FAQs – Chapter 3
1. Are all direct costs variable? Explain.
All direct costs are variable by definition since they can be directly traced to the
cost object, and thus must vary with the cost driver or volume of output.
2. Are all fixed costs indirect? Explain.
Fixed costs are usually indirect, since the increase in the cost driver or volume of
output does not affect the level of fixed cost. However, if the cost object is not volume
based (for example, if it is a department or product line), then some fixed costs (such as
the salary of the department head) could be directly traced to the cost object and therefore
the fixed cost would also be a direct cost in this case.
3. What is the difference between variable and fixed costs?
Variable costs are those for which total cost changes with each change in the cost driver.
Fixed costs are the portion of total cost which remains constant as the cost driver
changes.
4. What are step-fixed costs and give an example?
A step-fixed cost varies with the cost driver, but in discrete steps. Costs remain fixed over
narrow ranges of the cost driver. However, total costs increase by a constant amount at
set intervals. Examples of step-fixed costs are the costs for certain clerical tasks, order
filling, and other administrative tasks. At specific levels of the cost driver, an additional
clerk must be added. Therefore, total costs increase by a constant amount at these points.
5. Why might the term average cost be misleading?
Average cost can be misleading unless the activity level (denominator) is known.
Because average cost includes fixed cost, it will be different at each different activity
level. The term average cost is meaningless if the denominator is unknown.
6. What is the difference between costs based on cash flows and costs based on
accrual accounting?
Cash-basis accounting records transactions only when cash is received or disbursed. In
contrast, revenue is recorded when earned and expenses recorded when incurred
(regardless of the timing of cash flows) under the accrual method. The accrual method is
preferred because it more accurately depicts the economic events which occurred during
the period.
