Variable Cost

A  variable cost  varies, in total, in direct proportion to changes in the level of activity. Common examples of variable costs include cost of goods sold for a merchandising company, direct materials, direct labor, variable elements of manufacturing overhead, such as indirect materials, supplies, and power, and variable elements of selling and administrative expenses, such as commissions and shipping costs. 1

For a cost to be variable, it must be variable with respect to something. That “something” is itsactivity base. An  activity base  is a measure of whatever causes the incurrence of a variable cost. An activity base is sometimes referred to as a cost driver. Some of the most common activity bases are direct labor-hours, machine-hours, units produced, and units sold. Other examples of activity bases (cost drivers) include the number of miles driven by salespersons, the number of pounds of laundry cleaned by a hotel, the number of calls handled by technical support staff at a software company, and the number of beds occupied in a hospital. While there are many activity bases within organizations, throughout this textbook, unless stated otherwise, you should assume that the activity base under consideration is the total volume of goods and services provided by the organization. We will specify the activity base only when it is something other than total output.

IN BUSINESS: COST DRIVERS IN THE ELECTRONICS INDUSTRY

Accenture Ltd. estimates that the U.S. electronics industry spends $13.8 billion annually to rebox, restock, and resell returned products. Conventional wisdom is that customers only return products when they are defective, but the data shows that this explanation only accounts for 5% of customer returns. The biggest cost drivers that cause product returns are that customers often inadvertently buy the wrong products and that they cannot understand how to use the products that they have purchased. Television manufacturer Vizio Inc. has started including more information on its packaging to help customers avoid buying the wrong product. Seagate Technologies is replacing thick instruction manuals with simpler guides that make it easier for customers to begin using their products.

Source: Christopher Lawton, “The War on Returns,” The Wall Street Journal, May 8, 2008, pp. D1 and D6.

To provide an example of a variable cost, consider Nooksack Expeditions, a small company that provides daylong whitewater rafting excursions on rivers in the North Cascade Mountains. The company provides all of the necessary equipment and experienced guides, and it serves gourmet meals to its guests. The meals are purchased from a caterer for $30 a person for a daylong excursion. The behavior of this variable cost, on both a per unit and a total basis, is shown below: