A variable cost is a cost that changes directly and proportionately with the level of activity. Some examples of variable costs are direct materials, direct labor, payroll taxes, and sales commissions. Variable costs in total fluctuate based on activity, while the variable cost per unit stays the same regardless of the level of activity. When there is no activity, there is no variable cost. The equation expressing the relationship between activity and variable cost is Y = bX, where Y is total variable cost, X is the activity level, and b is the variable cost per unit of activity. For example, if 800 units are produced with a variable cost of $2 per unit, the total variable cost is $1,600.
Some costs contain characteristics of both fixed and variable costs. These costs are called mixed costs. In order to analyze mixed costs, they must be broken down into their fixed and variable components. One example of a mixed cost would be sales staff compensation where the sales staff receives both a base salary and a commission on their sales. The fixed component would be the base salary, and the variable component would be the commission, since it varies based on the amount of sales that employee generates.
Because a mixed cost is the sum of a fixed component and a variable component, the formula would be the formula for a fixed cost added to the formula for a variable cost. This would be expressed as Y = a + bX, where Y is the mixed cost, a is the fixed cost, b is the variable cost per unit of activity, and X is the activity level. In the example given above, the sales staff’s total compensation is the mixed cost. The separate fixed and variable components of a mixed cost are evaluated separately in the same manner that any fixed or variable cost would be evaluated and analyzed.
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