 Hello and welcome to the session in which we will discuss cost behavior. This topic is important whether you are taking managerial accounting, the CPA exam, cost accounting or the CMA exam. We have to understand how costs behave because when we make a costing decision, it's important to know whether the cost is a variable cost, a fixed cost or a mixed cost. Before we start I would like to remind you whether you are an accounting student or a CPA candidate. I strongly suggest you take a look at my website farhatlectures.com. No, I don't replace your CPA review course. I can be a useful addition to your CPA review course. I can be supplemental material to your CPA review course. My course is designed to mirror image your CPA review course. The risk of trying me is one month of subscription. The potential gain is passing the actual CPA exam. And if not for anything, take a look at my website to find out how well or not well your university is doing on the CPA exam. I also have accounting lectures for intermediate accounting, auditing, managerial accounting, cost, taxation. Also, I have the AI CPA previously released questions and my courses are there to mirror image your CPA review course. If you're taking an audit course with Roger or a reg course with Glyme, my course are designed to help you with these courses hand in hand or if you're taking a course with Becker. If you haven't connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation like this recording, share it with other, connect with me on Instagram, Facebook, Twitter and Reddit. So let's talk about how costs behave. So how costs behave, we have three, three types of cost behaviors and I'll have to let you know upfront that in the real world, those like for example, you may not have a 100% variable cost or 100% fixed. Mostly they are variable within a range, fixed within a range, mostly mixed. But for educational purposes, for knowledge purposes, we're going to assume that certain cost is a variable cost. What is a variable cost? From the word variables, it means it varies. And how does it varies? It varies in total and direct proportion to changes in the level of activity. The best example I can give you to illustrate this concept is the old cell phones, cell phone plans. When the cell phone was becoming a more popular, a common household item, here's what would happen. You would pay for the phone and you will pay based on the usage. So if you did not use the phone, if you use the phone, zero minutes. Okay. So this is, let's assume this is the minutes and this is the dollar. And I'm going to say, I'm going to say one minute per dollar to make it easy. So if you use it one minute, you'll pay $1. Okay. If you use it two minutes, you'll pay $2. If you use it three minutes, so this is one, two, three minutes. And this is how it used to be actually, believe it or not, maybe some of you don't remember this, three minutes you'd pay $3. This is the dollar. Now we can draw a graph and it would look something like this. So as your usage goes up, as your usage goes up, your total, this is your total, goes up in proportion to the level of activity. So this is an example of total variable cost changing in proportion to the level of activity. Okay. Hopefully this make sense. Now in the real world, you might have cost drivers such as unit produced. For example, for each unit produced, you'd spend $4. If you produce two units, you will spend $8 so on and so forth. It could be based on machine hours. What's driving your cost? Again, the cell phone is the cell phone usage. For example, if you have a vehicle that's delivering its miles and miles driven, if you're using a vehicle to produce or it could be labor hours. So those are all cost drivers. So the variable cost per unit, you have to understand now what we are discussing. The variable cost per unit is constant. And if we go back to this example to my cell phone, I said for each one minute, you pay a dollar. So the cost per unit, the variable cost per unit is variable. Why is it variable? Well, because for every unit, the cost is always a dollar. The cost is always the same. Therefore, it would look something like this per unit, per one single unit, per one single unit. So per one single unit, you'll have a flat line. But in total, in total, in total, it varies in total. It increases in total. But per unit, it's $1 per unit. So this is the variable cost. Let's talk about the fixed cost. And if we always, when we say the fixed cost, we say the fixed cost within the relevant range, and I'll explain what do I mean by the relevant range in a moment. But what is a fixed cost? Well, as the terminology implies, it's fixed. Fixed regardless of the activity, again, within a relevant range. A cost cannot be fixed forever. For example, if you are renting a building, let's assume you are operating a building and you are renting that building. And let's assume you are paying $10,000 rent per month. And that $10,000 is for 1,000 square feet. Okay, so $10,000 to rent 1,000 square feet. So simply put, as long as you are within 1,000 square feet, you only have to pay $10,000. Okay, as long as you are that. But let's assume you are expanding your operation and now you need more space, more than 1,000 feet. The next thing is you cannot rent, for example, 5 square feet you have to rent. It goes from 1,000 to 2,000. So what we say is now the the fixed cost jumped. So since you need an additional 1,000, now you have to pay, we're going to say it's proportional, you have to pay 20,000. So what's happening here, the relevant range of the activity is flat within a relevant range. So this is flat up to 1,000 square feet. Then if you're going to go up to 2,000, then it's going to jump and it's going to stay flat to a certain degree. So the fixed cost always fixed within a range. So the cost remained constant regardless of the level of activities, again, within a relevant range, within a relevant range, it cannot be fixed forever. So in total, the cost is fixed. So in total, let's assume in total, so if we look at the look at the graph for the total fixed cost, let's assume we are paying $10,000. So the $10,000 is the same regardless of the activity, assuming we're not jumping activity. As long as we are within the relevant range, the fixed cost is the same. What happened to fixed cost per unit? Well, the fixed cost per unit is inversely related. What does that mean? Let's assume we are paying $10,000 as fixed cost, fixed cost, and we are producing for the sake of simplicity, $10,000 unit of XYZ. If I ask you, what is your fixed cost per unit? You would say $10,000 divided by $1,000, your fixed cost per unit is $1. Let's assume we were very productive and we produced 20,000 units for that month, and we're still paying, remember the fixed cost is $10,000. If we produce 20,000 units, now our fixed cost per unit is only half, 50 pennies. So what happened to our fixed cost per unit? As we produce more, our fixed cost per unit goes down, our fixed cost per unit. So per unit, it's inversely related. However, in total, in total, again, we are dealing within the relevant range, in total, it stays the same $10,000. So you need to understand how variable cost behave in terms of, in total, it varies in total, it stays constant per unit, fixed cost, it stays total in fixed cost, in total, it's fixed per unit, it's inversely related. And we'll see an example to illustrate these concepts. Now, who wants to guess what a mixed cost would be? Well, a mixed cost will have both the component of a fixed, will have a both fixed component and a variable component. That's why it's called mixed. And most costs under real word, they will take the form of a mixed cost. There's nothing 100% variable, there's nothing 100% fixed. So simply put, if we want to express this algebraically, we can say that the total cost Y, the total cost, the total mixed cost Y equal to the fixed component. So A, representing the fixed cost, or we're going to see this with or the Y intercept or, you know, fixed cost, we're going to see it on the graph, A is fixed cost, plus B is the variable cost, B is the variable cost, and X is the activity. So the total cost equal to the fixed cost plus the variable cost. So your cost consists of a fixed component and a variable component. And this is what it looks like on a graph. For example, here, and this is, this is an illustration of your utility bill. Notice here, even if you did not consume any kilowatt hours, zero kilowatt hours, you're still paying, let me change the color here, you're still paying a certain amount. And we're going to assume you pay $40 for your utility bill, even if you don't do anything, if you don't consume your away, everything was shut off. As long as you have your utility active at the house, you pay $40, regardless, even if you consume zero kilowatt. Then what happened is this, for each kilowatt you consume, we're going to charge you three pennies per kilowatt. Okay, now this is the variable component. Why? Because it's varying per the activity here is the consumption of the kilowatts. So let's assume you, for a particular month, you consumed 2,000 kilowatts, 2,000 kilowatts for a particular month. How do you find your total cost? Well, you have to pay $40. That's A, that's your fixed cost, plus, plus B, your variable cost is 0.03, three pennies. And for that particular month, we said you consumed 2,000 kilowatt. Now we can find, so this is A is the fixed cost and this part here is the variable cost. If we solve this, we find out that your total cost, which is Y, total cost is Y is $100. Now what we can do, we can start to estimate your cost for any level of activity. For example, if we say your activity goes up to 3,000, we can predict your total cost. If your activity goes down to 500 kilowatt, we can predict your total cost. So this is the cost formula, which is your total cost equal to your fixed component, plus your variable component. Your fixed component is the Y intercept, is this point here, is the Y intercept. Now let's take a look at an example to see if we can solve this problem. Ronald Company recorded sales volume of 50,000 units, its total fixed cost are 50,000. If I ask you right now, what is the fixed cost per unit? That's easy. Fixed cost is $50,000 of fixed cost and we produce 50,000 units. We would say the fixed cost per unit is a dollar. The variable cost per unit is 70,000. This is the variable cost and the relevant range is 40 to 60. So we are within the relevant range. Now if I ask you, what is the variable cost per unit? Well, you could compute variable cost per unit. You can take 70,000 divided by 50,000 unit and let's see how much would that be. And we can find, if I take 70,000 dollar divided by 50,000 unit, we know this is equal to $1.40. This is $1.40. And I can tell you, if I ask you right now, what is the total cost per unit? You would say the total cost per unit is $2.40. What would be the total expected cost per unit? If Ronald were to sell rather than 50, sell 60,000 unit. My first question to you is this. What cost per unit goes up or what cost per unit goes down? I hope you can answer this question immediately. The cost per unit should go down. Why? Because you are within the relevant range and now you are selling or you are producing or selling 60,000 unit versus 50. So as you produce more, this $1 should go down. This fixed cost per unit should go down. For example, if I know it's $2.40, I can immediately eliminate $2.40. I can eliminate $2.44 and I'm down to two options. Either it must be C or D. Now, I'm going to have to use my formula to compute my total cost per unit. Well, my fixed component is fixed. It's not going to change. So that's going to be $50,000. That's A in the formula, the fixed cost plus B of X. Well, the variable cost per unit, remember the variable cost per unit is constant. So this $1.40 is constant. So 1.4 times 60,000 unit. So that's going to give me my total cost. Let's do the computation and see how much do we get as total cost. So if we take $1.40, which is the variable cost per unit, which is we computed earlier times 60,000 unit, that's going to give us 84,000 plus the fixed cost of 50,000. That's going to give us total of 134,000. Now 134,000 and we're going to split it or allocated over 60,000 unit. And now, again, as I said, we are ready to do the computation. If we take 134 divided by 60,000, and it's $2.23, $2.22, $2.23. As I told you, it's going to be less than 240, which we predicted this. Therefore, the answer is 223. Now, if you're looking to practice additional exercises in addition to viewing these lectures, you can go to my website, farhatlectures.com. I don't replace your CPA review course. I provide alternative resources. I can help you understand the material better. I can provide you with supplemental resources. This is what I can do. Invest in your career. Invest in yourself. Don't shortchange yourself. The CPA is a lifetime investment. Good luck. Study hard. And of course, stay safe and take a look at my course catalog. Good luck.