Chapter 5
Cost Behavior
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Cost Behavior Patterns
Cost behavior describes the way total cost behaves,
or changes, when some measure of activity changes.
The range of activity within which
assumptions about cost behavior
hold true is the relevant range.
Unit variable costs
remain unchanged.
Total fixed costs
remain unchanged.
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Learning Objective 5-1
Identify costs as variable, fixed, step,
or mixed.
5- 4
Variable Costs
Total variable costs
increase as
activity increases.
Variable cost per unit is
constant as
activity increases.
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Fixed Costs
Total fixed costs
remain constant as
activity increases.
Cost per cup
declines as
activity increases.
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Cost Behavior Summary
Cost
Variable
Fixed
In Total
Per Unit
Changes proportionately
with changes in activity
within the relevant range.
Remains constant for each
additional unit as long as
activity is in the relevant
range.
Remains the same even
when activity changes
within the relevant range.
The per unit amount
changes each time the
level of activity changes
due to the fixed nature of
the related costs.
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Step Costs
Step-variable costs
rise in multiple steps
across the relevant range.
Step-fixed costs are fixed
over a fairly wide range of
activities.
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Mixed Costs
Total Utility Cost
Mixed costs contain a fixed portion that is incurred even when the
facility is unused, and a variable portion that increases with
usage. Utilities typically behave in this manner.
Variable
Cost per KW
Activity (Kilowatt Hours)
Fixed Monthly
Utility Charge
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Mixed Costs
Total mixed costs
increase as
activity increases.
Per unit mixed costs
decrease as
activity increases.
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Linear Approaches to Analyzing Mixed Costs
a = total fixed cost, an amount that will be
incurred regardless of the activity level,
and is called the intercept or the constant.
b = the slope of the line, the unit variable cost,
which tells us how much the total cost (y) will
increase for each unit increase in activity (x).
x = the activity that causes total cost (y) to
change. Activity (x) is also called the cost
driver, or the independent variable.
y = Total Costs
y = total cost, which is plotted on the vertical
axis, and is called the dependent variable.
a = Intercept
x = Activity
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Linear Approaches to Analyzing Mixed Costs
There are three different methods to analyze mixed costs, all using the
linear assumption as a base.
1.Scattergraph: A graph that provides a visual representation of the
relationship between total cost (y) and activity level (x). A scattergraph
is a useful first step in analyzing cost behavior because it helps
determine the nature of the relationship and whether the linearity
assumption is valid.
2.High-low method: A simple approach that uses the two most
extreme data points to determine the slope of the line (variable cost
per unit) and the intercept (total fixed cost).
3.Least-squares regression: A statistical technique for finding the best
fitting line based on historical data. The slope of the line provides an
estimate of the variable cost per unit, while the intercept provides an
estimate of the total fixed cost.
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Learning Objective 5-2
Prepare a scattergraph to illustrate
the relationship between total cost
and activity.
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Scattergraph
A scattergraph is a graph with total cost plotted on
the vertical (Y) axis and some measure of activity on
the horizontal (X) axis.
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Preparing a Scattergraph
A scattergraph can be created by manually plotting data points on
graph-paper, or by using a the following steps in Excel:
1. Enter the data in Excel, and highlight the data that you want to plot.
2. Select the Chart Wizard from the toolbar.
3. Select XY (Scatter) as the chart type. Be sure total cost is on the
Y axis, with the activity driver on the X axis.
4. Add a chart title and labels for the X and Y axes.
To apply these steps, consider the
following data showing the total
overhead cost (Y)
of running our hypothetical
Starbucks location, along with the
number of customers
served (X).
January
February
March
April
May
June
Customers
Served (X)
9,000
15,000
12,500
6,000
5,000
10,000
Total OH
Cost (Y)
$
15,000
15,750
16,000
12,500
13,250
13,000
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Preparing a Scattergraph
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Learning Objective 5-3
Use the high-low method to analyze
mixed costs.
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High-Low Method
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High-Low Method
Total Fixed Cost
=
_
Total Cost
Variable Cost per Unit × Activity
February Estimate
Total Fixed Cost
=
$15,750
=
Total Fixed Cost
=
Total Fixed Cost
$13,250
=
$0.25 × 15,000
$12,000
May Estimate
Total Fixed Cost
_
_
$0.25 × 5,000
$12,000
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High-Low Method
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Learning Objective 5-4
Use least-squares regression to
analyze mixed costs.
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Least-Squares Regression Method
A statistical method used to analyze mixed costs.
18,000
16,000
} Error
Total Overhead Cost
14,000
12,000
10,000
8,000
6,000
4,000
2,000
-
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
Customers Served
The goal of this method is to minimize the sum of the squared errors.
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Least-Squares Regression Method

Software such as Excel
can be used to fit a
regression line through the
data points.

The cost analysis objective
is the same:
y = a + bx
The output from the regression analysis can be
used to create an equation that enables you to
estimate total costs at any activity level.
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Least-Squares Regression Method
5- 24
Least-Squares Regression Method
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.802489134
R Square
0.643988811
Adjusted R Square
0.554986013
Standard Error
1011.697667
Observations
6
ANOVA
Regression
Residual
Total
Intercept
Customers Served (X)
df
1
3
4
R2 tell us how closely we can
explain the relationship
between our two variables. In
our example, the number of
customers explains about
64% of the overhead costs.
SS
7405871.321
4094128.679
11500000
Coefficients Standard Error
11180.90017 1213.424073
0.320253895 0.11905759
The intercept and x
coefficient,
respectively, are
estimated total fixed
cost and variable
cost per unit.
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Least-Squares Regression Method
Total
Cost
=
Total Fixed
Cost
+
Total Variable Cost
(Variable Cost per Unit × X)
Using our regression output, if Starbucks expected to
serve 8,000 customers in July, we would estimate total
overhead costs as follows:
$0.32 × 8,000 =
$2,560
+
$11,181
=
$13,741
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Summary of Linear Methods
5- 27
Learning Objective 5-5
Prepare and interpret a contribution
margin income statement.
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Contribution Margin Approach
Contribution margin is the difference between sales
revenue and variable costs.
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Contribution Margin Ratio
Contribution Margin Formula
Contribution
Margin
=
Sales
Revenue
‒
Variable
Costs
Contribution Margin Ratio
Contribution
Margin Ratio
=
Contribution Margin
Sales Revenue
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Contribution Margin
Unit
contribution
margin
Contribution margin ratio
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Contribution Margin
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Supplement 5A
Variable Versus Full Absorption Costing
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 5-S1
Compare variable costing to full
absorption costing.
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Variable Versus Full Absorption Costing
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Reconciling Variable and
Full Absorption Costing
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Full Absorption Costing
Income Statement
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Variable Costing Income Statement
Variable costs only.
All fixed manufacturing overhead is expensed.
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Reconciling Variable and
Full Absorption Costing
Difference between Full
Absorption and Variable
Costing Income
$40,000
=
Change in Units in
Ending Inventory
(Production ‒ Sales)
×
Fixed Manufacturing
Overhead Cost per
Unit
=
2,000 units
×
$20 per unit
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Effect of Changes in Inventory Under Full
Absorption and Variable Costing
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End of Chapter 5
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