IGNOU : M.COM : MCO 5 : UNIT 2 : Q - 1. Distinguish among variable, fixed and semi-variable costs. Why is this distinction important?

Ans. 

Fixed Costs : These costs remain fixed irrespective of a change in the volume of output. But fixed cost varies when it is expressed on per unit basis. In other words fixed cost per unit decreases when the volume of production increases and vice versa. Rent and lease, salary of production manager, salaries of staff, etc., are the examples of fixed cost. It should also be noted that fixed costs do not remain fixed always. They remain fixed only upto a certain level of production activity. If there is a change in the production capacity which require additional building and equipment, staff, etc., such cost will also change. Therefore, fixed costs are fixed within a relevant range of production. For example, if we produce 1000 units or 10,000 units of a particular product during a particular period, the rent of the factory building or the salary of the production manager will remain the same.

Variable Costs : Variable costs are those costs which vary directly or almost proportionately with the level of output. When volume of output increases, total variable cost also increases and when volume of output decreases the variable cost also decreases. But the variable cost per unit will remain unaffected. The examples of variable costs are : direct material, direct wages, power, commission of salesmen etc.

The following are the characteristics of variable costs :

i) The variable cost varies direct proportion to the volume of output.

ii) The cost per unit will remain the same irrespective of level of activity.

iii) It is easy to accurate allocation and apportionment to different cost centres.

iv) Variable costs can be controlled by functional managers as they incur only when production takes place.

Semi-variable Costs (or semi-fixed costs) : These costs are partly fixed and partly variable. These are the costs which do vary but not in direct proportion to output. A part of semi variable costs comprising of fixed cost component , is not expected to change in response to the changes in the level of activity. Thus, semi-variable costs vary in the same direction but not direct proportion to the changes in the volume of output. Telephone bills, power consumption, depreciation, repairs, etc., are the examples of semi-variable costs. In case of telephone bills, there is a minimum rent and after specified number of calls, the charges are according to the number of calls made. Similarly, power costs include a fixed portion of minimum charge will be charged even if the power is not consumed and variable charge is based on the consumption of power. Thus, telephone and power charges increase with an increase in the usage level but not in the same direction.