Step fixed costs are those costs which remain constant or do not change within a certain range of production level/ activity, but will change to new constant value if the production/ activity falls out of this range of production level/ activity. Step fixed costs will increase to a new constant value or fall to a new constant value depending on whether the upper limit or the lower limit of that production level/ activity, respectively is breached. This concept is best seen with an example.
Example: Step fixed costs
ABC Company is a manufacturing concern involved in the production of footballs. ABC uses machinery acquired on operating lease for a monthly rental of $ 800. Monthly production capacity of the machinery is 5,000 footballs. Workout monthly rental cost in each of the following cases:
- If planned production is 3,000 footballs.
- If planned production is 4,000 footballs.
- If planned production is 5,000 footballs.
- If planned production is 6,000 footballs.
- If planned production is 12,000 footballs.
Answer: Monthly rental cost depends on the number of machineries used. If the production is not more than 5,000 footballs, rental cost will be a constant of $ 800. When the production exceeds 5,000 footballs, rental cost would change to a new constant value of $ 1,600 (2 machineries x $ 800 per machine). Rental cost in each of the above cases would be:
- $ 800 (1 machine x $ 800 per machine)
- $ 800 (1 machine x $ 800 per machine)
- $ 800 (1 machine x $ 800 per machine)
- $ 1,600 (2 machines x $ 800 per machine)
- $ 2,400 (3 machines x $ 800 per machine)
