Step fixed cost

Step fixed cost
See also
Step cost Cost oriented pricing Fixed cost Differential costing Marginal pricing Cost behavior Controllable costs Mixed cost Committed cost

A step fixed cost is a cost that is determined within the scope of activity. It is not dependent on the size of the business thresholds. It changes when the threshold is exceeded. A key conceptual issue at a fixed cost is that they be established only within a specified scope of activity. If you go beyond this range, the cost structure will change significantly.

Conditions in regard to a step fixed cost

A step fixed cost varies within high and low business thresholds. When the cost changes the threshold, a new set of activity thresholds is used in which the fixed cost will not change significantly. This concept is good for making investment decisions in a company. A limit breach can result in one of two conditions in respect to a step fixed cost.

• Activity declines. Management has the option of deciding when the activity level will fall below the lower threshold level. For example, when the sales volume drops, you can sell the production line. In this way, all costs associated with it are eliminated. In this situation, the step fixed cost goes to a lower level.
• Activity increases. In this situation, management also has a choice. When the level of activity rises to the upper threshold, they can decide that they remain at the current level of step fixed cost. They can also accept an increase in activity and incur an additional cost. For example, when sales increase to their maximum level, management may maintain an step fixed cost and not take more orders. The second solution is accepting orders and increasing the step fixed cost to a higher level.

Example of a step fixed cost

The company has involved in significant foreign expansion. As a result, there has been massive increase in business. It turned out that the company is forced to open new offices because there is not enough. The changes will cause that the rental costs will no longer remain fixed. As the volume of activity increments from zero, the rent (a fixed cost) is unaffected. In any case, at a specific point, the volume of activity cannot increment without extra space being leased. The cost of renting the extra space will cause a 'step' within the rent cost. The higher rent cost will unaffected that volume were to rise advance, until another step point would be come to. The figure (Fig.1) shows how the rental cost will behave in the described example. This cost behavior is known a step fixed.

Fig. 1. Graph of rent cost against the level of activity (adapted from Nobes 2014, p. 97).

Step-cost function

“A step-cost function displays a constant level of cost for a range of and then jumps to a higher level of cost at some point, where it remains for a similar range of activity”. In reality, thanks to the step-cost function it is possible to describe many of the step fixed costs. Many committed assets - especially those that include verifiable contracting - follow a step-cost function. Step-fixed costs are allocated to the fixed cost category, since most are settled over the firm's ordinary working range.

Advantages of Step fixed cost

Step fixed costs offer several advantages to business owners and executives. These include:

• Predictability: Step fixed costs enable businesses to have a greater degree of predictability of costs, since they are not dependent on the size of the business. This can help businesses plan their budgets and operations more efficiently.
• Flexibility: Step fixed costs are also flexible, as they can be adjusted by changing the scope of activity. This allows businesses to adjust their cost structure to better match their operational needs.
• Cost Savings: Step fixed costs can be beneficial for businesses in terms of cost savings. By controlling the scope of activity, businesses can often reduce their overall costs and increase their profitability.
• Efficiency: Step fixed costs can also help businesses become more efficient. By controlling the scope of activity, businesses can ensure that resources are used more effectively and efficiently.

Limitations of Step fixed cost

Step fixed costs are a useful tool for businesses to budget and plan their expenses. However, there are some limitations that should be considered when using them. These include:

• The cost structure can change significantly when activities exceed the specified range. This can lead to unexpected costs or a need to re-budget.
• Step fixed costs do not take into account changes in the price of goods or services. As such, businesses can experience unexpected costs if the price of goods or services increases.
• Step fixed costs do not account for fluctuations in demand or supply. As such, businesses may experience unexpected costs due to unexpected changes in demand or supply.
• Step fixed costs can be difficult to accurately estimate, as they are based on projections instead of actual data. This can lead to unexpected costs if the projections are inaccurate.

Other approaches related to Step fixed cost

A step fixed cost is a cost that is determined within the scope of activity and is not dependent on the size of the business thresholds. Other approaches related to step fixed cost include:

• Activity-based costing: This approach allocates the cost of an activity to the resulting products or services based on their individual usage of the activity. This approach is useful when businesses have a wide range of products and services with varying usage of activities.
• Target costing: Target costing focuses on the customer's needs and the cost associated with meeting them. The costs are determined by the customer's willingness to pay and the company's cost structure.
• Total cost management: Total cost management looks at the cost of the entire system, including all of the business's operations, processes, and materials. This approach helps to identify cost-saving opportunities and improve the efficiency of the organization.

In summary, step fixed cost is a cost determined within the scope of activity, and there are several other approaches related to step fixed cost such as activity-based costing, target costing, and total cost management. These approaches focus on different aspects of cost management and help to identify cost-saving opportunities.

References

• Finkler S. A., Ward D. M., Baker J. J. (2007), Essentials of Cost Accounting for Health Care Organizations, Jones & Bartlett Learning, Sudbury
• Hansen D., Mowen M. (2014), Cornerstones of Cost Management, Cengage Learning
• Hansen D., Mowen M., Guan L. (2007), Cost Management: Accounting and Control, Cengage Learning, South-Western, USA
• Nobes Ch. (2014), Accounting: A Very Short Introduction, Oxford University Press, United Kingdom
• Walther L. M. , Skousen Ch. J. (2010), Cost Analysis: Managerial and Cost Accounting, Bookboon

Author: Monika Wójcik