One of the keys to manage a profitable business is to manage and control costs. Every type of business incurs various costs while its operations are underway. An important aspect of managing these costs is to understand their nature and to understand what factors impact them.
This article looks at meaning of and differences between two types of costs bifurcated based on variability – variable and semi-variable costs.
Definitions and meanings
Variable cost is a type of cost that changes with a change in the level of production or in the quantum of business. Such costs are directly proportionate to the level of production/business – an increase in the units produced will lead to a proportionate increase in the quantum of this cost.
Example – direct material cost in a factory which is directly proportionate to and directly related to the number of units produced.
Such costs are not incurred if there is no production or no business generated.
Such costs can be identified to the product or process with which they vary. They are thus allocated generally on a per unit basis. The amount per unit of such cost is likely to remain the same with an increase in production or may reduce if economies of scale are achieved at greater production volumes.
Semi-variable cost (also known as mixed cost) is a cost which has components of both fixed cost and variable cost. Such costs are fixed up to a particular level of production and become variable after production crosses that particular level.
A certain specified proportion of such cost will be incurred no matter what the level of production even if production is minimal or zero. Cost will exceed this specified amount when production exceeds the specified level of production.
Examples of such cost include:
In case of a factory – cost of permanent labor – the fixed portion of the salary represents the amount that has to be paid while they are employed no matter what the level of production. Say the factory’s per shift production capacity is 5000 units, then this cost will remain fixed till 5000 units. If the factory has to produce 6000 units then it will be required to pay overtime for extra shift hours worked by the labor. This overtime cost will increase proportionate to the increase in quantum of production.
In case of a tele-calling company – bandwidth charges – say the company has a plan with the telecom company for a certain bandwidth at a fixed monthly charge with an additional per unit charge for bandwidth used in excess of this range. Bandwidth charges will remain fixed irrespective of the number of calls made provided they are in the agreed upon bandwidth range. Once calls increase beyond this range, the bandwidth charges will increase proportionately to the increase in use of bandwidth.
Difference between variable and semi-variable cost:
Difference between variable and semi-variable cost has been detailed below:
- Variable costs are those costs which are directly proportionate to the quantum of production.
- Semi-variable costs are costs which behave like fixed costs up to a specific production threshold and become variable once this production threshold is exceeded.
- Variable cost has only one component.
- Semi-variable cost has both fixed and variable cost components.
3. Related to
- Variable costs are production related i.e.: they change in relation to the level of production.
- Semi-variable costs are both time and production related. The fixed element varies over a specific period of time whereas the variable cost varies with the level of production.
4. At zero production level
- Variable costs are not incurred at if there is no actual production.
- The fixed component of semi-variable cost is incurred even if there is zero production.
5. Per unit amount
- Variable costs remain constant per unit of production; they may decrease per unit of production only if economies of scale are achieved at greater production volumes.
- Semi-variable costs decrease per unit as quantum of production increases due to the fixed cost component embedded in it.
6. Subject to control
- Variable costs are directly related to and dependent on production they can thus be controlled and limited in lull periods of the business.
- Semi-variable costs are subject to lesser control owing to their fixed cost component which must be incurred to keep the business running irrespective of the production volume.
- Example of variable costs – direct raw material cost, other production consumables.
- Example of semi-variable cost– permanent labor charges, internet charges.
Variable cost versus semi-variable cost – tabular comparison
A tabular comparison of variable and semi-variable costs is given below:
|Cost that changes with the volume of production||Cost which is fixed up to a specific volume of production and become variable per unit for production in excess of this specific volume|
|Only variable component||Combination of fixed and variable component|
|Related to volume of production and passage of time||Time and production level related|
|At zero production level|
|Not incurred||Incurred to the extent of fixed component|
|Per unit amount|
|Remains constant or may reduce as production volume increases||Decreases as production volume increases|
|Subject to control|
|Subject to greater level of control||Subject to lower level of control|
|Direct materials cost, production consumables etc.||Permanent labor charges (due to overtime), internet bandwidth charges|
Conclusion – variable cost vs semi-variable cost:
Most businesses incur both variable and semi-variable costs. Cost accountants consider both these costs and their appropriate allocation while undertaking costing for any product or process. Variable costs, as they are subject to the highest level of control generally receive more attention of management with the intent of managing and controlling them.