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What are mixed costs?

The term mixed costs often refers to the behavior of costs and expenses. Mixed costs consist of a fixed component and a variable component. The annual expense of operating an automobile is a mixed cost. Some of the expenses are fixed, because they do not change in total as the number of annual miles change. Think insurance, parking fees, and some depreciation. Other expenses are variable, because they will increase for the year when the miles driven increase (and will decrease when the miles driven decrease). Think gas, oil, tires, and some depreciation.

The algebraic formula for a mixed cost is y = a + bx, where y is the total cost, a is the fixed cost per period, b is the variable rate per unit of activity, and x is the number of units of activity. For the annual expense of operating an automobile, the fixed cost, a, might be $5,000 per year; the variable rate, b, could be $0.20; and the number of units of activity, x, might be 15,000 miles per year. With these hypothetical assumptions, the annual expense, y, would be $8,000. If x were 10,000 miles, the annual expense y would be $7,000.

To gain insight on the behavior of a mixed cost, it is helpful to graph the cost: For each observation, indicate a point on the graph where the total mixed cost amount aligns with the amounts on y-axis and also aligns with the activity amounts on the x-axis. To compute the best fitting line through the graphed data, you could use a mathematical tool known as regression analysis. This will calculate the fixed expenses, a, and the variable rate, b, based on the historical data that is utilized.