Lesson No.

2: Cost Concepts, Classification and Behavior

COST DEFINITION
- 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 becomes
operational (e.g, acquisition cost, production cost, cost of goods sold).

DIFFERENT TYPE OF COSTS

1. Cost classified by the functional areas of the organization to which costs relate.
a. Manufacturing cost
b. Non-manufacturing cost
2. Cost classified as to timing charge to revenue in an accounting period.
a. Product cost
b. Period cost The cost formula
3. Cost classified as to Traceability Y = A + BX
a. Direct cost
b. Indirect cost Where:
4. Cost classified as to Controllability [Y] – Total cost dependent variable
a. Controllable cost [A] – The total fixed cost
b. Uncontrollable cost [B] – The variable cost per unit
5. Costs classified in relation to decision making [X] – The activity or the cost driver
a. Opportunity cost [BX] – The Total Variable cost
b. Differential cost
c. Relevant cost
d. Marginal cost
e. Average cost per unit
f. Sunk cost
6. Cost classified in relation to organization’s activity and its behaviour

COST BEHAVIOR
- Cost behaviour is the relationship between cost and activity – as to how cost reacts to changes in
an activity like production. As to production increases, some costs remain the same (i.e, fixed
cost) while some costs increase or decrease (i.e, variable cost). Consider the following (assuming
the activity is based on production):

COSTS TOTAL amount PER UNIT amount

1. Fixed Constant Decrease per production increases
Decrease as the production increases
(i.e, inverse relationship)
2. Variable Increase as the production increases Constant
(i.e, direct relationship)
3. Mixed Cost Increase less proportionately (vs. total Decrease less proportionately (vs. unit cost)
(semi-variable cost) variable cost) as production increases as production increases

COST BEHAVIOR ASSUMPTION AND LIMITATIONS

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

EXERCISE 1: VARIABLE COST vs. FIXED COSTS

Akio 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 25 to 75 units produced each year given below:
UNITS PRODUCED (I) 25 (II) 50 (III) 75
TOTAL COSTS
A. Variable cost P50 ? ?
B. Fixed cost ? 600.00 ?
C. Total costs ? ? ?
PER UNIT COSTS
D. Variable cost ? ? 2
E. Fixed cost ? ? ?

Determine the correct amounts of those with (?) mark.

Lesson No. 2: Cost Concepts, Classification and Behavior
COST ESTIMATION: SEGREGATING VARIABLE & FIXED COSTS
1. HIGH-LOW METHOD
2. LEAST-SQUARES REGRESSION METHOD
3. SCATTERGRAPH (Scatter Diagram) METHOD
4. OTHER COST ESTIMATION (e,g. Industrial Engineering Method, Account Analysis Method, conference method)

EXERCISE 2: HIGH-LOW METHOD

MONTH Total Quantity Total Cost

(X) (Y)
January 15,000 P45,000
February 18,000 56,000
March 22,000 60,000
April 26,000 48,000
May 29,000 66,000
June 26,000 62,000

Required: Using the HIGH-LOW method, determine the following

1. Variable cost per unit
2. Annual Fixed cost
3. Monthly cost function
4. How much is the Total cost if in July produce 20,000 units

EXERCISE 3: HIGH-LOW METHOD w/ outliers

The controller of SUREDEAD Hospital would like to come up with a cost formula that link Admitting Department
cost to the number of patients admitted during a month. The admitting costs and the number the number of patients
admitted during the past nine months follow:

MONTH Number of Patients Admitting Department’s Cost

April 18 P15,600
May 19 15,200
June 17 13,700
July 15 14,600
August 15 14,300
September 11 13,200
October 11 12,800
November 48 72,500
December 16 14,000

Required: Using the HIGH-LOW method, determine the following

1. Variable cost per unit
2. Monthly Fixed cost
3. Monthly cost function
4. Department estimated cost assuming 14 patients will be admitted next month

EXERCISE 4: LEASE-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 P970
April 400 851
May 600 1,089
June 700 1,208

The breakdown of the overhead costs in April at 400 machine-hour level of activity is as follows:
Supplies (Variable) P260
Salaries (Fixed) 300 The Least square formulas:
Utilities (Mixed) 291 ΣY = na + bΣx
Total P851 Σxy = Σxa + bΣx2
Required
1. How much of June’s overhead cost of P1,208 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. What would be the total overhead costs if the operating level is at 200 machine hours?
Lesson No. 2: Cost Concepts, Classification and Behavior
Solution Guide: (Requirement 1)
April (400hrs) June (700hrs)
Supplies (Variable) P260
Salaries (Fixed) 300
Utilities (Mixed) 291
Total Overhead Cost 851 P1,208
Solution Guide: (Requirement 4)

Month Hours (X) Total Costs (Y) X.Y X2

March 500 970
April 400 851
May 600 1,089
June 700 1,208
Total

SCATTERGRAPH (Scatter Diagram) METHOD

All observed costs are at different activity levels are plotted on a graph. Based on the sound judgment, a regression
line is then fitted to the points to represent the line function.

Suggested to use CORRELATION ANALYSIS

EXERCISE 5: SCATTERGRAPH (Scatter Diagram) METHOD

1. The closeness of the linear relationship between the cost and the activity is known as
a. Variation c. Deviation
b. Correlation d. Standard Error

2. Looking at the following scatter diagrams, we can conclude that

COST A COST B

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

3. Which of these correlation coefficients represent the strongest relationship between the two variable
a. +0.50 c. -0.05
b. -0.80 d. +1.05

MULTIPLE CHOICE QUESTIONS

1. Consider the following graphic representation of certain costs:

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

2. 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

3. Which of the following best describes a step cost?

a. It is partly variable and fixed cost c. It increases proportionately with volume
b. It remains constant in all cases d. It increases abruptly outside the relevant range

4. In describing the cost formula equation Y = A + BX, which of the following statement is correct?
a. Y is the independent variable
b. a is the variable rate
c. a and b are valid for all levels of activity
d. In high-low method, ‘b’ equals the change in cost (Y) divided by the change in activity (X)
Lesson No. 2: Cost Concepts, Classification and Behavior
5. A data point that falls far away from other data points in a scatter diagram is called a (an)
a. Outlier c. Standard deviation
b. Margin of error d. Coefficient of determination

6. Mockingbird Company applies the high-low method of cost estimation to customer order data for the first 4 months
of 2018:
Month Orders Cost (P)
January 1,200 3,120
February 1,300 3,185
March 1,800 4,320
April 1,700 3,895

What is the estimated variable cost components per order?

a. P 2.00 c. P 2.48
b. P 2.42 d. P 2.50

7. Black Co. has an average unit cost of P45 at 10,000 units and P25 at 30,000 units. What is the variable cost?
a. P10 c. P20
b. P15 d. An exact amount cannot be determined without more
information
8. 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

9. The following cost data for different hours of operations are made available to you by Florida Manufacturing
Company for your analysis:
Number of Months 10
Sum of Hours 350
Sum of Costs 1,000
Sum of Hours x Costs 39,200
Sum of Hours squared 14,250
How much is the monthly fixed cost?
a. P 26.50 c. P 318
b. P 35.00 d. P 420

10. The major objective of preparing scatter diagram is to?

a. Determine the relevant range c. Perform regression
b. Derive an equation to predict future cost d. An exact amount cannot be determined without more
information
11. The R-squared (r2) is a measure of?
a. The fixed cost components c. The spurious relationship between the cost and activity
b. The variable cost per unit of activity d. How well regression line accounts for the changes in the
independent variable
12. Jackrose Company uses regression analysis to develop a model for predicting overhead costs. Two different cost
drivers (machine hours and direct materials weight) are under consideration as the independent variable. Relevant data
were run on a computer using one of the standard regression programs, with the following results:

MACHINE HOURS Coefficient DIRECT MATERIALS WEIGHT Coefficient

Y-Intercept 2,500 Y-Intercept 4,600
B 5.0 B 2.6
r2 = .070 r2 = .050

What regression equation should be used?

a. Y = 2,500 + 5.0X c. Y = 4,600 + 2.6X
b. Y = 2,500 + 3.5X d. Y = 4,600 + 1.3X

13. What is appropriate range for coefficient of determination (r2)

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

14. Ana Company is interested in the relationship between sales (dependent variable) and occurrence of rain
(independent variable). Using the proper formula, the coefficient of correlation (r) is computed as -.99. What conclusion
about the sales and rain occurrence could one make?
a. An increase in sales causes an increase in rain occurrence c. An increase in rain occurrence causes an decrease in sales
b. An increase in sales causes an decrease in rain occurrence d. An increase in rain occurrence causes an increase in sales

15. Which of the following is not a method of splitting the fixed cost and variable cost?
a. High and low method point c. Scatter chart
b. Method of least squares d. Linear programming