, C. (2018). Effects a Sales Volume Increase or Decrease Will Have on Unit Fixed Cost. Retrieved from https://smallbusiness.chron.com/effects-sales-volume-increase-decrease-unit-fixed-cost-36066.html  

Maverick, J. (2019). What are some of the advantages and disadvantages of absorption costing?. Retrieved from https://www.investopedia.com/ask/answers/052715/what-are-some-advantages-and-disadvantages-absorption-costing.asp  

Singh, S. (2018). Absorption Costing: Meaning, Advantages, and Disadvantages. Retrieved from http://www.accountingnotes.net/cost-accounting/absorption-costing/absorption-costing-meaning-advantages-and-disadvantages/5871  

Variable, fixed and mixed (semi-variable) costs - explanation and examples | Accounting for Management. (2018). Retrieved from https://www.accountingformanagement.org/variable-fixed-and-mixed-costs/