MAS-01: COST BEHAVIOR ANALYSIS

COST - the monetary amount of the resources given up or sacrificed to attain some objective such as
acquiring goods and services. When notified by a term that defines the purpose, cost Do
operational (e.g., acquisition cost; production cost; cost of goods sold).

COST BEHAVIOR
Cost behavior is the relationship between cost and activity as to how costs react to changes n a
activity like production. As production increases, some costs remain the same (i.e., fixed) while some
increase or decrease (1.e., variable). Consider the following (3ssurning activity is based on production)
COSTS TOTAL amount PER UNIT amount
1. FIXED Constant Decrease as production increases
(i.e., inverse relationship)
2. VARIABLE Increase as production increases Constant
(i.e., direct relationship)
3. MIXED Increases less proportionately (vs. Decreases less proportionately (vs.
(semi-variable) total variable) cost as production unit fixed costs) as production increase
increases

FIXED COST (a) VARIABLE COST (bX)

Discretionary Fixed True Variable

Committed Fixed Step Variable

MIXED COST
Y = a + bX

Where: [Y] - the total costs (dependent variable)

[a] - the total fixed costs (vertical/y axis intercept)
[b] - the variable cost per unit (slope of the line)
[X] - the activity or cost driver (independent variable)
[bX] - the total variable costs

COST BEHAVIOR ASSUMPTIONS and LIMITATIONS

RELEVANT RANGE Assumption
Relevant range refers to the range of activity within which the cost behavior patterns are valid. Any
level of activity outside this range may show a different cost behavior pattern.
TIME Assumption
The cost behavior patterns identified are true only over a specified period of time. Beyond this, the
cost may show a different cost behavior pattern.
LINEARITY Assumption
The cost is assumed to manifest a linear relationship over a relevant range despite its tendency to
show otherwise over the long run.

COST ESTIMATION: SEGREGATING VARIABLE & FIXED COSTS

1) HIGH-LOW POINTS Method
The fixed and variable portions o' the mixed costs are computed from two sampled data point the highest
and lowest points based on activity or cost driver.
Variable cost per unit (b) = Change in Costs
(YH-YL)
Change in Activity
2) SCATTERGRAPH (Scatter Diagram) Method
All observed costs at different activity levels are plotted on a graph. Based on sound Judgment, a
regression line is then fitted to the plotted points to represent the line function.

3) LEAST SQUARES REGRESSION Method

Least-squares method is a statistical technique that investigates the association between dependent and
independent variables. This method determines the line or best fit for a set of observations by minimizing
the sum of the squared deviations between cost line and the data points.
●If there is only one independent variable, the analysis is known as SIMPLE REGRESSION
●If the analysis involves multiple Independent variables, it is known as MULTIPLE REGRESSION
4) Other Cost Estimation Methods:
A) Industrial Engineering Method based on the relationship between inputs and Outputs n physical
forms; engineering estimates indicate what and how much costs should be.
B) Account Analysis Method each account is classified as either fixed or variable based on experience
and judgment of accounting and other qualified personnel in the organization
C) Conference Method -costs are classified based on opinions from various company department.
 CORRELATION ANALYSIS
CORRELATION ANALYSIS is used to measure the strength of Linear Relationship between two or
more variables
The correlation between two variables can be seen by drawing a scatter diagram:
● If the points seem to form a straight line, there is a high correlation.
● If the points form a random pattern, there is a low correlation or no correlation at all.
COEFFICTENT OF CORRELATTON (r) measures the relative strength of linear relationship between
two (2) variables. Its value ranges from- 10 to 1.0
● If r = -1.0, there is perfect inverse linear relationship between X and Y.
● If r = 0, no linear relationship.
● If r = +1.0, there is perfect direct relationship between X and Y.

COEFFICIENT OF DETERMINATION (r2) is the proportion of the total variation in Y that is accounted
for by the regression equation, regardless of whether the relationship between X and Y 15 direct or
inverse. It is a measure of goodness of fit n the regression. The higher the r2, the more confidence
one can have in tie estimated cost formula.

EXERCISES: COST BEHAVIOR ANALYSIS

1. Variable Costs vs. Fixed Costs
Adriel Company manufactures and sells a single product. A partially completed schedule of the
company s total and per unit costs over a relevant range of 60 to 100 units produced each year is given
below:
Units Produced
(I) 80 (II) 100 (III) 120
TOTAL COSTS
(A) Variable costs P? P? P?
(B) Fixed costs P? P? P?
(C) Total costs P? P? P?
PER UNIT COSTS
(D) Variable costs P? P? P?
(E) Fixed costs P? P? P?

REQUIRED:
1. Determine the correct amounts of those with () mark
2. Which two (2) specific costs remain constant over the relevant range?
3. Which two (2) specific costs are directly related with production?
4. Which specific cost is inversely related with production? E
5. Express the cost formula based on the line equation form 'Y = a + bx.
6. If the company produces 110 units, then how much is the expected total costs?
(Adapted Managerial Accounting by Garrison & Noreen)

2. High-Low Method
The controller of SUREDEAD Hospital would like to come up with a cost formula that links Admitting
Department cost to the number o patients admitted during a month The Admitting Department's costs
and the number of patients admitted during the past nine months follow:
Month Number of Patients Admitting. Department's Cost
April 18 P 15,600
May 19 P 15,200
June 17 P 13,700
July 15 P 14,600
August 15 P 14,300
September 11 P 13,200
October 11 P 12,800
November 48 P 72,500
December 16 P 10,000

REQUIRED: Using the high-law method, determine

1. Variable cost per unit
2. Annual fixed costs
3. Monthly cost function
4. Department's estimated cot assuming 12 patients will be admitted next month Y
(Adapted Managerial Accounting by Garrison & Nareen)
3. Correlation Analysis
3A) The closeness of the linear relationship between the cost and the activity 1s known as
a. Variation c. Deviation
b. Correlation d. Standard error
3B) Looking at the following scatter diagrams, we can conclude that:
Cost A Cost B
Costs (P) Costs (P)

Units Units

a. Cost A will be easier to predict than cost B.

b. Cost B will be easier to predict than cost A.
c. Cost B has no variable component
d. Cost A is out-of-control

3C) which of these correlation coefficients represents strongest relationship between two variables?
a. + 0.05 c. – 0.05
b. – 0.75 d. + 1.05

(Adapted: Managerial Accounting by Louderback)

4. Least-Squares Regression Method

Sydney Company's total overhead costs at various levels of activity are presented below:
Month Machine Hours Total Overhead Costs
March 500 P 970
April 400 P 851
May 600 P 1,089
June 700 P 1,208

The breakdown of the overhead costs in April at 400 machine hour level of activity is as follows
Supplies (Variable) P 260
Salaries (Fixed) 300
Utilities (Mixed) 291
Total P 851

REQUIRED:
1. How much of June's overhead cost of P 1,208 consisted of utilities cost?
2. Using high-low method, determine the cost function for utilities cost.
3. Using high-low method, determine the cost function for total overhead cost.
4. Using least-squares method, determine the cost function for total overhead costs.
5. What would be the total overhead costs if operating level is at 200 machine hours?
(Adapted Managerial Accounting by Garrison & Noreen)

SOLUTION GUIDE (requirement 1)

April (400 hrs) June (700 hrs)
Supplies (Variable) P 260
Salaries (Fixed) 300
Utilities (Mixed) 291
Total Overhead Costs P 851

SOLUTION GUIDE (requirement 4- Least Squares method)

Month Hours (X) Total Costs (Y) X•Y X2
Mar 500 970
Apr 400 851
May 600 1,089
Jun 700 1,208
SUM
 WRAP UP EXERCISES IRUE OR FALSE, MULTTPLE-CHOICE

1. Unit variable costs are costs that change in direct proportion to changes in the activity level

2. Consider the following graphic representation of certain costs

Costs (P

Units
Which of the following costs are most likely represented by the above graph?
a. Total fixed costs and total variable costs
b. Total fixed costs and unit variable c0st
c. Unit fixed costs and total variable costs
d. Unit fixed costs and unit variable costs

3. In cost analysis using the line equation Y = a + bX, the total fixed cost (a) is regarded as the
a. Independent variable c. Slope of the line
b. Dependent variable d. Y-axis intercept

4. A company has developed a production cost equation for its lone product Y 30 + 5X, where X is based
on the number of labor hours. Assuming a relevant range of 10 to 20 labor hours, what is the estimated
production cost at zero (0) labor hour
a. P 30
b. P 80
c. P 1,130
d. The exact amount cannot be determined without additional information

5. If the coefficient of correlation (r) between two variables is + 1, then a scatter diagram will appear to be a
regression line that slopes upward to the left.

6. Ana Company is interested in the relationship between sales (dependent variable) and occurrence rain
(independent variable). Using the proper formula, the coefficient of correlation (r) is computed 0.99 What
conclusion about the sales and rain occurrence could one make?
a. An increase in sales causes an increase i rain occurrence
b. An increase in sales causes a decrease in rain occurrence.
c. An increase in rain occurrence causes a decrease in sales.
d. An increase in rain occurrence causes an increase in sales

7. What is the appropriate range for the coefficient of determination ( r2)?

a. 0 t0 +1 c. - 1 to 0
b. 0 to – 1 d. – 1 to +1

8. Using statistical normal relationships, the least-squares method uses which of the following equations?
a. y = na + bx
∑xy = a∑x + b∑x2
b. y = ax + b∑x
∑xy = a∑x + b∑x
c. y = na + bx2
∑y = na + b∑x
d. ∑y = na + b∑x
∑xy = a∑x + b∑x2

9. What cost segregation technique gives the most mathematically precise cost estimate?
a. Scatter diagram method c. High-low method
b. Least-squares method d. Calendar method

10. Under Cost-Volume Profit (CVP) analysis, a mixed cost should be

a. Disregarded
b. Treated as a fixed cost
c. Treated as a variable cost
d. Separated into fixed and variable components