Factories and other companies typically must pay costs that include variable and fixed components, challenging accountants to figure out which camp these costs belong in. These mixed costs typically change with the level of activity, but not proportionately. Therefore, in order to predict cost behavior, you need to split mixed costs into variable and fixed components. Analyzing accounts is the common sense method.
Break out total costs into individual categories or accounts, such as direct materials, direct labor, and utilities.
When checking out the trial balance for Xeon Company, you notice the breakdown of costs specified.
Use your knowledge of operations and your common sense to classify each account as variable or fixed.
Variable costs change with the cost driver, but fixed costs don’t.
If appropriate, you can classify some accounts as mixed and then assign percentages of each that are variable and fixed. For example, an account may be 50 percent variable and 50 percent fixed.
Place variable costs and fixed costs in separate columns and add them up.
According to the classifications that you set up in the preceding section, fully separate and add up the variable and fixed costs as shown.
Compute variable cost per unit by dividing total variable costs by the number of units produced.
To compute variable cost per unit, divide total variable cost by the number of units produced.
You know that total fixed costs come to $36,000, and variable costs amount to $70 per unit. Figuring out the total variable costs and adding in fixed costs allows you to predict total cost:
Total cost = (Variable cost per unit x Units produced) + Total fixed cost
Using this formula lets you determine that making 1,000 units would cost $70,000 (1,000 units x $70 per unit). Total fixed costs always equal $36,000; therefore, total costs equal $106,000. The figure is a graph of this information.
Note that while the total fixed cost line is horizontal, the slope of the total cost line equals variable cost per unit. The graph shows that when producing no units (a situation known as zero production), the company incurs only total fixed costs.
