Semi Variable Cost

Definition of Semi-Variable Cost

Semi-variable cost is the mixture of fixed cost and variable cost as it contains the feature that up to a certain level of production cost will be termed as the fixed cost, and after the limit of production exceeds the nature of cost becomes the variable cost. In case of no production, the fixed cost will continue to apply.

Explanation

Semi Variable cost, as the name suggests, is the combination of fixed and variable costs. For example, some of the laborers of the organization are permanent. Therefore, the salary has to be paid irrespective of the work or production. On the other hand, if the production exceeds, the organization needs to appoint more laborers on a contract basis, i.e., they are temporary. So, the fixed salary is fixed, whereas wages paid to temporary laborers consist of variable costs. Hence the payment of wages is considered a semi-variable cost. In the case of semi-variable costs, the fixed portion of the cost has to be incurred irrespective of the earnings or income.

In contrast, the variable portion must be paid if it functions as a function of the activity volume. As per the accounting principles, there is no need to bifurcate the cost into the semi-variable cost. It is to be determined for internal purposes only.

The formula for Semi Variable Cost

The formula for Semi Variable cost is defined as under:

Total Cost or Semi Variable Cost = Fixed Cost + (no of The Units of Activity * per Unit Variable Cost)

Per the concept of semi-variable cost, the fixed cost has to be incurred irrespective of the production or income. In contrast, variable cost is based on additional activity or after income generation.

Examples of Semi Variable Cost

ABC Ltd is the manufacturer of bottles. The variable cost is the cost of maintenance and the additional labor charges in case of an export order. The fixed cost is the depreciation of the machinery and salaries of the certain permanent laborers involved in producing bottles. The details of the overall cost related to production are-

Particulars (Cost Incurred)	Amount ($)
Rent of Factory per month where production is done	50000
Repairs to Machinery p.a.	40000
Salaries fixed per month	35000
Depreciation of machinery (p.a.)	32000
Labor Charges Per Hour of Temporary Labors	$ 25 Per Hour

The organization’s Production Capacity is 5,000 units. Sales for the year 2019-20 are estimated at 4500 units. The organization has received an export order of 1000 units, and the selling price per bottle is $ 300. Determine whether the export order is to be accepted or not; also determine the additional cost to be incurred if the export order is accepted.

In case of repairs, $ 25,000 is fixed in nature, and additional is based on production. Depreciation is fixed. The rent is fixed. If the export order is accepted, ten laborers must work 8 hours daily for 30 days.

Solution:

Calculation of Fixed Cost

Particulars	Amount ($)
Rent Per Annum ($ 50,000 * 12)	600000
Repairs (Fixed in nature)	25000
Fixed Salaries p.a. (35000*12)	420000
Depreciation	32000
Total Fixed Cost	1077000

Calculation of Variable Cost per unit

Particulars	Amount ($)
Repairs (40000-25000) = 15000/ 4500 units	3.3333 per unit
Additional Labor cost (10 Labors * 8 hours per day * 30 days * 25 per hour)	60,000.00

Calculation of Profitability if no export order is accepted

Particulars	Amount ($)
Sales (4500 units * $ 300 per unit)	1,350,000.00
Less: Variable Cost
Repairs Cost	-15,000.00
Less: Fixed Cost
Salaries	-420,000.00
Repairs Fixed	-25,000.00
Rent	-600,000.00
Depreciation	-32,000.00
Profit	258,000.00

Calculation of Profitability if export order is accepted

Particulars	Amount ($)
Sales (5500 units * $ 300 per unit)	1650000
Less: Variable Cost
Repairs Cost (for 5000 units)	-15000
Repairs Cost (for 500 units)	-1666.67
Labor charges (10 Labors * 8 hours per day * 30 days * 25 per hour)	-60000
Less: Fixed Cost
Salaries	-420000
Repairs Fixed	-25000
Rent	-600000
Depreciation	-32000
Profit	496333.34

The Export Order is to be accepted as the organization will be able to increase the profit by 92% approximately. The additional cost that is considered the semi-variable cost to be incurred in the case of export is Labor charges of additional labor and repairs costs for additional units produced.

Semi Variable Cost Graph

Semi-variable cost graphs are given below:

In the graph depicted above, different output levels are shown on the X-axis, and the different cost is shown on the Y-axis. Semi-variable cost is represented by the line BD, which is the total cost incurred at different levels of output in the company, and it is the sum of fixed cost and variable cost. In this case, there are some costs that the company has to incur that do not change with a change in output, and this cost is known as the fixed cost (like BF). On the other hand, line CE is the variable cost that changes with a change in production level.

Advantages

Advantages of semi-variable cost are provided and discussed below-

• The cost contains a mixture of fixed and variable costs, and the variable cost component is to be incurred only as a function of activity volume.
• It can prove beneficial for business because of the lower breakeven point in case of lower fixed costs.
• The variable portion of the semi-variable cost is incurred only after a certain production or income generation level.
• The semi-variable cost need not be classified separately; an organization can show it as the normal expenses.
• It is beneficial for organizations that rarely receive large orders.
• In the case of additional or large-scale production, the semi-variable cost may be beneficial in lowering the overall cost and increasing the organization’s profit.

Disadvantages

Disadvantages of Semi Variable costs are provided and discussed below-

• In case of production is lower, the fixed cost has to be incurred, which might increase the cost of production and decrease the profit.
• If the fixed cost increases, the breakeven might create a loss situation.
• The cost is used for internal purposes only; hence it is not given so much importance in the accounts.
• The readers of the financial statement won’t be able to know how much portion is fixed cost and how much portion is variable cost as it is reflected as a single cost in the income or profit and loss statement.

Conclusion

It is the part of the expense that consists of fixed and variable cost components. Up to a certain production level, the cost is to be considered fixed, and after the production increases or reaches a certain level, the variable cost has to be incurred. The main benefit of it is that it is beneficial if the fixed cost is lower, so the breakeven can be achieved easily. On the other hand, if the fixed cost is higher, it is difficult to achieve breakeven, and the organization may suffer a loss. But, on the other hand, the fixed cost has to be incurred irrespective of income or production volume, which might increase the production cost.

Recommended Articles

This is a guide to Semi Variable Cost. Here we also discuss the definition and examples of semi-variable cost, advantages, and disadvantages. You may also have a look at the following articles to learn more –

1. Fixed Cost
2. Mixed Cost
3. Fixed vs. Variable
4. Financial Assets