Dr. Bob’s 256 Notes, 5-1
CHAPTER 5
COST BEHAVIOR: ANALYSIS AND USE
CHAPTER 5 OBJECTIVES
 Behavior of variable and fixed costs
 Significance of the relevant range to cost behavior analysis
 Analysis of mixed costs
 Contribution format for income statements
I.
TYPES OF COST BEHAVIOR PATTERNS
 3 common cost behavior patterns
A.
Variable Costs
 Changes in total in proportion to changes in activity

 Examples
Merchandisers
Manufacturers
Service Organizations
B.
Fixed Costs
 Remains constant in total amount throughout wide ranges of activity





Examples
Merchandisers
Manufacturers
Service Organizations
Dr. Bob’s 256 Notes, 5-2
C.
Summary of Variable and Fixed Costs
Demo Problem: The data below pertain to the monthly production and sales of Como Company.
Fill in the blanks, assuming that all costs are divided into strictly fixed and strictly variable
elements.
Production
Level
Total Fixed Costs
Total Variable
Costs
5,000
$180,000
$120,000
Fixed Costs per
Unit
Variable Costs per
Unit
6,000
4,000
D.
Mixed Costs (a.k.a. Semi-Variable cost)
 Contains both variable and fixed cost elements
E.
Summary of these costs:
Variable Cost
Per Unit
In Total
Fixed Cost
Mixed Cost
Dr. Bob’s 256 Notes, 5-3
II.
ISSUES FOR COST BEHAVIOR PATTERNS
A.
Variable Costs
 Activity base
 A measure of the event causing the incurrence of a variable cost - a
_____________________________________
 Linearity Assumption & Relevant Range
B.




Fixed Costs
__________________ fixed costs
Long-term, cannot be reduced in the short-term
Can not be reduced to zero without seriously impairing profitability of long-run goals
Examples:
 ___________________ fixed costs
 Generally adjusted periodically (short-term) by management decisions
 Examples:
 Fixed Costs & Relevant Range
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.
Dr. Bob’s 256 Notes, 5-4
III.
ANALYSIS OF MIXED COSTS
A.
High-Low Method
 Focuses on the highest and lowest levels of activity
 To determine variable cost,
 Two major defects:
1-
2-
B.
Scattergraph Method
 Line is fitted to plotted points “by eye” using a ruler.
 Ordinarily better way of determining cost formula than the high-low method, because it
includes all of the observed cost data in the analysis.
C.
Least Squares Regression Method
 Line is fitted to points using mathematical formulas to minimized the sum of the squared
errors
 Much more precise & objective than scattergraph
 We’ll leave this topic to our BA201 friends.
Dr. Bob’s 256 Notes, 5-5
Demo Problem:
Kohler Company incurred shipping costs as follows over the past 8 months:
Month
January
February
March
April
May
June
July
August
Units Sold
6,000
5,000
7,000
9,000
8,000
10,000
12,000
11,000
Shipping Cost
$66,000
65,000
70,000
80,000
76,000
85,000
100,000
87,000
Using the high-low method, estimate the variable and fixed components:
Using the scattergraph method, estimate the variable and fixed components:
Dr. Bob’s 256 Notes, 5-6
INCOME STATEMENT – CONTRIBUTION FORMAT
IV.
A.
Traditional Approach
 Organized in a functional format (production, administration, sales)
 No attempt to identify the behavior of the costs under each functional heading
 Used for
B.
Contribution Approach
 Organizes costs by behavior (vs. function)
 Separates costs into variable and fixed (in that order)
 Determines the ________________________________________, computed as




Can be expressed as:
total dollars
per unit amount - typically used in single product environment
percentage of sales (CM ratio) - typically used in a multiple product environment
 Used for
C.
Illustration. RemCo. Reports the following account balances for the current year:
Sales
Cost of goods sold
Selling & admin. expenses
Sales
$100,000
70,000 (includes $10,000 of fixed factory overhead)
20,000 (includes $5,000 of fixed expenses)
Comparison of Traditional Format Income Statement
with Contribution Format Income Statement
Traditional Approach
Contribution Approach
$100,000 Sales
$100,000