Read the Chapter 5 introduction, and then click on "Next Section" to read section 5.1. Bikes Unlimited is planning its monthly sales. They have recently concluded a successful advertising campaign and expect that sales will increase 10 to 20%. They need to know what happens if they adjust manufacturing to meet the predicted increase in sales and their predictions of sales are, in fact, true. How will increased sales volumes impact profit? First, you have to identify how costs behave with changes in sales and production—behavior depends upon whether the costs are variable, fixed, or mixed. Once you have classified the costs, you can set up an income statement in a "contribution-margin" format, that will give management a major tool in their decision making.
Variable Costs The key to understanding and being able to classify a variable cost is to remember that you are thinking about how costs behave relative to production. Variable costs will fluctuate based on how much product is sold. The cost of purchasing chrome tubing for Bikes Unlimited is an obvious variable cost, some variable costs are not so obvious. Fixed Costs
Fixed costs are incurred whether Bikes Unlimited sells zero units or a billion units. The payment of the annual lease on Bikes Unlimited's factory/warehouse is a good example of a fixed cost; even if Bikes Unlimited chooses to make no bikes, it would have to continue to pay its lease. There are two kinds of fixed costs: some are "committed," those that must happen, such as the lease payment stated above, and others that are discretionary, such as advertising or research and development. Both of these activities could be suspended in the short term.
Bikes Unlimited also has mixed costs which have both fixed and variable components. Bikes Unlimited pays its sales staff a base salary plus a commission based on units sold and, finally, a year-end bonus based on overall profitability, which demonstrates all three cost behavior patterns.