MA -Cost Behavior
Mendoza MV
A. Cost behavior is defined as the way in which total cost behaves, or changes, when
some measure of activity changes. Activities that cause total cost to change are
referred to as cost drivers.
1. Relevant Range – the range of activity over which we expect our assumptions
about cost behavior to hold true.
2. Variable Costs – change in total in direct proportion to changes in activity.
Although total variable costs change with activity, variable cost per unit remains
constant.
3. Fixed Costs– remain the same in total regardless of activity level. On a per unit
basis, however, fixed costs decrease with increases in activity levels because fixed
cost is spread over more units.
4. Step Costs– are fixed over a range of activity and then increase in a step-like
fashion.
a. Step-variable costs tend to be fixed over a fairly narrow range of activity and
rise in multiple steps across the relevant range.
b. Step-fixed costs are fixed over a much wider range of activity than stepvariable costs.
5. Mixed Costs– also known as semivariable costs, have both a fixed and a
variable component.
a. The fixed portion represents the base amount that will be incurred regardless
of activity.
b. The variable cost is the amount that is based on activity or usage.
B. Linear Approach to Analyzing Mixed Costs
1. Three methods are used to analyze mixed costs: the scattergraph, the high-low
method, and least-squares regression.
2. All three methods are based on the linearity assumption or the assumption that
the relationship between total cost and activity can be approximated by a straight
line, as shown in the following formula:
Y= a + bX
a. The dependent variable, Y, represents total cost.
b. The independent variable or cost driver, X, is the activity that causes Y to
change.
c. Total fixed cost, a, is the amount that will be incurred regardless of activity.
This term is also called the intercept or the constant.
d. The variable cost per unit of X, b, indicates how much total cost will change
as activity changes. It represents the slope of the total cost line.
Contribution Margin Approach Income Statement
A. The contribution margin income statement is appropriate only for use by internal
management.
B. Instead of differentiating between manufacturing (product) and nonmanufacturing
(period) costs, a contribution margin income statement is based on cost behavior.
C. On the contribution margin income statement, variable costs are deducted from sale
revenue to get contribution margin and then fixed costs are subtracted to arrive at
operating income.
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D. Contribution margin is the difference between sales revenue and variable costs. It
represents the amount of sales revenue that is left, after variable costs have been
covered, to contribute to fixed costs and profit.
Contribution margin = Sales revenue – Total variable cost
E. The contribution margin income statement provides a tool for managers to do “whatif” analysis, i.e.., to analyze what will happen to profit if something changes.
F. Unit contribution margin is the difference between sales price per unit and variable
cost per unit.
Contribution margin per unit = Sales price per unit – Variable cost per unit
Advantages of the Contribution Approach. There are a number of advantages to using
variable costing (and the contribution approach) in internal reports and analysis.
1. More useful for CVP analysis. Variable costing statements provide data that are
immediately useful for CVP analysis since they categorize costs on the basis of their
behavior.
2. Income is not affected by changes in production volume. Under absorption costing,
reported net income is affected by changes in production since fixed costs are spread
across more or fewer units. This can distort income and may even result in income
moving in an opposite direction from sales. This does not occur under variable costing.
3. Avoids misunderstandings concerning unit product costs. Absorption costing unit
product costs can be easily misinterpreted as variable costs since they are stated on
a per unit basis. Such a misperception can lead to serious errors in making decisions.
Variable costing avoids this problem since unit costs include only variable costs.
4. Fixed costs are more visible. The impact of fixed costs on profits is emphasized
because the total amount of such costs for the period appears separately and is
highlighted in the income statement rather than being buried in cost of goods sold and
ending inventory.
5. Understandability. Managers may find it easier to understand variable costing reports
because data are organized by behavior and because variable costing is much closer
to a cash flow concept.
6. Control is facilitated. Variable costing ties in with cost control methods such as flexible
budgets.
7. Incremental analysis is more straight-forward. Variable cost corresponds closely with
the current out-of-pocket expenditure necessary to produce and sell products and
services and can therefore be used more readily in incremental analysis than
absorption costing data. And since variable costing net income is closer to net cash
flow than absorption costing net income, it is likely to be more useful to companies
that have cash flow problems.
EXERCISES
Exercise 1. Below is an examination of Marlow Co. financial data. Labor hours
and production costs for its sole product O for the last four months of the
year were given below:
Months
September
October
November
December
Labor Hours
25
35
45
35
1. High-Low Point Method
2. The Scatter Graph Method
Total Production Costs
P 200
250
300
250
3. The Regression Analysis Method
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Answer:
1. High-Low Point Method
High and Low: 45-25 = 20
Prod Cost: 300-200 = 100
Per Cost:
5 variable cost
Fixed Content 45*5 is 225 -300 is 75 Total Fixed Content
2. Scatter Graph Method
3. Regression Analysis Method
Exercise 2. Hubert Company gathered the following information on power costs and
factory machine usage for the last six months:
Month
January
February
March
April
May
June
Power Cost
P24,400
31,300
29,000
22,340
19,900
14,800
Machine Hours
13,900
17,600
16,800
13,200
11,600
6,600
Instructions
Using the high-low method of analyzing costs, answer the following questions
and show computations to support your answers.
(a) What is the estimated variable portion of power costs per factory machine hour?
(b) What is the estimated fixed power cost each month?
(c) If it is estimated that 10,000 factory machine hours will be run in July, what is the
expected total power costs for July?
Exercise 3. Linda Company needs to determine the variable utilities rate per machine
hour in order to estimate cost for August. Relevant information is as follows.
Month MH worked Utilities
Cost
April
4,500
P9,560
May
4,200
9,440
June
6,500
10,725
July
7,000
11,400
Lewis anticipates producing 5,000 units in August, each unit requiring 1.5 hours of
machine time. The company uses the high-low method to analyze costs.
Required:
A. Calculate the variable and fixed components of the utilities cost.
B. Using the data calculated above, estimate the utilities cost for August.
Exercise 4. Cardo Company reports the following data for the first four months of the year:
Machine Electrical
Month
Hours
Cost
January
300
P30
February
400
P50
March
300
P40
April
200
P30
Using the least-squares regression method, determine the cost-predicting equation.
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MULTIPLE CHOICE
1. The following data relate to the Hopes Company for May and August of the
current year:
Maintenance hours
Maintenance cost
May
10,000
P260,000
August
12,000
P300,000
May and August were the lowest and highest activity levels, and Hodges uses
the high-low method to analyze cost behavior. Which of the following statements
is true?
A. The variable maintenance cost is P25 per hour.
B. The variable maintenance cost is P25.50 per hour.
C. The variable maintenance cost is P26 per hour.
D. The fixed maintenance cost is P60,000 per month.
2. Atlanta, Inc., which uses the high-low method to analyze cost behavior, has
determined that machine hours best explain the company's utilities cost. The
company's relevant range of activity varies from a low of 600 machine hours to a high of
1,100 machine hours, with the following data being available for the first six months of
the year:
Month
Utilities
Machine
Hours
January
P8,700
800
February
8,360
720
March
8,950
810
April
9,360
920
May
9,625
950
June
9,150
900
Using the high-low method, the utilities cost associated with 980 machine hours would
be:
A. P9,510.
B. P9,660.
C. P9,700.
D. P9,790.
3.
Hitchcock, Inc., uses the high-low method to analyze cost behavior. The
company observed that at 12,000 machine hours of activity, total maintenance costs
averaged P7.00 per hour. When activity jumped to 15,000 machine hours, which was
still within the relevant range, the average cost per machine hour totaled P6.40. On the
basis of this information, the variable cost per machine hour was:
A. P4.00.
B. P6.40.
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C. P6.70.
D. P7.00.
End
“The fear of God is the beginning of wisdom”…….
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