To return to the example, this means that the QA person could be more efficient or work somewhat longer hours in order to avoid incurring the large incremental cost of an additional person. In such a situation, it may be more cost-effective for the employer to offer overtime to the existing staff than to pay the more substantial cost of a new hire. Businesses generally anticipate a certain amount of fixed or budgeted cost when activity levels remain constant over an expected range. If activity levels spike upward or downward unexpectedly, costs can increase or decrease disproportionately. To illustrate a stepped cost, let’s assume that you are developing a website and find that the monthly cost of hosting the site is based on the number of visits.
- Businesses generally anticipate a certain amount of fixed or budgeted cost when activity levels remain constant over an expected range.
- At higher level, it again remains constant until the completion of a certain volume of output and then jumps to the next higher level.
- A Step Variable Cost is an expense that remains constant within a given range but can increase or decrease when outside that range.
- When depicted on a graph, these types of expenses will be represented by a stair-step pattern.
- Overtime shifts can help you produce more units without hiring additional full-time staff.
The difference between a step-variable cost and a step-fixed cost has to do with the width of the range of activity. If the total cost increases with small increases in activity, it may be referred to as a step-variable cost. If the total cost will change only with large increases in the quantity of activity, the term step-fixed cost is more likely to be used. For example, a cost can be say $100 up to 500units, increase to $185 for 501 to 1,000 units and to $260 if output crosses 1,000 units. The cost with such a pattern of increase would be classified as step variable cost.
What is Step Variable Cost?
A high-tech gear manufacturer makes 400 virtual reality headsets in one shift of eight hours with 25 employees and one supervisor. Let’s briefly explain, differentiate and exemplify these two types of variable costs. As these costs vary directly in proportion to the level of production, they would not be incurred in situations where production level is zero. The owner eventually decides to hire a second cashier due to the shop’s additional customer flow.
Unlike a true variable cost, it does not respond to small changes in activity levels (such as an additional unit produced) but remains unchanged over a significantly wide range of business operation or activity. Once a certain activity level is reached, it jumps to the next level in terms of total dollar amount. Because a step variable cost can remain approximately the same while activity levels change, this step effect can impact the allocated cost per manufactured unit. Because the blades’ cost has a direct one-to-one relation with your business’s production activity, it is an example of true variable cost of your sharpener manufacturing business. The quantities and cost of these two materials would also increase in direct proportion i.e., on a per unit basis.
Impact on per unit costs
Thus, the cost of the QA person generally varies with the level of activity, but only changes at discrete points – when the existing QA staff can no longer handle the work load, forcing another person to be hired. From a production cycle standpoint, costs per unit tend to decrease as the number of units produced increase until the occurrence of a step variable cost. When the activity rises above a certain level, the step cost will increase. Consider an example where a production company typically produces 1,000 units in one shift. If demand rises to 1,050 units, the company might create an additional production shift to manufacture more units. The step cost incurred would be the salaries as the company would pay additional salaries for shift supervisors to oversee the additional shift.
Understanding step costing is extremely important when a company is about to reach a new and higher activity level, where it will be required to traverse a large step cost. In some cases, the step cost may eliminate profits that management had been expecting with increased volume. If the shop receives anywhere from zero to 30 customers per hour, it will only need to pay the cost of having one employee, say $50 ($20 for the employee, $30 for all other expenses, fixed and operating). If the shop begins receiving 31 or more customers per hour, it must hire a second employee, increasing its costs to $70 ($40 for two employees, $30 for others). The salary of a shop floor supervisor in a production department overseeing 1,500-2,000 units produced daily is an example of this concept. As supply and demand changes, a flight of stairs is a good visual representation of step variable cost.
TRUE VARIABLE COST VS STEP VARIABLE COST
Conversely, a truly variable cost will vary continually and directly in concert with the level of activity. A second shop floor supervisor, along with additional support personnel, would be necessary if demand for the product increased to 2,001-4,000 units per day. Therefore, the total salary costs of shop floor supervisors vary with changes in product demand. If you need to delay the sudden jump in step costs, consider offering overtime to employees.
One shop floor supervisor has daily capacity limits above 2,000 units whereby two shop floor supervisors have daily capacity limits up to 4,000 units. If you look at your business finances, you’ll discover that many of your expenses are examples of step costs. Sometimes the shop has 20 customers per hour and other times it has 0 customers in an hour.
True variable costs
If you need one worker to manufacture 10,000 sharpeners in a month, then the worker’s monthly wages would remain unchanged over a production range of one to 10,000 sharpeners. If you manufacture more than 10,000 sharpeners, say 11,000 pieces in a month, you would need to hire another worker and your wages cost would jump to its double. For making more than 20,000 sharpeners, say 22,000 pieces in a month, you would need to hire another worker and your total wage cost would be tripled. The wages of these direct labor workers, therefore, qualifies as a step variable cost of your sharpener manufacturing business. The step variable cost does not behave in exactly the same pattern as the true variable cost.
Cost behavior
Variable cost is one key categorization of total costs incurred in a business unit. Every cost that explicitly changes with a change in the level of output or another business activity qualifies to be a variable cost. Within variable costs as well, there are different cost categorizations based on their relationship with level of output.
Step costs move up and down in a step-like manner—horizontally over a range, then vertically, then horizontally, and so on. The opposite is true, too—if business activity slackens, a material portion of costs will drop, with a step-down. Step variable cost is also a subtype of variable cost that remains the same up to a particular level of output and increases once that particular output level is breached. These costs also vary with the level of output but they have a staggered relation with the level of output. When a company is growing, the higher output can introduce sudden rises in step costs. There are times, however, when crossing that threshold line for step costs can result in a loss.
