4. Learning Objective
• To understand how fixed and variable
costs behave and how to use them to
predict costs.•To use a scatter graph plot to diagnose cost
behavior.
• To analyze a mixed cost using the high-
low method
•To prepare an income statement using the
contribution format.
•To use variable costing to prepare a contribution
format income statement and contrast absorption
costing and variable costing.
(Appendix 5A)
5. To understand how fixed and
variable costs behave and how
to use them to predict costs.
L1
LO1
6. Summary of Variable and Fixed Cost Behavior
Cost In Total Per Unit
Variable Total variable cost is Variable cost per unit remains
proportional to the activity the same over wide ranges
level within the relevant range. of activity.
Total fixed cost remains the
same even when the activity Fixed cost per unit goes
Fixed level changes within the down as activity level goes up.
relevant range.
A variable cost is a cost whose total
dollar amount varies in direct
proportion to changes in the
activity level
7. •While total variable costs change as the
activity level change it is important to the
variable is constant if expressed on a per
unit basis for example cost of batteries
remain constant a 24 even through the
•A variable cost is a constant amount per
unit produced or used. Therefore,
the total amount of the variable cost will
change proportionately with volume or
activity. Generally, a product's direct
materials are a variable cost.
8. A measure of what
causes the
incurrence of a
variable cost
Units
produce
d
Miles
driven
Labor
hours
Machine
hours
9. Minutes Talked
TotalLongDistance
TelephoneBill
A variable cost is a cost whose total dollar
amount varies in direct proportion to changes
in the activity level. Your total long distance
telephone bill is based on how many minutes
you talk.
10. Summary of Variable and Fixed Cost Behavior
Cost In Total Per Unit
Variable Total variable cost is Variable cost per unit remains
proportional to the activity the same over wide ranges
level within the relevant range. of activity.
Total fixed cost remains the
same even when the activity Fixed cost per unit goes
Fixed level changes within the down as activity level goes up.
relevant range.
Recall the summary of our cost behavior
discussion from Chapter 1.
12. The type of variable costs in an organization
will depend in large part on the organizations
structure and purpose A public utility like
light with large investments in equipment will
tend to have few variable costs
Most of the costs are associated with its
plant and these cost tend to be insensitive to
changes in level of services provide
These cost associated with manufacturing
and distributing its product to customers
13. The proportion of variable costs differs across
organizations. For example . . .
A public utility with
large investments in
equipment will tend
to have fewer
variable costs.
A manufacturing company
will often have many
variable costs.
A merchandising company
usually will have a high
proportion of variable costs
like cost of sales.
A service company
will normally have a high
proportion of variable costs.
14. 1. Manufacturing companies – direct materials,
direct labor, and variable overhead.
2. Merchandising companies – cost of goods sold.
3. Merchandising and manufacturing companies –
commissions, shipping costs, and clerical costs
such as invoicing.
4. Service companies – supplies, travel, and
clerical.
15. Not all variable costs have exactly the
same behavior pattern some variable
costs behave in a true variable or
proportionately variable pattern other
variable cost behave in a step variable
pattern
16. Volume
Cost
Direct materials is a true or proportionately
variable cost because the amount used during a
period will vary in direct proportion to the level
of production activity. Moreover any amount
purchase but not used can be stored and carried
forward to the next period as inventory
17. A resource that is obtainable only in large chunks (such
as maintenance workers) and whose costs increase or
decrease only in response to fairly wide changes in
activity is known as a step-variable cost.
Volume
Cost
18. Volume
Cost
Small changes in the level of production are
not likely to have any effect on the number of
maintenance workers employed.
19. Only fairly wide changes in the activity level will
cause a change in the number of maintenance
workers employed
Volume
Cost
20. Summary of Variable and Fixed Cost Behavior
Cost In Total Per Unit
Variable Total variable cost is Variable cost per unit remains
proportional to the activity the same over wide ranges
level within the relevant range. of activity.
Total fixed cost remains the
same even when the activity Fixed cost per unit goes
Fixed level changes within the down as activity level goes up.
relevant range.
Let’s look at fixed cost behavior on the next
screens.
21. Number of Local Calls
MonthlyBasic
TelephoneBill
A fixed cost is a cost whose total dollar amount
remains constant as the activity level changes.
Your monthly basic telephone bill is probably
fixed and does not change when you make more
local calls.
22. 'Fixed Cost‘
A cost that does not change with an
increase or decrease in the amount of
goods or services produced. Fixed costs
are expenses that have to be paid by a
company, independent of any business
activity. It is one of the two components
of the total cost of a good or service,
along with variable cost.
23. Summary of Variable and Fixed Cost Behavior
Cost In Total Per Unit
Variable Total variable cost is Variable cost per unit remains
proportional to the activity the same over wide ranges
level within the relevant range. of activity.
Total fixed cost remains the
same even when the activity Fixed cost per unit goes
Fixed level changes within the down as activity level goes up.
relevant range.
Recall the summary of our cost behavior
discussion from Chapter 1.
24. Number of Local Calls
MonthlyBasicTelephone
BillperLocalCall
Average fixed costs per unit decrease as the
activity level increases. The fixed cost per
local call decreases as more local calls are
made.
29. The trend in many industries is toward
greater fixed costs relative to variable costs.
As machines take over
many mundane tasks
previously performed
by humans,
“knowledge workers”
are demanded for
their minds rather
than their muscles.
Knowledge workers
tend to be salaried,
highly-trained and
difficult to replace. The
cost to compensate
these valued employees
is relatively fixed
rather than variable.
30. The behavior of wage and salary costs can
differ across countries, depending on labor
regulations, labor contracts, and custom.
In France, Germany, China, and Japan,
management has little flexibility in adjusting
the size of the labor force.
Labor costs are more fixed in nature.
In the United States and the United Kingdom,
management has greater latitude. Labor costs
are more variable in nature.
31. RentCostin
ThousandsofDollars
0 1,000 2,000 3,000
Rented Area (Square Feet)
0
30
60
90
Relevant
Range
Total cost doesn’t
change for a wide
range of activity, and
then jumps to a new
higher cost for the
next higher range of
activity.
32. Example: Office space
is available at a rental
rate of $30,000 per year
in increments of 1,000
square feet. As the
business grows, more
space is rented,
increasing the total cost.
The relevant range of activity for a fixed cost
is the range of activity over which the graph
of the cost is flat.
33. Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
TotalUtilityCost
X
Y
A mixed cost has both fixed and variable
components. Consider your utility costs.
34. Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
TotalUtilityCost
X
Y
The total mixed cost line can be expressed
as an equation: Y = a + bX
Where: Y = the total mixed cost
a = the total fixed cost (the
vertical intercept of the line)
b = the variable cost per unit of
activity (the slope of the line)
X = the level of activity
35. If your fixed monthly utility charge is $40, your
variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours,
what is the amount of your utility bill?
Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y = $100
36. Each account is classified as either
variable or fixed based on the analyst’s
knowledge of how the account behaves.
Cost estimates are based on an
evaluation of production methods, and
material, labor and overhead
requirements.
Account Analysis and the Engineering Approach
37. LO2
To use a scatter graph plot
to diagnose cost behavior.
38. Plot the data points on a graph
(total cost vs. activity).
0 1 2 3 4
*
MaintenanceCost
1,000’sofDollars
10
20
0
*
**
*
*
*
*
*
*
Patient-days in 1,000’s
X
Y
39. Use one data point to estimate the total level of activity
and the total cost.
Intercept = Fixed cost: $10,000
0 1 2 3 4
*
MaintenanceCost
1,000’sofDollars
10
20
0
*
**
*
*
*
*
*
*
Patient-days in 1,000’s
X
Y
Patient days = 800
Total maintenance cost = $11,000
40. Make a quick estimate of variable cost per unit and
determine the cost equation.
Variable cost per unit =
$1,000
800
= $1.25/patient-day
Y = $10,000 + $1.25X
Total maintenance at 800 patients 11,000$
Less: Fixed cost 10,000
Estimated total variable cost for 800 patients 1,000$
Total maintenance cost Number of patient days
42. Assume the following hours of maintenance work and the total maintenance costs for six months.
43. The variable cost
per hour of
maintenance is
equal to the change
in cost divided by
the change in hours.
= $8.00/hour
$2,400
300
Hours Total Cost
High 800 9,800$
Low 500 7,400
Change 300 2,400$
44. Total Fixed Cost = Total Cost – Total Variable Cost
Total Fixed Cost = $9,800 – ($8/hour × 800 hours)
Total Fixed Cost = $9,800 – $6,400
Total Fixed Cost = $3,400
45. Y = $3,400 + $8.00X
The Cost Equation for Maintenance
46. A method used to analyze mixed costs if a
scattergraph plot reveals an approximately linear
relationship between the X and Y variables.
This method uses all of the
data points to estimate
the fixed and variable
cost components of a
mixed cost.
The goal of this method is
to fit a straight line to the
data that minimizes the
sum of the squared errors.
47. Software can be used to
fit a regression line
through the data
points.
The cost analysis
objective is the same:
Y = a + bX
The output from the regression analysis can be
used to create an equation that enables you to
estimate total costs at any activity level.
48. The three methods just discussed provide
slightly different estimates of the fixed and
variable cost components of the mixed cost.
This is to be expected because each method
uses different amounts of the data points to
provide estimates.
Least-squares regression provides the most
accurate estimate because it uses all the data
points.
