Introduction to Management Accounting
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Introduction to Management Accounting
Chapter 3
Measurement of Cost Behavior
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Linear-cost Behavior
Costs are assumed to be fixed or variable
within the relevant range of activity
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Learning
Objective 1
Step Cost Behavior Patterns
Step costs change abruptly at intervals
of activity because the resources and
their costs come in indivisible chunks.
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Step Cost Behavior Patterns
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Mixed-Cost Behavior Patterns
Mixed costs contain elements of both
fixed- and variable-cost behavior.
The fixed-cost element is unchanged
over a range of cost-driver activity.
The variable-cost element varies
proportionately with cost-driver activity.
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Mixed-Cost Behavior Patterns
Parkview Medical Center
Predicted costs = fixed + variable costs (patient-days)
Predicted costs = $10,000 + $5(4,000)
Predicted costs = $30,000
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Learning
Objective 2
Management’s Influence on Cost Behavior
Choice of process and product design
Quality levels
Product features
Distribution channels
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Capacity Decisions
They are the fixed costs of being able
to achieve a desired level of production or
to provide a desired level of service while
maintaining product or service attributes.
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Committed Fixed Costs
Committed fixed costs arise
from the possession of facilities,
equipment, and a basic organization.
Lease payments
Property taxes
Salaries of key personnel
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Discretionary Fixed Costs
Discretionary fixed costs are costs fixed at certain levels
only because management decided that these levels of cost
should be incurred to meet the organization’s goals.
These discretionary fixed costs have no obvious
relationship to levels of output activity but
are determined as part of the periodic planning process.
Each planning period, management will determine
how much to spend on discretionary items. These costs
then become fixed until the next planning period.
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Examples of Discretionary
Fixed Costs
Research and
development
Advertising
and promotion
Management
salaries
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Technology Decisions
Choice of technology (e-commerce versus
in-store or mail-order sales) positions the
organization to meet its current goals and
to respond to changes in the environment.
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Cost-Control Incentives
Managers use their
knowledge of cost
behavior to set
cost expectations.
Employees may
Receive rewards that
are tied to meeting
these expectations.
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Learning
Objective 3
Cost Functions
Planning and controlling the activities
of an organization require accurate
and useful estimates of future
fixed and variable costs.
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Cost Functions
Understanding relationships between costs
and their cost drivers allows managers to...
Make better operating, marketing,
And production decisions
Plan and evaluate actions
Determine appropriate costs for
short-run and long-run decisions.
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Cost Functions
The first step in estimating or predicting
costs is measuring cost behavior as a
function of appropriate cost drivers.
The second step is to use these cost
measures to estimate future costs at
expected levels of cost-driver activity.
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Cost Function Equation
Let:
Y = Total cost
F = Fixed cost
V = Variable cost per unit
X = Cost-driver activity in number of units
The mixed-cost function is called a linear-cost function.
Mixed-cost function:
Y = F + VX
Y = $10,000 + $5.00X
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Developing Cost Functions
The cost function must be believable.
A cost function’s estimates of costs
at actual levels of activity must reliably
conform with actually observed costs.
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Learning
Objective 4
Choice of Cost Drivers: Activity Analysis
Choosing a cost function starts
with choosing cost drivers.
Managers use activity analysis to
identify appropriate cost drivers.
Activity analysis directs management
accountants to the appropriate
cost drivers for each cost.
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Choice of Cost Drivers: Activity Analysis
Northwestern Computers makes two
products: Mozart-Plus and Powerdrive
In the past, most of the support costs
were twice as much as labor costs.
Northwest has upgraded the production
function, which has increased support
costs and reduced labor cost.
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Choice of Cost Drivers: Activity Analysis
Using the old cost driver, labor cost, the
prediction of support costs would be:
Labor cost
Support cost:
2 × Direct labor cost
Mozart-Plus
$ 8.50
Powerdrive
$130.00
$17.00
$260.00
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Choice of Cost Drivers: Activity Analysis
Using the more appropriate cost driver, the number of components
added to products, the predicted support costs are:
Mozart-Plus
Support cost at $20/component
$20 × 5 components
$20 × 9 components
Difference in predicted
support cost
Powerdrive
$100.00
$180.00
$ 83.00
higher
$ 80.00
lower
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Learning
Objective 5
Methods of Measuring Cost Functions
1. Engineering analysis
 2. Account analysis
 3. High-low analysis
 4. Visual-fit analysis
 5. Least-squares regression analysis

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Engineering Analysis
Engineering analysis measures cost behavior
according to what costs should be,
not by what costs have been.
Engineering analysis entails a systematic
review of materials, supplies, labor,
support services, and facilities
needed for products and services.
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Account Analysis
The simplest method of account analysis selects a plausible
cost driver and classifies each account as a variable or fixed cost.
Parkview Medical Center
Monthly cost
Amount
Fixed
Supervisor’s salary and benefits
Hourly workers’ wages and benefits
Equipment depreciation and rentals
Equipment repairs
Cleaning supplies
Total maintenance costs
$ 3,800
14,674
5,873
5,604
7,472
$37,423
$3,800
Variable
$14,674
5,873
$9,673
5,604
7,472
$27,750
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Account Analysis Example
3,700 patient-days
Fixed cost per month = $9,673
Variable cost per patient-day
= $27,750 ÷ 3,700
= $7.50 per patient-day
Y = $9,673 + ($7.50 × patient-days)
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High-Low Method
Plot historical data points on a graph.
Focus on the highest- and lowest-activity points.
High month: April
Maintenance cost: $47,000
Number of patient-days: 4,900
Low month: September
Maintenance cost: $17,000
Number of patient-days: 1,200
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High-Low Method Example
The point at which the line intersects the Y axis is the intercept, F, or
estimate of Fixed Costs, and the slope of the line measures the variable cost.
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High-Low Method Example
What is the variable cost (V)?
Using algebra to solve for variable and fixed costs.
Variable costs = Change in costs
change in activity
V = ($47,000 – $17,000) ÷ (4,900 – 1,200)
= $30,000 ÷ 3,700 = $8.1081
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High-Low Method Example
What is the fixed cost (F)?
F = Total mixed cost – total variable cost
At X (high) F = $47,000 - ($8.1081× 4,900 patient days)
= $47,000 – $39,730
= $7,270 a month
At X (low) F = $17,000 = ($8.1081× 1,200 patient days)
= $17,000 – $9,730
= $7,270 a month
Cost function measured by high-low method:
Y = $7,270 per month + ($8.1081 × patient-days)
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Visual-Fit Method
In the visual-fit method, the cost analyst
visually fits a straight line through a plot
of all of the available data, not just
between the high point and the
low point, making it more reliable
than the high-low method.
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Least-Squares Regression Method
Regression analysis measures
a cost function more objectively
by using statistics to fit a cost
function to all the data.
Regression analysis measures
cost behavior more reliably than
other cost measurement methods.
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Coefficient of Determination
One measure of reliability,
or goodness of fit, is the
coefficient of determination,
R² (or R-squared).
The coefficient of determination
measures how much of the
fluctuation of a cost is explained
by changes in the cost driver.
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The End
End of Chapter 3
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