Step cost

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Step cost
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Step cost is a cost which has a tendency to remain fixed in total over various small ranges of production but increase by separate amounts as the activity level increases from one range to another. Inputs which are acquired in discrete quantities but whose usage takes place in fractional quantities show this type of behaviour[1].

Step costs classification

Depending upon the period up to which an expense can be kept up to a certain level in spite of increase in activity, the height and width of steps vary. Therefore, step costs may be classified[2][3]:

  • step variable costs - costs where steps in step cost function are small and narrow. If the width of the step is narrow, the cost of the resource changes in response to fairly small changes in resource usage. The behaviour of cost is nearly like that of pure variable cost,
  • step fixed costs - costs where steps in step cost function are wider. Cost is said to behave nearly like that of fixed cost.

Step cost function

Some cost functions display characteristics of a discontinuous function. In case of step costs, one such discontinuous function is called a step-cost function. A step-cost function displays a constant level of cost for a range of output and then jumps to a higher level of cost at some point, where it remains for a similar range of activity[4]. Step cost function characteristics are a result of input factors that cannot be increased in very small portions. The appearance of step cost is similar to the stairs or steps in a building[5].

Real world applications

In reality, many so-called fixed costs may be described by a step-cost function. Many committed resources - particularly those that involve implicit contracting - follow a step-cost function[6]. Step costs stay at the same level for certain activity range (for example, one to four people), but jump to a higher amount if the volume of activity increases beyond this range (adding a fifth person to the group)[7]. It is found that all labour costs usually behave in a step-cost manner. The reason underlying this is that it is not possible to store the services of labour. Secondly, when the acquisition of labour takes place, it is done in indivisible lumps[8]. Step-cost function analysis may be beneficial to the company - if managers know the total capacity available as well as the capacity used, they can better utilize the activity capacity and know when additional capacity must be acquired[9].

Step cost example

Example of this type of cost is the number of supervisors in a factory. One supervisor is in a position to supervise up to an optimum number of workers effectively. Increase in the number of supervised employees raises the need to have another supervisor for the supervision to stay effective. Assuming that one supervisor is in a position to do effective supervision of fifteen workers, a second supervisor would be needed if the number of workers increases to sixteen, a third supervisor if the number of workers exceeds thirty and a fourth supervisor would be needed only if the number of workers exceeds forty but remains within sixty. Therefore, there is a sudden increase in the number of supervisors as the activity level increases from one range to next[10].

References

Footnotes

  1. Dutta, M., 2004, p1.12
  2. Dutta, M., 2004, p1.12
  3. Hansen, D. R., Mowen, M. M., 2013, p83
  4. Hansen, D. R., Mowen, M. M., 2013, p83
  5. Layne, W. A., Rickwood, C., 1984, p126
  6. Hansen, D. R., Mowen, M. M., 2013, p83
  7. Balakrishnan R., Sivaramakrishnan K., Sprinkle G., 2012, p53
  8. Dutta, M., 2004, p1.12
  9. Hansen, D. R., Mowen, M. M., 2013, p85
  10. Dutta, M., 2004, p1.12

Author: Gabriela Sambór