Measurement of
Cost Behavior
Chapter 3
©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
3-1
Learning Objective 1
Describe step- and
mixed-cost behavior.
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Step- and Mixed-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- and Mixed-Cost
Behavior Patterns
Lease cost example
Relevant
range
Lease cost
Actual cost
behavior
Fixed cost
approximation
Oil and gas exploration activity
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Step- and Mixed-Cost
Behavior Patterns
Supermarket checker wage cost example
Relevant range
Wage cost
Actual cost
behavior
Variable
cost
approximation
40
Shoppers per hour
440
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Step- and 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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Facilities maintenance
department cost
Step- and Mixed-Cost
Behavior Patterns
Relevant range
$5.00 per
patient day
Total
variable
cost
$10,000
Fixed
cost
1,000
5,000
Number of patient-days per month
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Learning Objective 2
Describe management
influences on cost behavior.
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Product and Service Decisions
and the Value Chain
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 usually 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.
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Discretionary Fixed Costs
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
Advertising and promotion
Employee training
Management salaries
Research and development
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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
Measure and mathematically
express cost functions and
use them to predict costs.
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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...
evaluate strategic plans and
operational improvement programs.
make short- and long-run decisions.
plan or budget the effects of future activities.
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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
Y = Total cost
F = Fixed cost
V = Variable cost per unit
X = Cost-driver activity in number of units
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Cost Function Equation
Mixed-cost function:
Y = F + VX
Y = $10,000 + $5.00X
The mixed-cost function is
called a linear-cost function.
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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
Describe the importance
of activity analysis for
measuring cost functions.
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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:
Mozart-Plus Powerdrive
Labor cost
Support cost:
2 × Direct labor cost
$ 8.50
$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:
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Choice of Cost Drivers:
Activity Analysis
Mozart-Plus Powerdrive
Support cost
at $20/component
$20 × 5 components $100.00
$20 × 9 components
Difference in predicted
support cost
$ 83.00
higher
$180.00
$ 80.00
lower
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Learning Objective 5
Measure cost behavior using
the account analysis, high-low,
visual-fit, and least-squares
regression methods.
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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
It 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.
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Account Analysis Example
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
The first step if to plot the historical
data points on a graph.
The focus of this method is normally on
the highest- and lowest-activity points.
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High-Low Method Example
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
What is the variable cost?
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High-Low Method Example
($47,000 – $17,000) ÷ (4,900 – 1,200)
= $30,000 ÷ 3,700 = $8.1081
What is the fixed cost?
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High-Low Method Example
$47,000 = Fixed cost + ($8.1081× 4,900)
$47,000 – $39,730 = $7,270
$17,000 = Fixed cost + ($8.1081× 1,200)
$17,000 – $9,730 = $7,270
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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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End of Chapter 3
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