A cost is an expenditure that companies must incur to produce or sell their products. It may also include investment in assets and bringing them to a usable condition. For companies, costs may come from various sources and in different forms. In management and cost accounting, analyzing costs is crucial for obtaining further information about a product or service. Similarly, it is necessary to establish costs to understand profitability.
When it comes to costs, companies can classify them into several categories. These categories may differ according to the aspects or factors they consider. Usually, companies can separate costs in four different ways. These include classifying costs by behaviour, element, function, or nature. Each of these is different and can show distinct aspects of the expenditures incurred by a company.
What are the various cost classifications?
As mentioned, there are four different ways through which companies may classify costs. Firstly, companies can classify costs through behaviour. In this approach to cost classification, companies categorize costs based on how they differ in relation to activity levels. Identifying costs by behaviour is necessary for budgeting and forecasting purposes.
Similarly, companies can classify costs by element. With this approach, companies group expenditures together, based on whether they relate to the material, labour, or overheads. This form of classification is useful for controlling and monitoring costs.
Next, companies can classify costs by function. Classifying costs by function allows companies to determine whether expenditures relate to production or non-production activities. This type of classification is mostly relevant for financial accounting.
Lastly, companies can classify costs by nature. This method involves examining if expenditures are direct or indirect in relation to a product or service. Classifying costs by nature is a crucial part of cost accounting.
What are the different costs classified by behaviour?
With cost classification by behaviour, companies can group together costs according to how they change with activity levels. These may include variable, fixed, stepped fixed and semi-variable costs. Each of these shows different characteristics that costs demonstrate when activity levels change. Among these, semi-variable costs are distinct as these include a feature of both fixed and variable costs.
What is Semi Variable Cost?
A semi-variable cost represents costs that include both a fixed element and a variable element. Other names used for semi-variable costs include semi-fixed and mixed costs. These costs are common in many industries or specific types of expenditures. Companies need to identify these costs because these may not behave like fixed or variable costs.
With fixed costs, companies can expect a constant amount of expense regardless or activity levels. However, when it comes to per-unit costs, fixed costs decrease as the activity levels increase. The more units companies produce, the lower the fixed cost absorbed into product costs will be.
On the other hand, variable costs change in direct relation to activity levels. Variable costs will stay nil if there is no production involved, unlike fixed costs. Similarly, the per-unit variable costs for companies usually remain fixed.
When it comes to semi-variable costs, they change with regard to activity levels. However, unlike variable costs, they are not nil when there is no activity. Instead, there is always a fixed element that the company has to incur. These costs do not stay fixed per unit, unlike variable costs. These decrease as the activity levels increase.
How to calculate Semi Variable Cost?
As mentioned, these costs include both a fixed element and a variable element. Therefore, companies need to account for both when calculating the overall expenditure. Companies can use the following formula to calculate the semi-variable costs.
Semi Variable Costs = Fixed Costs + Variable Costs
Companies can also further expand the formula to calculate semi-variable costs as follows.
Semi Variable Costs = Fixed Costs + (Variable Cost Per Unit x Number of Units Produced)
Example
A company, Kite Co., pays electricity expenses each month. These expenses include an element of both fixed and variable costs. The company pays $1,000 for electricity expenses, even if there is no activity involved. However, once Kite Co. begins manufacturing products, it estimates that each unit produced contributes $10 to the electricity expense. The company manufactures an average of 200 units per year.
As apparent from the above, the electricity costs for Kite Co. are semi-variable. These include both fixed and variable elements. The estimated electricity expense for Kite Co., based on the average expected production, will be as below.
Semi Variable Costs = Fixed Costs + (Variable Cost Per Unit x Number of Units Produced)
Semi Variable Costs = $1,000 + ($10 x 200 units) = $3,000
Conclusion
Companies need to classify their costs to understand them better. They can make classifications in several ways. One of these includes classifying costs by behaviour, including variable, fixed, semi-variable, and stepped costs. Semi-variable costs include an element of both fixed and variable costs. Semi-variable expenses are prevalent in most industries or come from specific types of expenditure.
