Topic:

Cost Behavior
Learning Objective 1

Classify costs by their

behavior as:
variable costs
fixed costs or
mixed costs.
 Variable Costs

A variable cost is a cost whose

total amount varies in
proportion to changes in the
level of activity.
 True Variable Cost

Direct materials is a true or proportionately

variable cost because the amount used during
a period will vary in direct proportion to the
level of production activity.
Cost

Volume
Example of Variable Cost: Cool Music Company
produces stereo sound systems. The parts for the
Cool Music stereos is P400 per unit.
Number of Cost per
Units Unit Total Cost

50 P400 P20,000
100 P400 40,000
300 P400 120,000
1,000 P400 120,000

5
Summary of Variable Cost Behavior

Cost In Total Per Unit

Variable Total variable cost is Variable cost per unit remains
proportional to the activity the same over wide ranges
level within the relevant range. of activity.
 Fixed Costs
Costs that remain the same,
in total amount, when
production level increase or
decrease.

7
Illustration: The production supervisor for Infinity
Perfume is paid P360,000 per year. The plant produces
from 50,000 to 300,000 bottles of perfume.
Number of Salary per
Bottles Total Salary Bottle
50,000 P360,000 P7.20

100,000 360,000 3.60

150,000 360,000 2.40
300,000 360,000 1.20
 Summary
SummaryofofFiof
Summary FixxededFixed
Cost
CostBehavioorr
BehaviCost
Cost
Cost InInTotal
Total PerPerUniUnit t

Total
Totalfxed fxedcostcostremai
remainnssthethe
same
sameeven evenwhenwhenthetheactiactivivtyity FiFixedxedcost
costperperuniunit goest goes
FiFixedxed lelvelevelchanges
changeswiwithithinnthethe down
downasasactiactivivtyitylelvelevelgoes
goesup.up.
relrelevant
evantrange.
range.
9
 Types of Fixed Costs

Committed
Committed Discretionary
Discretionary
Long-term,
Long-term, cannot
cannot bebe May
May be
be altered
altered in
in the
the
significantly
significantly reduced
reduced short-term
short-term byby current
current
in
in the
the short-term.
short-term. managerial
managerial decisions
decisions

Examples
Examples Examples
Examples
Depreciation
Depreciation on
on Advertising
Advertising and
and
Buildings
Buildings and
and Research
Research and
and
Equipment
Equipment and
and Development,
Development,
Real
Real Estate
Estate Taxes
Taxes Security
Security Guard
Guard
 Mixed Costs (Semi Variable or
Semi Fixed Cost)

A mixed cost has both fixed and variable

components. Consider your utility costs.
Y
Total Utility Cost

ost
dc
i xe
ta lm
To Variable
Cost per KW

X Fixed Monthly
Activity (Kilowatt Hours) Utility Charge
Mixed Costs, continued

Y
Total Utility Cost

ost
dc
i xe
ta lm
To Variable
Cost per KW

X Fixed Monthly
Activity (Kilowatt Hours) Utility Charge
Illustration of Mixed Cost:

IfIf your
your fixed
fixed monthly
monthly utility
utility charge
charge is
is
P500,
P500, your
your variable
variable cost
cost isis P0.50
P0.50 per
per
kilowatt
kilowatt hour,hour, and
and your
your monthly
monthly activity
activity
level
level is is 2,000
2,000 kilowatt
kilowatt hours,
hours, thethe amount
amount
of
of your
your utility
utility bill
bill is:
is:

Y = a + bX
Y = $500 + ($0.50 2,000)
Y = $1,500
Mixed Costs:
Fixed Costs and Relevant Range

90
Thousands of Dollars

Total
Total cost
cost doesnt
doesnt
Relevant
Rent Cost in

change
change forfor aa wide
wide
60 Range range
range ofof activity,
activity, and
and
then
then jumps
jumps to to aa new
new
higher
higher cost
cost for
for the
the
30 next
next higher
higher range
range ofof
activity.
activity.
0
0 1,000 2,000 3,000
Rented Area (Square Feet)
Mixed Costs:
Fixed Costs and Relevant Range
The relevant range of activity for a fixed
cost is the range of activity over which
the graph of the cost is flat.

Example: Office space is available at a

rental rate of $30,000 per year in
increments of 1,000 square feet. As the
business grows, more space is rented,
increasing the total cost.
Summary of Cost Behavior Patterns
Determining Cost Behavior Patterns in IS
Sales 10,000
Cost of GoodsSold
Direct materials VC 3,000
Direct labor VC 2,000
Factoryoverhead VC FC 2,500
Cost of GoodsSold 7,500
GrossProfit 2,500

Less: OperatingExpenses
Sellingexpenses VC FC 500
Administrativeexpenses VC FC 600
General expenses VC FC 700
Total Expenses 1,800
Net Income 700
Quiz: Determine the Cost Behavior Pattern
of the following F/O Costs:

1. Depreciation computed on straight line.

2. Indirect materials.
3. Property taxes.
4. Electricity.
5. Insurance on factory building.
6. Electricity to light the factory building.
7. Depreciation computed on units of production.
8. Electricity to run machineries.
9. Indirect labor
10. Salary of forklift operator
Quiz: Determine the Cost Behavior Pattern
of the following F/O Costs:

1. Depreciation computed on straight line. FC

2. Indirect materials. VC
3. Property taxes. FC
4. Electricity. MC
5. Insurance on factory building. FC
6. Electricity to light the factory building. MC
7. Depreciation computed on units of production. VC
8. Electricity to run machineries. VC
9. Indirect labor VC
10. Salary of forklift operator MC
Methods of Analyzing
Mixed Cost
Methods of Analyzing Mixed Cost

Observation Method or Account Analysis

Method - relies heavily on the ability of an
observer to detect a pattern of cost behavior
by reviewing past cost and volume data.

Mathematical Method due to increasing

emphasis on quantifying business data and
the availability of information technology.
Three Types of Mathematical Methods:

1. High Low Method

2. Scattergraph Method

3. Least Squares
Regression Method
High Low Method
High-Low Method compares a high
production volume and its related cost to a
low production volume with its related cost.
High Low Method, continued
High Low Method, continued
High Low Method, continued
Quick Check

Sales
Sales salaries
salaries and
and commissions
commissions are
are $10,000
$10,000
when
when 80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 when
when
120,000
120,000 units
units are
are sold.
sold. Using
Using the
the high-low
high-low
method,
method, what
what is
is the
the variable
variable portion
portion of
of sales
sales
salaries
salaries and
and commission?
commission?
a.
a. $0.08
$0.08 per
per unit
unit
b.
b. $0.10
$0.10 per
per unit
unit
c.
c. $0.12
$0.12 per
per unit
unit
d.
d. $0.125
$0.125 per
per unit
unit
Quick Check

Sales
Sales salaries
salaries and
and commissions
commissions are
are $10,000
$10,000
when
when 80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 when
when
120,000
120,000 units
units are
are sold.
sold. Using
Using the
the high-low
high-low
method,
method, what
what is
is the
the variable
variable portion
portion of
of sales
sales
salaries
salaries and
and commission?
commission?
a.
a. $0.08
$0.08 per
per unit
unit
Units Cost
b.
b. $0.10
$0.10 per
per unit
unit High level 120,000 $ 14,000
c.
c. $0.12
$0.12 per
per unit
unit Low level 80,000 10,000
Change 40,000 $ 4,000
d. $0.125 per unit
d. $0.125 per unit
$4,000 40,000 units
= $0.10 per unit
Quick Check

Sales
Sales salaries
salaries and
and commissions
commissions are are $10,000
$10,000
when
when 80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 when
when
120,000
120,000 units
units are
are sold.
sold. Using
Using the
the high-low
high-low
method,
method, what
what is
is the
the fixed
fixed portion
portion of
of sales
sales
salaries
salaries and
and commissions?
commissions?
a.
a. $$ 2,000
2,000
b.
b. $$ 4,000
4,000
c.
c. $10,000
$10,000
d.
d. $12,000
$12,000
Quick Check

Sales
Sales salaries
salaries and
and commissions
commissions are are $10,000
$10,000
when
when 80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 when
when
120,000
120,000 units
units are
are sold.
sold. Using
Using the
the high-low
high-low
method,
method, what
what is
is the
the fixed
fixed portion
portion of
of sales
sales
salaries
salaries and
and commissions?
commissions?
a.
a. $$ 2,000
2,000
b.
b. $$ 4,000
4,000
c.
c. $10,000
$10,000
d.
d. $12,000
$12,000
Scattergraph
Method
 The Scattergraph Method

Plot
Plot the
the data
data points
points on
on aa graph
graph
Y (total
(total cost
cost vs.
vs. activity).
activity).
20
Maintenance Cost

* * * ** *
(In 000s)

**
10 * *

0 X
0 1 2 3 4
Patient-days in 1,000s
 The Scattergraph Method, continued

Draw
Draw aa line
line
through
through thethe
Y
data
data points
points
20
Maintenance Cost

* * * ** * with
with about
an
about
an equal
equal
(In 000s)

** number
number of
10 * * points
points above
of
above
and
and below
below
the
the line.
line.
0 X
0 1 2 3 4
Patient-days in 1,000s
 The Scattergraph Method, continued

Use
Use oneone
Y Total maintenance cost = $11,000 data
data point
point
20 to
to estimate
estimate
Maintenance Cost

* ** *
1,000s of Dollars

the
the total
total
* *
** level
level of
of
10 * * activity
activity
Intercept = Fixed cost: $10,000 and
and the
the
0 X
total
total cost.
cost.
0 1 2 3 4
Patient-days in 1,000s
Patient days = 800
 The Scattergraph Method, continued

Make
Make aa quick
quick estimate
estimate of
of variable
variable cost
cost per
per
unit
unit and
and determine
determine the
the cost
cost equation.
equation.

$1,000
Variable cost per unit = = $1.25/patient-day
800

Y
Y == $10,000
$10,000 ++ $1.25X
$1.25X

Total
Total maintenance
maintenance cost
cost Number
Number of
of patient
patient days
days
 Least Squares
Regression Method
 Least-Squares Regression Method

AA method
method used
used toto analyze
analyze mixed
mixed costs
costs ifif aa
scattergraph
scattergraph plot
plot reveals
reveals an
an approximately
approximately linear
linear
relationship
relationship between
between the
the X
X and
and Y
Y variables.
variables.

This
This method
method uses
uses all
all of
of the
the
data
data points
points to
to estimate
estimate
the
the fixed
fixed and
and variable
variable
cost
cost components
components of of aa The
The goal
goal ofof this
this method
method is is
mixed
mixed cost.
cost. to
to fit
fit aa straight
straight line
line to
to the
the
data
data that
that minimizes
minimizes the the
sum
sum of of the
the squared
squared errors
errors..
Least-Squares Regression Method, continued
Software can be used to fit a
regression line through the
data points.
The cost analysis objective is
the same:
Y = a + bX
The
The output
output from
from the
the regression
regression analysis
analysis can
can be
be used
used
to
to create
create an
an equation
equation that
that enables
enables you
you to
to estimate
estimate
total
total costs
costs at
at any
any activity
activity level.
level.
Least-squares regression also provides a statistic, called the
R22, which is a measure of the goodness
of fit of the regression line to the data points.
Example: Simple Regression Analysis

Matrix,
Matrix, Inc.
Inc. wants
wants to
to
know
know itsits average
average
fixed
fixed cost
cost and
and
variable
variable cost
cost per
per unit.
unit.
Using
Using the
the data
data to
to the
the
right,
right, let
letss see
see how
how toto
do
do aa regression
regression using
using
Microsoft
Microsoft Excel.
Excel.
Example: Simple Regression Analysis, continued

You
You will
will need
need three
three pieces
pieces of
of
information
information fromfrom your
your
regression
regression analysis:
analysis:
1.
1. Estimated
Estimated Variable
Variable Cost
Cost Per
Per
Unit
Unit (line
(line slope)
slope)
2.
2. Estimated
Estimated Fixed
Fixed Costs
Costs (line
(line
intercept)
intercept)
3.
3. Goodness
Goodness of of fit,
fit, or
or R
R22

To
To get
get these
these three
three
pieces
pieces information
information
we
we will
will need
need to
to use
use
three
three Excel
Excel functions.
functions.
SLOPE,
SLOPE, INTERCEPT,
INTERCEPT, and
and
RSQ
RSQ
Example: Simple Regression Analysis, continued

Place
Place your
your cursor
cursor in in
cell
cell F4
F4 and
and press
press the the
== key.
key. Click
Click on
on the the
pull
pull down
down menu
menu and and
scroll
scroll down
down toto More
More
Functions
Functions .. .. ..
Example: Simple Regression Analysis, continued

Scroll
Scroll down
down toto the
the
Statistical
Statistical,,
functions.
functions. Now
Now
scroll
scroll down
down thethe
statistical
statistical
functions
functions until
until you
you
highlight
highlight SLOP
SLOP
EE
Example: Simple Regression Analysis, continued

1. In the Known_ys box, enter C4:C19 for the range.

2. In the Known_xs box, enter D4:D19 for the range.
Example: Simple Regression Analysis, continued

Here is the
estimate of the
slope of the line.

1. In the Known_ys box, enter C4:C19 for the range.

2. In the Known_xs box, enter D4:D19 for the range.
Example: Simple Regression Analysis, continued

With
With your
your cursor
cursor in in
cell
cell F5,
F5, press
press the
the ==
key
key and
and gogo to
to the
the pull
pull
down
down menu
menu forfor
Special
Special Functions.
Functions.
Select
Select Statistical
Statistical and
and
scroll
scroll down
down to to
highlight
highlight the
the
INTERCEPT
INTERCEPT function.
function.
Example: Simple Regression Analysis, continued

Here is the
estimate of the
fixed costs.

1. In the Known_ys box, enter C4:C19 for the range.

2. In the Known_xs box, enter D4:D19 for the range.
Example: Simple Regression Analysis, continued

Finally,
Finally, we we will
will
determine
determine the the
goodness
goodness of of
fit
fit,, or
or R
R22,, by
by
using
using the the RSQ
RSQ
function.
function.
Example: Simple Regression Analysis, continued

Here is the
estimate of R2.

1. In the Known_ys box, enter C4:C19 for the range.

2. In the Known_xs box, enter D4:D19 for the range.
Comparing Results From the Three Methods

The
The three
three methods
methods just
just discussed
discussed provide
provide
slightly
slightly different
different estimates
estimates ofof the
the fixed
fixed and
and
variable
variable cost
cost components
components of of the
the mixed
mixed cost.
cost.
This
This is
is to
to be
be expected
expected because
because each
each method
method
uses
uses different
different amounts
amounts of
of the
the data
data points
points to
to
provide
provide estimates.
estimates.
Least-squares
Least-squares regression
regression provides
provides the
the most
most
accurate
accurate estimate
estimate because
because itit uses
uses all
all of
of the
the
data
data points.
points.
Questions and Answers