MBA 309 – MANAGERIAL ACCOUNTING & CONTROL

Cost Concepts & Cost Behavior Analysis

Cost - is cash or cash equivalent necessary to attain an objective such as acquiring goods or services, performing a function
or producing and distributing a product.

Cost Accounting - is an expanded phase of financial accounting which informs management promptly with the cost of
rendering a particular service, buying and selling a product, and producing a product. It is the field of accounting that
measures, records and reports information about costs.

Cost of Sales, Operating Expenses and Losses

- Cost of sales or costs of goods sold are those production costs incurred related to the units sold.
- Expenses are those incurred in selling goods, distributing goods and managing a business (operating expenses).
- Both costs and expenses give benefits to the business.
- Losses do not give any benefit to the business.

Different Costs for different purposes (Classifications of Costs)

A. As to type
1. Product Costs – costs incurred to manufacture the product. Product costs of the units sold are recognized as expense
(COGS) while product costs of the unsold units become the costs of inventory.
2. Period Costs – non-manufacturing costs that include selling, administrative and research and development costs.
These costs are expensed in the period of incurrence and do not become part of the cost of inventory.

B. As to function
 Manufacturing Costs Salary and wages for employees that directly contribute to the production of the goods
 Rent for buildings and offices
 Raw materials expenses
 Equipment, machines, and supplies
 Utilities for factories

 Non-manufacturing Costs
 Selling expenses
 General expenses
 Interest expense

C. As to traceability
1. Direct Costs – related to a particular cost object and can economically and effectively be traced to that object.
(Direct Materials and Direct Labor)
2. Indirect Costs – related to a cost object, but cannot practically, economically and effectively be traced to such cost
object. Cost assignment is done by allocating the indirect cost to the related cost objects.

D. For decision-making
1. Relevant Costs – future costs that will differ under alternative courses of action.
2. Differential Costs – difference in costs between any two alternative courses of action.
a. Incremental Cost – increase in cost from one alternative to another.
b. Decremental Cost – decrease in cost from one alternative to another.
3. Opportunity Costs – income or benefit given up when one alternative is selected over another.
4. Sunk, Past or Historical Costs – already incurred and cannot be changed by any decision made now or to be made in
the future.

E. As to relation to an accounting period:

1. Capital Expenditure are payments made for goods or services that are recorded or capitalized on a company's
balance sheet instead of expensed on the income statement. Capital expenditures are used to purchase, upgrade, or
extend the life of an asset, and are long-term investments35. Examples of capital expenditures include purchases of
property, equipment, land, computers, furniture, and software3.
2. Revenue Expenditure a cost that is charged to expense as soon as the cost is incurred. By doing so, a business is
using the matching principle to link the expense incurred to revenues generated in the same reporting period. This
yields the most accurate income statement results.
F. As to behavior (Reaction to changes in Cost Driver)
1. Variable Cost
2. Fixed Cost
a. Committed Fixed Cost
b. Discretionary Fixed Cost
3. Mixed Cost

Cost Behavior - refers to the way costs change with respect to a change in the activity level, such as production or sales
volume, labor or machine hours, etc. There are costs which remain constant, some change directly or proportionately with
the activity level, and others change in different patterns.

Types of Cost Total amount Amount per unit

1. FIXED Constant Decreases as production increases
2. VARIABLE Increases as production increases Constant
3. MIXED Increases less proportionately (vs. total Decreases less proportionately (vs. fixed cost per
variable costs) as production increases unit) as production increases

Cost Behavior Assumptions

A. 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.

B. 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.

C. 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.

Equation “Y = a + bX”

Y = total costs (dependent variable)

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

Illustration: Variable, Fixed and Mixed Costs

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Problem I:

Cleveland Manufacturing Company has the following information available regarding costs at various levels of monthly
production:

Production Volume
14,000 units 20,000 units
Direct materials P 70,000 P 100,000
Direct labor 56,000 80,000
Indirect materials 21,000 30,000
Supervisor’s salaries 12,000 12,000
Depreciation on plant assets 10,000 10,000
Maintenance 32,000 44,000
Utilities 15,000 21,000
Insurance on plant assets 1,600 1,600
 Property taxes on plant assets 2,000 2,000
Totals P 219,600 P 300,600

Required:
1. Identify each cost as being variable, fixed or mixed cost.
2. Determine the variable cost per unit and the fixed cost per month.
3. Predict the total cost for a monthly production volume of 16,000 units.

Problem II:

Chicago Co. 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 and sold each year is given below:

Units produced and sold

60 80 100
Total costs:
Variable P120
Fixed 600
Total
Cost per unit:
Variable
Fixed

Required: Based on the above data,

1. Complete the schedule on total and unit costs (Fill in the blanks).
2. Identify two specific costs that remain constant over the relevant range.
3. Identify two specific costs that are directly related with unit production.
4. Identify the specific cost that is inversely related with unit production.
5. Express the cost formula based on the line equation for “Y = a + bX”.
6. If the company produces 90 units, then the total cost is expected to be P .

Cost Estimation: Segregation of Mixed Costs into Fixed and Variable Elements
1. High-Low Method 4. Engineering Method
2. Least-Squares Method 5. Account Analysis Method
3. Scattergraph (Scatter Diagram) Method

High-Low Method
The fixed and variable elements of the mixed costs are computed from two sampled data points – the highest and
lowest points as to activity level or cost driver. For analysis purposes, the high-low method usually produces a reasonable,
not precise estimate. However, this method is criticized because it ignores much of the available data by concentrating on
only the extreme points.

Illustration: Separation of the Fixed and Variable Components of Mixed Costs

Problem I:

Machine hours and electricity costs for Indiana Industries for 2014 were as follows:

Month Machine Hours Utility Costs

January 2,500 P 36,800
February 2,900 42,000
March 1,900 27,000
April 3,100 46,000
May 3,800 56,500
 June 3,300 44,000
July 4,100 49,500
August 3,500 45,500
September 2,000 31,000
October 3,700 52,000
November 4,700 62,000
December 4,200 55,500

Required: Using the high-low method;

1. Compute for the variable cost per machine hour.
2. Compute the total variable cost at the highest and lowest level of activity.
3. Determine the fixed cost at each level of activity.
4. Develop an equation to determine the total cost at any level of activity.

Problem II:

Los Angeles Company wants to conduct an analysis of the behavior of the maintenance cost of its factory equipment in
relation to the number of units produced using such equipment. Historical cost and production data were gathered for the
past 10 months.

Month Maintenance Cost Units Produced

March P 2,750 450
April 2,250 200
May 5,000 700
June 3,500 700
July 4,000 600
August 3,250 400
September 4,500 800
October 125 25
November 2,500 350
December 3,000 300

Required: Compute for the variable maintenance cost per unit and monthly fixed cost using high-low method.

Least-Squares Method
Least-squares method is a statistical technique that investigates the association between dependent and
independent variables. This method determines the line of best fit for a set of observations by minimizing the sum of the
squares of the vertical deviations between actual points and the regression line.
• 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.

In the method of least squares, the deviation is the difference between the predicted and actual costs.

Formula:
∑y = na + b∑x
∑xy = a∑x + b ∑x²

Illustration: Least-Squares Method

The following activity and cost data that were provided by Liz Quer Corp. would help in estimating its future maintenance
costs:
Units Maintenance Cost
3 P 450
7 530
 11 640
15 700
Using the least-squares regression method, the expected total cost for an activity level of 10 units would be:

Illustration: High-Low vs. Least-Squares Method

Green Company’s total overhead costs at various levels of activity are presented below:
Month Machine Hours Total Overhead Costs
March 500 P 970
April 400 851
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) P 260
Salaries (fixed) 300
Utilities (mixed) 291
Total P 851

Required:
1. Determine 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. 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 450 machine hours?

Scattergraph (Scatter Diagram) Method

All observed costs at various 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. Its principal advantage over the high-low method is that it
considers more than two points. The major objective of this method is to develop an equation to predict future costs.

Engineering Method
This method is best used for estimating costs for totally new activities. It can detail each step required to perform an
operation and sometimes can be quite expensive to use.

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.

Conference Method
Costs are classified based on opinions from various company departments such as purchasing, process engineering,
manufacturing, employee relations and so on.

EXERCISES

1.The relationship between cost and activity is termed:

a. cost estimation.
b. cost prediction.
c. cost behavior.
d. cost analysis.
e. cost approximation.

2.Which of the following costs changes in direct proportion to a change in the activity level?
a. Variable cost d. Step-variable cost
b. Fixed cost e. Step-fixed cost
c. Semi-variable cost

3. Montgomery Company has a variable selling cost. If sales volume increases, how will the total variable cost and the
variable cost per unit behave?
Total Variable Cost Variable Cost Per Unit
a. Increase Increase
b. Increase Remain constant
 c. Increase Decrease
d. Remain constant Decrease
e. Decrease Increase

4.What type of cost exhibits the behavior that follows?

Manufacturing
Volume (Units) Cost Per Unit
50,000 P1.95
70,000 1.95
a. Variable cost d. Discretionary fixed cost
b. Fixed cost e. Step-fixed cost
c. Semi-variable cost

5.Plaza Corporation observed that when 25,000 units were sold, a particular cost amounted to P70,000, or P2.80 per
unit. When volume increased by 15%, the cost totaled P80,500 (i.e., P2.80 per unit). The cost that Plaza is
studying can best be described as a:
a. variable cost d. discretionary fixed cost
b. fixed cost e. step-fixed cost
c. semi-variable cost

6.A company observed a decrease in the cost per unit. All other things being equal, which of the following is probably
true?
a. The company is studying a variable cost, and total volume has increased.
b. The company is studying a variable cost, and total volume has decreased.
c. The company is studying a fixed cost, and total volume has increased.
d. The company is studying a fixed cost, and total volume has decreased.
e. The company is studying a fixed cost, and total volume has remained constant.

7.What type of cost exhibits the behavior that follows?

Manufacturing Total Cost
Volume (Units) Cost Per Unit
50,000 P150,000 P3.00
80,000 150,000 1.88

a. Variable cost b. Fixed cost c. Semi-variable cost d. Step-variable cost

8.When graphed, a typical variable cost appears as:

a. a horizontal line
b. a vertical line
c. a u-shaped line
d. a diagonal line that slopes downward to the right
e. a diagonal line that slopes upward to the right

9.When graphed, a typical fixed cost appears as:

a. a horizontal line.
b. a vertical line.
c. a u-shaped line.
d. a diagonal line that slopes downward to the right.

10. Costs that remain the same over a wide range of activity, but jump to a different amount outside that range, are
termed:
a. step-fixed costs b. step-variable costs c. semi-variable costs d. curvilinear costs

11. Straight-line depreciation is a typical example of a:

a. variable cost b. step-variable cost c. fixed cost d. mixed cost

12. Douglas Corporation recently produced and sold 100,000 units. Fixed costs at this level of activity amounted to
P50,000; variable costs were P100,000. How much cost would the company anticipate if during the next period it
produced and sold 102,000 units?
a. P150,000 b. P151,000 c. P152,000 d. P153,000

13. A mixed cost is often known as a:

 a. semi-variable cost d. curvilinear cost
b. step-fixed cost e. discretionary cost
c. variable cost

14. Richard Hamilton has a fast-food franchise and must pay a franchise fee of P350,000 plus 3% of gross sales. In
terms of cost behavior, the fee is a:
a. variable cost b. fixed cost c. step-fixed cost d. semi-variable cost

15. Which of the following are examples of a mixed cost?

I. A building that is used for both manufacturing and sales activities.

II. An employee's compensation, which consists of a flat salary plus a commission.
III. Depreciation that relates to five different machines.
IV. Maintenance cost that must be split between sales and administrative offices.

a. I only d. I, III, and IV

b. II only e. I, II, III, and IV
c. I and III

Use the following to answer questions 16 and 17:

Swanson and Associates presently leases a copy machine under an agreement that calls for a fixed fee each month
and a charge for each copy made. Swanson made 7,000 copies and paid a total of P360 in March; in May, the firm
paid P280 for 5,000 copies. The company uses the high-low method to analyze costs.

16. Swanson's variable cost per copy is:

a. P0.040 b. P0.051 c. P0.053 d. P0.056

17. Swanson's monthly fixed fee is:

a. P80 b. P102 c. P106 d. P112

Use the following to answer questions 18 to 20:

Atlanta, Inc., which uses the high-low method to analyze cost behavior, has determined that machine hours best
explain the company's utilities cost. The company's relevant range of activity varies from a low of 600 machine
hours to a high of 1,100 machine hours, with the following data being available for the first six months of the year:

Month Utilities Machine Hours

January P8,700 800
February 8,360 720
March 8,950 810
April 9,360 920
May 9,625 950
June 9,150 900

18. The variable utilities cost per machine hour is:

a. P0.18 b. P4.50 c. P5.00 d. P5.50

19. The fixed utilities cost per month is:

a. P3,764 b. P4,400 c. P4,760 d. P5,100

20. Using the high-low method, the utilities cost associated with 980 machine hours would be:
a. P9,510 b. P9,660 c. P9,700 d. P9,790