Accounting Best Practices, Fifth Edition

5–6. Identify Step-Costing Change Points

A typical problem for anyone constructing a budget is to determine when step-costing points occur. A step-cost is a block of additional expenses that must be added when a certain level of activity is reached. For example, machinery can only operate at a reasonable capacity level, perhaps 75 percent, before another machine must be added to cope with more work, even if that workload will only fill the machine at a very low level of capacity. The same principle applies to adding personnel or building space. In all cases, there is a considerable added expense that must be incurred in one large block. If the expense is sufficiently large, it can play havoc with the total level of expenses. Or, in the case of a really large capital purchase, it may leave no room for other capital purchases for the next year. Accordingly, it is necessary to keep close track of step-cost change points.

The best way to determine when an increase in step-costs will occur is to create a table of activity measures that directly relates to each step-cost. For example, a new shipping person is needed for every 135 pallets of product shipped per day. By relating sales for the next year to the number of pallet loads of shipments, one can reasonably predict when an additional shipper is needed. Similarly, if a piece of production machinery will support $1 million of sales, ...