Semi-Fixed Cost Definition
A Semi-Fixed Cost refers to the cost that contains both variable as well as fixed elements of costs i.e., the cost remains fixed up to some level of the activity or even if there is no activity but then increases with the increase in the level of activity.
Suppose there was a company of toy manufacturing. The factory of toy manufacturing was taken on rent for $ 20,000 per month. The total units produced in the factory in one month were 100,000 units. The production cost was $ 500,000. There was a supervision person Mr. John in the factory who charges $ 40,000 per month. But the company has also decided to give $ 1 per unit if the units produced in his supervision increases by 100,000. In the month of April, the units produced were 110,000. In this case, we need to calculate the total semi-fixed cost in the month of April.
In the above scenario, Rent paid is the fixed cost because rent is to be paid at every level of production in the company, and the same does not change with the change in the level of production in the company. The production cost of $ 500,000 is the variable cost as it changes with the change in the production level in the company.
But in this case, the salary of the supervision person, Mr. John, is semi-fixed cost as this salary is fixed up to the level of 100,000 units, but beyond that, it increases with the units produced under his supervision.
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- = ($ 40,000 + $ 1 (110,000-100,000))
- = ($ 40,000 + $ 10,000)
- = $ 50,000
Semi Fixed Cost Graph
In the above graph, the X-axis shows the different activity levels, i.e., different output levels, and the Y-axis shows the costs. Line BC shows the total cost incurred at different levels of output in the company. It is a semi-fixed cost. Here it can be observed that there is some cost (as depicted by point BD), which has to be incurred even if there is no production, i.e., zero output. This cost is known as the fixed cost of the company. Fixed Cost will remain the same at all output levels. Rest all of the cost changes with the change in the level of production so, it will be variable cost.
Semi fixed costs play an important role in the decision-making process of the company. This is so because when the company plans the level of output which it should produce during a particular period of time, then the semi-fixed cost is to be considered as these costs may limit the profitability of the company at the higher levels of production and erode the bottom line of the company.
Semi Fixed Cost vs. Semi Variable Cost
Both types of costs are the same as they both are the mixture of variable and fixed components. For example, the company has taken a package from the telephone company that up to 10,000 minutes and less. The telephone company will charge $500, but when the consumption of minute increases from 10,000 minutes, the telephone company will charge $0.5 per additional minute of call. Therefore, the consumption of minutes should be taken care of to not increase the cost of the organization.
The advantages are provided and discussed as below-
- In order to have an appropriate system of costing, it is important for the company to know its semi-fixed cost and also bifurcate its different costs.
- This cost helps in planning the level of output which the company should target during the period under consideration.
The disadvantages are provided and discussed as below-
- In the practical scenarios, many of the times, it becomes difficult to know the exact amount of the semi-fixed cost in the company as its calculation is not as straight forward as it is provided in theory.
- If this cost is not calculated correctly, then it would lead to an incorrect forecast of different important aspects of the company.
Semi-fixed cost is the cost that includes both fixed and the variable component as these are the costs which are fixed up to some level of production in the company, but it then increases with the increase in the level of production activity of the company. Therefore, the companies are required to take these costs into consideration while considering the increase in the level of production, i.e., they are to be considered while panning the level of production output in the company for every period.
This has been a guide to Semi-Fixed Cost and its definition. Here we discuss its formula along with its graph, example, advantages, and disadvantages. You may learn more about financing from the following articles –