Definition of Mixed Costs
Example of Mixed Costs
An example of a mixed cost is the electricity used in a manufacturing facility. A part of each monthly electricity bill is a variable cost since more electricity is used when more machines are working to manufacture more products. However, part of each monthly electricity bill is fixed because this part of the bill does not change because of the number of products manufactured. For instance, the cost of the air conditioning and air purifying occurs continuously. In addition, the electric bill includes a fixed charge based on the manufacturer's peak day electricity usage that occurred in the prior 12 months.
Examples of Methods for Separating Mixed Costs
Three methods for separating mixed costs into the fixed portion and the variable portion are:
It is important to prepare the scattergraph for all three of the above methods, since it allows you to see if some of the plotted points are simply out of line. These outliers must be reviewed and possibly adjusted or eliminated since you don't want incorrect data to distort the calculations under any method.
To understand the three methods, assume that a company uses only one type of equipment and it wants to know how much of the monthly electricity bill is a fixed amount and how the electricity bill will increase when the equipment runs for an additional hour. The scattergraph's vertical or y-axis indicates the dollars of total monthly electricity cost. The horizontal or x-axis indicates the number of equipment hours. For each monthly electricity bill, a point is entered on the graph at the intersection of 1) the amount of the electricity bill, and 2) the number of equipment hours that occurred between the meter reading dates on the electricity bill. If you plot this information for the most recent 12 months onto the scattergraph, you may see some type of pattern, such as the total cost line rising as the number of equipment hours increase.
If you draw a line through the plotted points and extend the line through the y-axis, the amount where the line crosses the y-axis is the approximate amount of the monthly fixed cost. The slope of the line indicates the variable cost per equipment hour. The slope is the increase in the total monthly electricity cost divided by the increase in the total number of equipment hours.
The high-low calculation is similar but it uses only two of the plotted points: the highest point and the lowest point. The scattergraph will reveal if either of the two points is an outlier.
Regression analysis uses all of the monthly electricity bill amounts and their related number of equipment hours to calculate the monthly fixed cost of electricity and the variable rate for each equipment hour. Software is available to calculate the best fitting line, the resulting fixed cost and variable rate, and additional statistical insights such as the level of confidence for various amounts.