Cost Behaviour
Examples of normally variable costs
Merchandisers
Service Organizations
Cost of Goods Sold
Supplies and travel
Manufacturers
Merchandisers and
Manufacturers
Direct Material, Direct
Labour, and Variable
Manufacturing Overhead
Sales commissions and
shipping costs
Examples of normally fixed costs
Merchandisers, manufacturers, and
service organizations
Real estate taxes, Insurance, Sales salaries
Depreciation, Advertising
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The Activity Base
Units
produced
Machine
hours
A measure of the event
causing the incurrence of a
variable cost – a cost driver
Kilometres
driven
Labour
hours
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Types of Fixed Costs
Fixed Costs
Committed
Discretionary
Long-term, cannot be
reduced in the short
term.
May be altered in the
short term by current
managerial decisions
Examples
Examples
Depreciation on
Buildings and
Equipment
Advertising and
Research and
Development
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Mixed Costs
A mixed cost
has both fixed and variable
components.
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Mixed Costs
Total Utility Cost
Y
Variable
Utility Charge
Fixed Monthly
X
Activity (Kilowatt Hours)
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Utility Charge
Mixed Costs
The total mixed cost line can be expressed
as an equation: Y = a + bX
Total Utility Cost
Y
Where:
Y = the total mixed cost
a = the total fixed cost (the
vertical intercept of the line)
b = the variable Variable
cost per unit of
activity (the
slopeCharge
of the line)
Utility
X = the level of activity
Fixed Monthly
X
Activity (Kilowatt Hours)
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Utility Charge
Mixed Costs
Total Utility Cost
Y
Variable
bX
Utility Charge
Fixed Monthly
a
X
Activity (Kilowatt Hours)
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Utility Charge
Example:
Lori Yang leases an
automated photo developer
for $2,500 per year plus 2¢
per photo developed.
Equation of a straight line: Y = a + bX
Y = $2,500 + $0.02X
So, Total mixed cost for 10,000 photos will be
$2,500+ ($0.02*10,000) =$2,700 Lease Cost
The Analysis of Mixed Costs
Account Analysis
Engineering Approach
High-Low Method
Scattergraph Method
Least-Square Regression Method
© 2008 McGraw-Hill Ryerson Limited.
The High-Low Method
WiseCo recorded the following production activity
and maintenance costs for two months:
High activity level
Low activity level
Change
Units
9,000
5,000
4,000
Cost
$ 9,700
6,100
$ 3,600
Using these two levels of activity, compute:
 the variable cost per unit;
 the fixed cost; and then
 express the costs in equation form Y = a + bX.
© 2008 McGraw-Hill Ryerson Limited.
The High-Low Method
High activity level
Low activity level
Change
 Unit variable cost =
Units
9,000
5,000
4,000
Cost
$ 9,700
6,100
$ 3,600
Change in cost
Change in units
© 2008 McGraw-Hill Ryerson Limited.
The High-Low Method
High activity level
Low activity level
Change
Units
9,000
5,000
4,000
Cost
$ 9,700
6,100
$ 3,600
 Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit
© 2008 McGraw-Hill Ryerson Limited.
The High-Low Method
High activity level
Low activity level
Change
Units
9,000
5,000
4,000
Cost
$ 9,700
6,100
$ 3,600
 Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit
 Fixed cost = Total cost – Total variable cost
Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)
Fixed cost = $9,700 – $8,100 = $1,600
© 2008 McGraw-Hill Ryerson Limited.
The High-Low Method
High activity level
Low activity level
Change
Units
9,000
5,000
4,000
Cost
$ 9,700
6,100
$ 3,600
 Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit
 Fixed cost = Total cost – Total variable cost
Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)
Fixed cost = $9,700 – $8,100 = $1,600
 Total cost = Fixed cost + Variable cost (Y = a + bX)
Y = $1,600 + $0.90X
© 2008 McGraw-Hill Ryerson Limited.
Quick Check 
If sales salaries and commissions are $10,000
when 80,000 units are sold and $14,000 when
120,000 units are sold, what is the variable
portion of sales salaries and commission?
A. $0.08 per unit
B. $0.10 per unit
C. $0.12 per unit
D. $0.125 per unit
© 2008 McGraw-Hill Ryerson Limited.
Quick Check 
If sales salaries and commissions are $10,000
when 80,000 units are sold and $14,000 when
120,000 units are sold, what is the fixed portion
of sales salaries and commissions?
A. $ 2,000
B. $ 4,000
C. $10,000
D. $12,000
© 2008 McGraw-Hill Ryerson Limited.
Note
• How does the high-low method work when you
have data for more than two periods?
March
April
Low May
June
High July
Patients
Admitted
2,510
2,550
2,480
2,590
2,670
Costs of
Admitting
$ 15,204
$ 14,976
$ 14,680
$ 15,108
$ 15,060
• Select the two periods with the lowest and
highest level of activity.
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The Scattergraph Method
Draw a line through the data points with about an
equal numbers of points above and below the line.
Total Cost in
1,000s of Dollars
Y
20
10
* *
* *
* ** *
**
0
X
0
1
2
3
4
Activity, 1,000s of Units Produced
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The Scattergraph Method
Total Cost in
1,000s of Dollars
The slope of this line is the variable unit
cost. (Slope is the change in total cost for
a one unit change in activity).
Y
20
10
* *
* *
* ** *
**
Estimated fixed cost = $10,000
0
X
0
1
2
3
4
Activity, 1,000s of Units Produced
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The Scattergraph Method
Slope =
Total Cost in
1,000s of Dollars
Y
20
10
* *
* *
Change in cost
Change in units
* ** *
**
Vertical
distance
is the
change
in cost.
Horizontal distance is
the change in activity.
0
X
0
1
2
3
4
Activity, 1,000s of Units Produced
© 2008 McGraw-Hill Ryerson Limited.
Least-Squares Regression
Method
• Software can be used to fit
a regression line through
the data points.
• The cost analysis objective
is the same: Y = a + bx
Least-squares regression also provides a statistic, called
the adjusted R2, that is a measure of the goodness
of fit of the regression line to the data points.
© 2008 McGraw-Hill Ryerson Limited.
Least-Squares Regression
Method
R2 is the percentage of the variation
in total cost explained by the activity.
Y
Total Cost
20
* *
* *2
10
0
0
* ** *
**
R for this relationship is near
100% since the data points are
very close to the regression line.
X
1
2
3
4
Activity
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Note
• Let’s plot the data for patient admitting costs.
Patient Admitting Costs
$15,400
$15,200
$15,000
$14,800
$14,600
$14,400
$14,200
$14,000
2,450
2,500
2,550
2,600
2,650
Patients Admitted
© 2008 McGraw-Hill Ryerson Limited.
2,700
Note
• Problems with the high-low method:
– Throws away information contained in all of the data
other than the low and the high points.
– The low and high levels of activity tend to be
unusual.
• You should always plot the data if you have
more than two points to make sure it even
makes sense to be using the high-low method.
© 2008 McGraw-Hill Ryerson Limited.
The Contribution Format
Sales Revenue
Less: Variable costs
Contribution margin
Less: Fixed costs
Net income
Total
$ 100,000
60,000
$ 40,000
30,000
$ 10,000
Unit
$ 50
30
$ 20
The contribution margin format emphasizes cost
behaviour. Contribution margin covers fixed costs
and provides for income.
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The Contribution Format
Used primarily for
external reporting.
Used primarily by
management.
© 2008 McGraw-Hill Ryerson Limited.