During the normal operation cycle, there are several costs that businesses normally incur. Classification of these costs tends to be important because it helps organizations make important decisions regarding pricing and product strategy.
Costs within an organization are mainly divided into fixed and variable costs.
As far as fixed costs are concerned, it cannot be seen that they do not change with the level of output at which the company is operating.
On the other hand, variable costs change with output and are directly correlated with the level of operation in the company.
However, in addition to this black-and-white classification of costs, there is also a third type, which is referred to as mixed costs.
Mixed Costs can simply be defined as costs that include both fixed and variable components. Therefore, they can best be described as costs that have a fixed component and a variable component.
As far as the fixed component is concerned, that does not vary with the output level.
The company is meant to incur that particular regardless of its output level. On the other hand, the variable component of the mixed cost will directly vary following the level of output (or level of usage) within the company.
Hence, mixed costs can be defined as costs incurred by the company, which cannot strictly be classified as either fixed or variable.
Instead, they comprise both, fixed and variable components. Both these components are added together to arrive at the total mixed cost of the company.
To calculate a specific cost that is classified as a mixed cost, the following formula can be used:
Mixed Cost = Fixed Cost + (Variable Cost per unit x Level of output)
The formula above shows that the mixed cost has both components, which need to be added together to arrive at the total figure of the mixed costs.
Example of Mixed Costs
Mixed Costs can further be explained using the illustration given below:
Jain Co. is a manufacturing concern, and they have outsourced their manufacturing for the production of T-Shirts to Tee Co. They have mutually agreed upon a fixed cost per month of $5,000, and an additional charge of $10 per T-shirt produced. For the month ended 31st December 2020, Jain Co. had ordered 750 T-shirts from Tee Co. What was the total cost incurred?
In the example given above, it can be seen that the manufacturing costs of Jain Co. can best be described as mixed costs.
This is because they have agreed upon a fixed monthly payment of $5,000, in addition to a variable charge of t-shirts, depending on the overall output that is produced.
Hence, in this case, the calculation of mixed costs can be done in the following manner:
Mixed Costs = Fixed Costs + (Variable Cost per unit x Level of output)
Mixed Costs = 5000 + (10*750) = 5000 + 7500 = $12,500
Therefore, it can be seen that the total Mixed Costs for Jain Co. amount to $12,500.
Other than the example above, during the normal course of business, there are numerous examples of Mixed Costs that the company bears and pays.
For example, telephone and electric subscriptions are often classified as Mixed Costs.
This is because they comprise the fixed component (the line rent, or the flat monthly subscription charge), and then a variable component directly related to the amount of electricity they have used over time.
Importance of Mixed Costs
Mixed Costs tend to be a very important part of the company, primarily because they help to calculate the cost of the product in a much more accurate manner.
It also helps companies to identify the contractual obligation that is going to suit them the best.
It gives them a much-needed insight into their operations, which can help to bring down the costs.
However, the most beneficial part about mixed costs is that they can contribute towards individual product costing, based on which the organization can viably decide how to price that specific product.
By classifying the fixed component as a fixed cost and the variable component as a variable cost, they can identify the product cost more accurately.
This traceability is a very important determinant in helping these companies properly make these decisions.