Chapter 3
Measurement of
Cost Behavior
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Learning Objective 1
Explain step- and
mixed-cost behavior.
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Linear-Cost Behavior
Linear-cost behavior can be graphed with
a straight line when a cost changes
proportionately with changes
in a single cost driver.
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Relevant Range
Relevant Range
The relevant range specifies the limits of
cost-driver activity within which a specific
relationship between a cost and its cost
driver will be valid.
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Step- and Mixed-Cost
Behavior Patterns
A purely variable cost varies in
proportion to the selected cost driver.
A purely fixed cost is not affected
by the cost-driver level.
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Step- and Mixed-Cost
Behavior Patterns

1
2
In addition to these pure versions of cost,
two additional types of costs combine
characteristics of both fixed- and variablecost behavior.
Step costs
Mixed costs
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Step Costs

Step costs change
abruptly at intervals
of activity because
the resources and
their costs come in
indivisible chunks.
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Step Costs
A. Lease Cost
Relevant
Range
Actual Cost
Behavior
Fixed Cost
Approximation
Oil and Gas Exploration Activity
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Step Costs
B. Supermarket Checker Wage Cost
Relevant Range
Actual Cost
Behavior
Variable
Cost
Approximation
40
Shoppers per Hour
440
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Step Costs
The total step cost at a level of activity is
the amount of fixed cost appropriate for the
range containing that activity level.
 When the steps are relatively small, the step
cost behaves much like a variable cost and
could be used as such for planning with
little loss of accuracy.

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Mixed Costs
Mixed costs contain elements of both fixedand variable-cost behavior.
 Unlike step costs, there is usually only one
relevant range of activity and one level of
fixed costs in a mixed cost.

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Facilities Maintenance
Department Cost
Mixed Costs
Relevant Range
$5.00 per
Patient Day
Total
Variable
Cost
$10,000
Fixed
Cost
1,000
5,000
Number of Patient-Days per Month
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Learning Objective 2
Explain management influences
on cost behavior.
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Product and Service Decisions
and the Value Chain
Managers influence cost behavior.
Choice of process and product design
Quality levels
Distribution
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Capacity Decisions
What are capacity costs?
 Capacity costs are the fixed costs of being
able to achieve a desired level of production
or to provide a desired level of service.

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Committed Fixed Costs
Committed fixed costs usually arise from
the possession of facilities, equipment,
and a basic organization.
 These are large, indivisible chunks of cost
that the organization is obliged to incur or
usually would not consider avoiding.

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Discretionary Fixed Costs
Discretionary fixed costs are costs fixed at
certain levels only because management
decided that these levels of cost should be
incurred to meet the organization’s goals.
 These discretionary fixed costs have no
obvious relationship to levels of output
activity but are determined as part of the
periodic planning process.

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Discretionary Fixed Costs
Each planning period, management will determine
how much to spend on discretionary items.
These costs then become fixed until the next
planning period.
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Examples of
Discretionary Fixed Costs
What are some examples?
Employee training programs
Advertising and promotion
Research and development
Charitable donations
Public relations
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Cost-Control Incentives
Managers use their knowledge of cost behavior to
set cost expectations.
Employees may receive rewards that are tied to
meeting these expectations.
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Learning Objective 3
Measure and mathematically
express cost functions and
use them to predict costs.
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Cost Functions
The first step in estimating or predicting
costs is measuring cost behavior as a
function of appropriate cost drivers.
 The second step is to use these cost
measures to estimate future costs at
expected, future levels of cost-driver
activity.

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Cost Function Equation
Y = Total cost
F = Fixed cost
V = Variable cost per unit
X = Cost-driver activity in number of units
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Cost Function Equation
Mixed Cost Function:
Y = F + VX
The mixed-cost function is called a
linear-cost function.
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Criteria for Choosing Functions
Plausibility
The cost function must be believable.
Reliability
A cost function’s estimates of costs at levels
of activity must reliably conform
to actually observed costs.
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Learning Objective 4
Describe the importance
of activity analysis for
measuring cost functions.
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Choice of Cost Drivers:
Activity Analysis
Choosing a cost function starts
with choosing cost drivers.
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Choice of Cost Drivers:
Activity Analysis
Managers use activity analysis to identify
appropriate cost drivers.
 Activity analysis is especially important for
measuring and predicting costs for which
cost drivers are not obvious.

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Choice of Cost Drivers:
Activity Analysis
What are some cost drivers?
Direct labor hours
Machine hours
Units of sales
Transactions
Work cells
Order size
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Methods of Measuring
Cost Functions
–
–
–
–
–
Engineering analysis
Account analysis
High-low analysis
Visual-fit analysis
Least-squares regression analysis
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Engineering Analysis
Engineering analysis entails a systematic
review of materials, supplies, labor, support
services, and facilities needed for products
and services.
 It measures cost behavior according to what
costs should be, not by what costs have
been.

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Learning Objective 5
Measure cost behavior using the
account analysis, high-low,
visual-fit, and least-squares
regression methods.
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Account Analysis
The simplest method of account analysis
selects a volume-related cost driver
and classifies each account as a
variable or fixed cost.
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High-Low Method
This method selects the lowest and the
highest activity levels.
 These levels should be within the relevant
range.
 The costs chosen should represent the
normal cost incurred at these levels.

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High-Low Method Example
High capacity January: 55,000 machine hours
Cost of electricity $80,450
Low capacity September: 30,000 machine hours
Cost of electricity: $64,200
What is the variable rate?
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High-Low Method Example
($80,450 – $64,200)
$16,250 = .65
=
(55,000 – 30,000)
25,000
What is the fixed cost
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High-Low Method Example
$80,450 = Fixed cost + 55,000($ 0.65)
$80,450 – $35,750 = $44,700
$64,200 = Fixed cost + 30,000($0.65)
$64,200 – $19,500 = $44,700
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Visual-Fit Method

In the visual-fit method, the cost analyst
visually fits a straight line through a plot of
all of the available data, not just between
the high point and the low point, making it
more reliable than the high-low method.
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Least-Squares Regression
Method
Regression analysis measures a cost
function more objectively by
using statistics to fit a cost
function to all the data.
Regression analysis usually measures
cost behavior more reliably than
other cost measurement methods.
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Coefficient of Determination
One measure of reliability, or goodness of
fit, is the coefficient of determination, R²
(or R-squared).
 The coefficient of determination measures
how much of the fluctuation of a cost is
explained by changes in the cost driver.

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Learning Objective 6
Understand the relationship
between management
decision making and
cost behavior.
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Management Decision Making
and Cost Behavior
Understanding cost behavior provides
managers with valuable insights about
how cost will respond to managers’
decisions as well as to outside influences.
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End of Chapter 3
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