Management
Accounting: The
Cornerstone for
Business Decisions
Cost Behavior
Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.
Learning Objectives
1. Explain the meaning of cost behavior
and define and describe fixed and
variable costs.
2. Define and describe mixed and step
costs.
3. Separate mixed costs into their fixed
and variable components using the
high-low method, the scattergraph
method, and the least squares method.
Learning Objectives
4. (Appendix) Use a personal computer
spreadsheet program to perform the
method of least squares.
Match Definitions
Relevant
Range
A cost that does not change as
output changes
Cost
Behavior
The range of output over which the
assumed cost relationships are valid
for normal operations
Fixed Cost
Variable
Cost
Driver
A factor that changes or leads to a
change in a cost or activity
Whether a cost changes when the
level of output changes
A cost that changes in the same
direction as changes in output
Illustrate Relevant Range
Define Mixed and Step Costs
◙ Mixed Cost
◙ Has both a fixed and variable component
◙ Step Cost
◙ Has constant level of cost for a range of
output then jumps to a new higher cost for a
similar range of output
Mixed Cost
Step Cost
What is the cost formula?
Output
Total Cost = Fixed Cost + Variable Rate x
in
Units
◙ The dependent variable, depends on the
value of another variable. Here it is the
cost we want to predict. The independent
variable, the output, explains the change
in cost; the intercept is the fixed cost; and
the slope is the variable cost.
3-1
How to create and use a cost
formula.
The Accounting Department of State College
decided to attend the State Business Leaders of
Tomorrow Conference (SBLTC) to recruit new
students. They must rent a display table space
and have chosen to advertise in the program
for a total cost of $500. In addition every
student who enters the raffle receives a free
calculator that costs $0.50.
REQUIRED:
1. Create a cost formula for recruiting accounting
majors at SBLTC.
3-1
How to create and use a cost
formula.
Calculation: The cost formula takes the following
form Total Cost = Fixed cost + (Variable rate x
Number of students entering the raffle)
Fixed cost = $500 (Table rental and Advertisement)
since this does not vary based on the number of
student that enter the raffle.
Variable cost = The total cost of calculators does
vary with the number of students who enter the
raffle. Cost per entry = $0.50
The cost formula is:
Total Cost of SBLTC = $500 + ($0.50 x # of Entries)
3-1
How to create and use a cost
formula.
REQUIRED: 2. If the Accounting Department
expects to have 1,500 students enter the raffle at
the SBLTC, what is the expected fixed cost?
Total variable cost? Total conference cost?
Calculation:
Expected fixed cost for the SBLTC = $500
Expected variable cost for the SBLTC =
$0.50 x 1,500 = $750
Expected conference cost = $500 + $750 = $1,250
What are the 4 steps of the
High-Low Method?
1. Find the highest & lowest activity or output
points. (a) Subtract the cost associated with
the lowest activity point from the cost
associated with the highest activity point to
get the change in cost. (b) Subtract the lowest
activity from the highest activity to get the
change in activity.
2. Calculate the variable rate. Divide the change
in cost from part a by the change in activity
from part b.
What are the 4 steps?
3. Calculate the fixed costs. Set up the cost
formula. TC = FC + (VR x Activity)
Substitute the variable rate calculated
in step 2 into the formula. Pick the
information in the high or the low.
Substitute the cost into total cost and
the activity into activity. This leaves
fixed costs, solve for it.
4. Form the cost equation.
3-2
How to use the high-low
method.
BlueDenim makes jeans. The controller
has assigned you to calculate fixed costs,
variable rate and the cost formula
associated with the electricity rate with
the data collected in the last year.
REQUIRED: Using the high-low method
calculate the fixed cost of electricity,
calculate the variable rate of electricity
per machine hour, and construct the cost
formula for total electricity cost.
3-2
How to use the high-low
method.
Month
Electricity Cost
January
February
March
April
$
3,255
3,485
4,100
3,300
Machine Hours
High
460
500
600
470
May
June
July
3,312
2,575
3,910
470
350
570
August
September
October
4,200
2,514
3,485
590
340
500
Low
3-2
How to use the high-low
method.
Calculation:
Step 1: - Find the high and low points: The high
machine hours occurs in March and the low
occurs in September.
Step 2: - Calculate the variable rate:
variable rate = (high cost – low cost) / (high
activity – low activity)
=($4,100 - $2,514) / (600 – 340) = $1,586 / 260
=$6.10 per machine hour
3-2
How to use the high-low
method.
Step 3: – Calculate the fixed cost:
Fixed cost = total cost – (variable rate x machine
hours)
Let’s choose the low point with cost of $2,514 and
machine hours of 340.
Fixed costs = $2,514 – ($6.10 x 340) = $2,514 - $2,074
= $440
Step 4: - Construct a cost formula: If the variable rate
is $6.10 per machine hour and the fixed cost is $440
per month then the monthly cost formula for
electricity is
Total electricity cost = $440 + ($6.10 x machine hours)
3-3
Using the high-low method to
predict total variable and total cost
for budgeted output.
BlueDenim constructed the following cost formula
for electricity cost in Cornerstone 3-2
Total electricity cost = $440 + ($6.10 x machine
hours)
Assume that 620 hours are budgeted for the month
of October. Use the above cost formula for the
following calculations:
1. Calculate the total variable electricity cost for
October.
2. Calculate the total electricity cost for October.
3-3
The high-low method of
predicting total variable and total
cost for budgeted output.
Calculation:
1. Total variable electricity cost = variable
rate x machine hours = $6.10 x 620
= $3,782
2. Total electricity cost = fixed cost +
(variable rate x machine hours)
=$440 + ($6.10 x 620) = $440 + $3,782
=$4,222
3-4
Using the high-low method to
predict costs when the time period
differs from that of the data.
BlueDenim constructed the following:
Total electricity cost = $440 + ($6.10 x machine
hours)
Required: Assume that 7,200 machine hours are
budgeted for the next year. Use the above cost
formula to make the following calculations:
1. Calculate total variable electricity cost for the
year.
2. Calculate total fixed electricity cost for the year.
3. Calculate total electricity cost for the next year.
3-4
Using the high-low method to
predict costs when the time period
differs from that of the data
Calculation:
1. Total variable electricity cost = variable rate x
machine hours = $6.10 x 7,200 = 43,920
2. There’s a trick here; the cost formula is for the
month, but we are being asked to budget for the
year so we need to multiple the fixed cost for
month by 12 (number of months in a year). Total
fixed electricity cost = fixed cost x 12 months in a
year = $440 x 12 = $5,280
3. Total electricity cost = 12($440) + ($6.10 x 7,200)
= $5,280 + $43,920 = $49,200
Discuss the Scattergraph
Method
◙ It allows you to see if there is a
relationship between the data
◙ Cost goes on the vertical or Y axis and the
driver or output measure goes on the
horizontal or X axis
◙ After plotting the data points, draw a line
so about half the data points are above
and half the data points are below the
line.
Scattergraph Method
700
Overhead Cost
600
500
400
300
200
100
0
0
50
100
150
Maintenance Hours
200
250
3-5
Using regression to calculate fixed
cost, variable rate, construct a cost
formula & budgeted cost.
The controller assigned you to calculate fixed and
variable costs associated with electricity used in
the factory. Data for the last nine months was
collected and is presented on the following slide.
REQUIRED: Using the results of the regression,
calculate the fixed cost of electricity and the
variable rate per machine hour. Construct the cost
formula for total electricity cost. Calculate the
budgeted cost for next month assuming that 550
machine hours are budgeted.
3-5
Using regression to calculate fixed
cost, variable rate, construct a cost
formula & budgeted cost.
Month
January
February
March
April
May
June
July
August
Electricity Cost
$
3,255
3,485
4,100
3,300
3,312
2,575
3,910
4,200
Machine Hours
460
500
600
470
470
350
570
590
3-5
Using regression to calculate fixed
cost, variable rate, construct a cost
formula & budgeted cost.
Coefficients shown by the regression program are:
Intercept
X Variable 1
Coefficients
$
321.03
$
6.38
1.The fixed cost and the variable rate are solved by
the regression.
2.The cost formula is:
Total electricity cost = $321 + ($6.38 x Machine hours
3.Budgeted electricity cost = $321 + ($6.38 x 550) =
$3,830
Comment on Managerial
Judgment
◙ Critically
Important
◙ Most Widely
Used Method
◙ Relies on
Experience and
Past Observation
◙ Appeal is its
Simplicity