A Semi-Variable Cost can be defined as a cost that comprises both fixed, and variable components. Also referred to as mixed costs, semi-variable costs tend to stay fixed for a given level of production.
After a certain level of production, they then tend to vary with the output. Even in the case where the company has no production, these costs still incur.
Semi-Variable costs can broadly be categorized into two broad components: the fixed component, and the variable component.
The fixed component is unrelated to the level of output at which the company is producing, whereas the variable component is directly contingent on the level of output at which the company produces. Both of these components (variable and fixed) are combined to arrive at the respective cost head.
Total Semi-Variable Cost includes the following:
Total Semi-Variable Cost = Fixed Cost + (Variable Cost * Level of Output)
How to calculate Semi Variable Cost?
As mentioned earlier it can be seen that Semi-Variable Costs include a Fixed Cost component, as well as a Variable Cost Component. The calculation of Total Semi Variable Cost can be illustrated by the following example:
Roopi Ltd. Is a production concern, which has subscribed for the following electricity plan. They are charged a flat fee of $500 line rent per month. Additionally, they are also charged on a per-unit consumption basis, and for units charged, they need to pay $1 as a utility. In the last month, Roopi Ltd. consumed 2300 units. What is the total outstanding amount they need to pay?
In the illustration above, it can be seen that the electricity charge for Roopi Ltd. can be considered as a semi-variable cost, simply because of the fact that it includes a fixed component (the line rent per month), and the variable component (the per unit charge). Therefore, the total cost of electricity would be a summation of both these costs, as shown below:
Electricity Cost = $500 (Fixed Line Rent) + (1*2300) (Variable Charge) = 2800
In this example above, it can be seen that the line rent would be charged, regardless of any units of electricity being utilized or not. In the same manner, the variable charges are going to fluctuate based on the units that are consumed by the business over the billing period.
Semi-variable cost is very common in the normal course of the business and offers some valuable insights for the decision-makers of the business. It helps to identify cost centers that can be controlled by the company, in addition to other product pricing decisions that can be taken by the company. The usefulness and viability of semi-variable costing are provided below:
- It helps the decision-makers to set the prices of the products as a reflection of this particular costing. In most cases, it can be seen that electricity is considered as a fixed cost, which does not vary with the output that is produced. However, if fixed costs like these are broken down into fixed and variable components, it gets easier for businesses to identify the relevant cost associated with one particular product, and hence, this is something that proves to be exceptionally helpful in product pricing decisions.
- Cost Controls: In most services that involve semi-variable costing, service providers give the option to businesses to choose from. In the case where companies have such an option available, variable costing analysis can help them pick and choose their plans, based on what is cost-effective for them. For example, in some months, a high line rent, and lower per-unit cost might be cost-effective for the company, whereas in some months, low line rent and a higher per-unit cost might prove to be effective. Hence, this particular analysis allows the company to identify and subsequently control its cost centers.
Regardless of the fact that semi-variable costing does allow the company to work towards efficiency and subsequent profitability, yet it can be seen that there are a couple of limitations of this analysis, that cannot be ignored.
- Firstly, it can be seen that semi-variable costs need proper categorization between fixed and variable components. In the case where the company has a considerable scale, it is often overwhelming to break down all the costs into fixed and variable components. Therefore, on a larger scale, it might be difficult to implement this particular strategy.
- In the same manner, it can also be deduced that it is often hard to dissect the different costs involved, and it might lead to an incorrect analysis between product costs and period costs. This might lead to incorrect decision making because it is harder to directly attribute fixed costs like these to specific units produced over the respective year.