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Cost Behavior: 
Analysis and Use 
Chapter Five
Learning Objective 1 
UUnnddeerrssttaanndd hhooww ffiixxeedd 
aanndd vvaarriiaabbllee ccoossttss 
bbeehhaavvee aanndd hhoo...
Types of Cost Behavior Patterns 
Recall the summary of our cost behavior discussion from an 
earlier chapter. 
Summary of ...
The Activity Base 
A measure of what 
A measure of what 
causes the 
causes the 
incurrence of a 
variable cost 
incurrenc...
Minutes Talked 
Total Long Distance 
Telephone Bill 
True Variable Cost Example 
A variable cost is a cost whose total dol...
Types of Cost Behavior Patterns 
Recall the summary of our cost behavior 
discussion from an earlier chapter. 
Summary of ...
Variable Cost Per Unit Example 
A variable cost remains constant if expressed on a per unit 
basis. The cost per minute ta...
Extent of Variable Costs 
The proportion of variable costs differs across 
organizations. For example . . . 
A public util...
Examples of Variable Costs 
1. Merchandising companies – cost of goods sold. 
2. Manufacturing companies – direct material...
Volume 
Cost 
True Variable Cost 
Direct materials is a true or proportionately variable cost 
because the amount used dur...
Step-Variable Costs 
A resource that is obtainable only in large chunks (such as 
maintenance workers) and whose costs inc...
Step-Variable Costs 
Small changes in the level of production are not 
likely to have any effect on the number of 
mainten...
Step-Variable Costs 
Only fairly wide changes in the activity level will 
cause a change in the number of maintenance 
wor...
The Linearity Assumption and the Relevant 
Relevant 
Range 
A straight line 
A straight line 
closely 
closely 
approximat...
Types of Cost Behavior Patterns 
Let’s look at fixed cost behavior on the next screens. 
Summary of Variable and Fixed Cos...
Number of Local Calls 
Monthly Basic 
Telephone Bill 
Total Fixed Cost Example 
A fixed cost is a cost whose total dollar ...
Types of Cost Behavior Patterns 
Recall the summary of our cost behavior discussion from an 
earlier chapter. 
Summary of ...
Fixed Cost Per Unit Example 
Average fixed costs per unit decrease as the activity level 
increases. The fixed cost per lo...
Types of Fixed Costs 
Examples 
Advertising and 
Research and 
Development 
Examples 
Depreciation on 
Equipment and 
Real...
The Trend Toward Fixed Costs 
The trend in many industries is toward greater fixed 
costs relative to variable costs. 
As ...
Is Labor a Variable or a Fixed Cost? 
The behavior of wage and salary costs can differ across 
countries, depending on lab...
Rent Cost in Thousands of 
Fixed Costs and Relevant Range 
90 
60 
Total cost doesn’t 
change for a wide 
range of activit...
Fixed Costs and Relevant Range 
The relevant range of activity for a fixed cost is the 
range of activity over which the g...
Fixed Costs and Relevant Range 
How does this 
type of fixed cost 
differ from a step-variable 
cost? 
Step-variable costs...
Quick Check  
Which of the following statements about cost 
behavior are true? 
1. Fixed costs per unit vary with the lev...
Quick Check  
Which of the following statements about cost behavior 
are true? 
1. Fixed costs per unit vary with the lev...
Variable 
Cost per KW 
Fixed Monthly 
Utility Charge 
Mixed Costs 
Activity (Kilowatt Hours) Total Utility Cost 
X 
Y 
A m...
Variable 
Cost per KW 
Fixed Monthly 
Utility Charge 
Activity (Kilowatt Hours) Total Utility Cost 
X 
Y 
Mixed Costs 
Tot...
Mixed Costs Example 
If your fixed monthly utility charge is $40, your variable 
cost is $0.03 per kilowatt hour, and your...
Analysis of Mixed Costs 
Account Analysis and the Engineering Approach 
Each account is classified as either 
variable or ...
Learning Objective 2 
UUssee aa ssccaatttteerrggrraapphh pplloott 
ttoo ddiiaaggnnoossee ccoosstt 
bbeehhaavviioorr..
Plot the data points on a graph 
(total cost vs. activity). 
* 
0 1 2 3 4 
* 
Maintenance Cost 
1,000’s of Dollars 
20 
10...
The Scattergraph Method 
Draw a line through the data points with about an 
equal numbers of points above and below the li...
The Scattergraph Method 
Use one data point to estimate the total level of activity 
and the total cost. 
TToottaall mmaai...
The Scattergraph Method 
Make a quick estimate of variable cost per unit and 
determine the cost equation. 
Total maintena...
Learning Objective 3 
AAnnaallyyzzee aa mmiixxeedd ccoosstt 
uussiinngg tthhee hhiigghh--llooww 
mmeetthhoodd..
The High-Low Method 
Assume the following hours of maintenance work and the 
total maintenance costs for six months.
The High-Low Method 
TThhee vvaarriiaabbllee ccoosstt 
ppeerr hhoouurr ooff 
mmaaiinntteennaannccee iiss 
eeqquuaall ttoo ...
The High-Low Method 
Total Fixed Cost = Total Cost – Total Variable Cost 
Total Fixed Cost = $9,800 – ($8/hour × 800 hours...
The High-Low Method 
The Cost Equation for Maintenance 
YY == $$33,,440000 ++ $$88..0000XX
Quick Check  
Sales salaries and commissions are $10,000 when 
80,000 units are sold, and $14,000 when 120,000 units 
are...
Quick Check  
Sales salaries and commissions are $10,000 when 
80,000 units are sold, and $14,000 when 120,000 units 
are...
Quick Check  
Sales salaries and commissions are $10,000 when 
80,000 units are sold, and $14,000 when 120,000 
units are...
Quick Check  
Sales salaries and commissions are $10,000 when 
80,000 units are sold, and $14,000 when 120,000 
units are...
Least-Squares Regression Method 
A method used to analyze mixed costs if a scattergraph 
plot reveals an approximately lin...
Least-Squares Regression Method 
• Software can be used to fit 
a regression line through 
the data points. 
• The cost an...
Least-Squares Regression Method 
R2 is the percentage of the variation in total 
cost explained by the activity. 
* 
0 1 2...
Comparing Results From the Three 
Methods
Learning Objective 4 
PPrreeppaarree aann iinnccoommee 
ssttaatteemmeenntt uussiinngg tthhee 
ccoonnttrriibbuuttiioonn ffo...
The Contribution Format 
Let’s put our 
knowledge of cost 
behavior to work by 
preparing a 
contribution format 
income s...
The Contribution Format 
Total Unit 
Sales Revenue $ 100,000 $ 50 
Less: Variable costs 60,000 30 
Contribution margin $ 4...
Uses of the Contribution Format 
The contribution income statement format is used as an 
internal planning and decision ma...
The Contribution Format 
Comparison of the Contribution Income Statement 
with the Traditional Income Statement 
Tradition...
Practice question 3 
• Sales for a retail store were $250,000. Net operating 
income totaled $30,000 and cost of goods sol...
Practice question 4 
• In January, Verba Corporation, a manufacturing company, 
reported the following financial data: 
• ...
End of Chapter 5
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Chapter5 140823230337-phpapp01

  1. 1. Cost Behavior: Analysis and Use Chapter Five
  2. 2. Learning Objective 1 UUnnddeerrssttaanndd hhooww ffiixxeedd aanndd vvaarriiaabbllee ccoossttss bbeehhaavvee aanndd hhooww ttoo uussee tthheemm ttoo pprreeddiicctt ccoossttss..
  3. 3. Types of Cost Behavior Patterns Recall the summary of our cost behavior discussion from an earlier chapter. 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.
  4. 4. The Activity Base A measure of what A measure of what causes the causes the incurrence of a variable cost incurrence of a variable cost Units produced Units produced Miles driven Miles driven Machine hours Machine hours Labor hours Labor hours
  5. 5. Minutes Talked Total Long Distance Telephone Bill True Variable Cost Example 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.
  6. 6. Types of Cost Behavior Patterns Recall the summary of our cost behavior discussion from an earlier chapter. 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.
  7. 7. Variable Cost Per Unit Example A variable cost remains constant if expressed on a per unit basis. The cost per minute talked is constant. For example, 10 cents per minute. Minutes Talked Telephone Charge Per Minute
  8. 8. Extent of Variable Costs 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.
  9. 9. Examples of Variable Costs 1. Merchandising companies – cost of goods sold. 2. Manufacturing companies – direct materials, direct labor, and variable overhead. 3. Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs, such as invoicing. 4. Service companies – supplies, travel, and clerical.
  10. 10. Volume Cost True Variable 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.
  11. 11. Step-Variable Costs 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
  12. 12. Step-Variable Costs Small changes in the level of production are not likely to have any effect on the number of maintenance workers employed. Volume Cost
  13. 13. Step-Variable Costs Only fairly wide changes in the activity level will cause a change in the number of maintenance workers employed Volume Cost
  14. 14. The Linearity Assumption and the Relevant Relevant Range A straight line A straight line closely closely approximates a curvilinear variable cost line within the approximates a curvilinear variable cost line within the relevant range. relevant range. Range Activity Total Cost Economist’s Curvilinear Cost Function Accountant’s Straight-Line Approximation (constant unit variable cost)
  15. 15. Types of Cost Behavior Patterns Let’s look at fixed cost behavior on the next screens. 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.
  16. 16. Number of Local Calls Monthly Basic Telephone Bill Total Fixed Cost Example 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.
  17. 17. Types of Cost Behavior Patterns Recall the summary of our cost behavior discussion from an earlier chapter. 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.
  18. 18. Fixed Cost Per Unit Example Average fixed costs per unit decrease as the activity level increases. The fixed cost per local call decreases as more local calls are made. Number of Local Calls Monthly Basic Telephone Bill per Local Call
  19. 19. Types of Fixed Costs Examples Advertising and Research and Development Examples Depreciation on Equipment and Real Estate Taxes Discretionary May be altered in the short-term by current managerial decisions Committed Long-term, cannot be significantly reduced in the short term.
  20. 20. The Trend Toward Fixed Costs 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.
  21. 21. Is Labor a Variable or a Fixed Cost? 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.
  22. 22. Rent Cost in Thousands of Fixed Costs and Relevant Range 90 60 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 Dollars 0 1,000 2,000 3,000 activity. Rented Area (Square Feet) 30 0 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.
  23. 23. Fixed Costs and Relevant Range The relevant range of activity for a fixed cost is the range of activity over which the graph of the cost is flat. EExxaammppllee:: OOffffiiccee ssppaaccee iiss aavvaaiillaabbllee aatt aa rreennttaall rraattee ooff $$330,,000 ppeerr yyeeaarr iinn iinnccrreemmeennttss ooff 1,,000 ssqquuaarree ffeeeett.. AAss tthhee bbuussiinneessss ggrroowwss,, mmoorree ssppaaccee iiss rreenntteedd,, iinnccrreeaassiinngg tthhee ttoottaall ccoosstt..
  24. 24. Fixed Costs and Relevant Range How does this type of fixed cost differ from a step-variable cost? Step-variable costs can be adjusted more quickly and . . . The width of the activity steps is much wider for the fixed cost.
  25. 25. Quick Check  Which of the following statements about cost behavior are true? 1. Fixed costs per unit vary with the level of activity. 2. Variable costs per unit are constant within the relevant range. 3. Total fixed costs are constant within the relevant range. 4. Total variable costs are constant within the relevant range.
  26. 26. Quick Check  Which of the following statements about cost behavior are true? 1. Fixed costs per unit vary with the level of activity. 2. Variable costs per unit are constant within the relevant range. 3. Total fixed costs are constant within the relevant range. 4. Total variable costs are constant within the relevant range.
  27. 27. Variable Cost per KW Fixed Monthly Utility Charge Mixed Costs Activity (Kilowatt Hours) Total Utility Cost X Y A mixed cost has both fixed and variable components. Consider the example of utility cost. Total mixed cost
  28. 28. Variable Cost per KW Fixed Monthly Utility Charge Activity (Kilowatt Hours) Total Utility Cost X Y Mixed Costs Total mixed cost
  29. 29. Mixed Costs Example 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
  30. 30. Analysis of Mixed Costs Account Analysis and the Engineering Approach 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.
  31. 31. Learning Objective 2 UUssee aa ssccaatttteerrggrraapphh pplloott ttoo ddiiaaggnnoossee ccoosstt bbeehhaavviioorr..
  32. 32. Plot the data points on a graph (total cost vs. activity). * 0 1 2 3 4 * Maintenance Cost 1,000’s of Dollars 20 10 0 * * * * * * * * Patient-days in 1,000’s X Y The Scattergraph Method
  33. 33. The Scattergraph Method Draw a line through the data points with about an equal numbers of points above and below the line. * 0 1 2 3 4 * Maintenance Cost 1,000’s of Dollars 20 10 0 * * * * * * * * Patient-days in 1,000’s X Y
  34. 34. The Scattergraph Method Use one data point to estimate the total level of activity and the total cost. TToottaall mmaaiinntteennaannccee ccoosstt == $$1111,,000000 * Intercept = Fixed cost: $10,000 0 1 2 3 4 * Maintenance Cost 1,000’s of Dollars 20 10 0 * * * * * * * * Patient-days in 1,000’s X Y PPaattiieenntt ddaayyss == 880000
  35. 35. The Scattergraph Method Make a quick estimate of variable cost per unit and determine the cost equation. Total maintenance at 800 patients $ 11,000 Less: Fixed cost 10,000 Estimated total variable cost for 800 patients $ 1,000 Variable cost per unit = $1,000 800 = $$11..2255//ppaattiieenntt--ddaayy YY == $$1100,,000000 ++ $$11..2255XX
  36. 36. Learning Objective 3 AAnnaallyyzzee aa mmiixxeedd ccoosstt uussiinngg tthhee hhiigghh--llooww mmeetthhoodd..
  37. 37. The High-Low Method Assume the following hours of maintenance work and the total maintenance costs for six months.
  38. 38. The High-Low Method TThhee vvaarriiaabbllee ccoosstt ppeerr hhoouurr ooff mmaaiinntteennaannccee iiss eeqquuaall ttoo tthhee cchhaannggee iinn ccoosstt ddiivviiddeedd bbyy tthhee cchhaannggee iinn hhoouurrss..
  39. 39. The High-Low Method Total Fixed Cost = Total Cost – Total Variable Cost Total Fixed Cost = $9,800 – ($8/hour × 800 hours) Total Fixed Cost = $9,800 – $6,400 Total Fixed Cost = $3,400
  40. 40. The High-Low Method The Cost Equation for Maintenance YY == $$33,,440000 ++ $$88..0000XX
  41. 41. Quick Check  Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the variable portion of sales salaries and commission? a. $0.08 per unit b. $0.10 per unit c. $0.12 per unit d. $0.125 per unit
  42. 42. Quick Check  Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the variable portion of sales salaries and commission? a. $0.08 per unit b. $0.10 per unit Units Cost c. $0.12 per unit d. $0.125 per unit High level 120,000 $ 14,000 Low level 80,000 10,000 Change 40,000 $ 4,000 $4,000 ÷ 40,000 units = $0.10 per unit
  43. 43. Quick Check  Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000
  44. 44. Quick Check  Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000
  45. 45. Least-Squares Regression Method 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. TThhee ggooaall ooff tthhiiss mmeetthhoodd iiss ttoo ffiitt aa ssttrraaiigghhtt lliinnee ttoo tthhee ddaattaa tthhaatt minimizes the sum of the squared errors..
  46. 46. Least-Squares Regression Method • Software can be used to fit a regression line through the data points. • The cost analysis objective is the same: Y = a + bX Least-squares regression also provides a statistic, called the R2, which is a measure of the goodness of fit of the regression line to the data points.
  47. 47. Least-Squares Regression Method R2 is the percentage of the variation in total cost explained by the activity. * 0 1 2 3 4 Total Cost 20 10 0 Activity * * * * * * * * * R2 varies from 0% to 100%, and the higher the percentage the better. X Y
  48. 48. Comparing Results From the Three Methods
  49. 49. Learning Objective 4 PPrreeppaarree aann iinnccoommee ssttaatteemmeenntt uussiinngg tthhee ccoonnttrriibbuuttiioonn ffoorrmmaatt..
  50. 50. The Contribution Format Let’s put our knowledge of cost behavior to work by preparing a contribution format income statement.
  51. 51. The Contribution Format Total Unit Sales Revenue $ 100,000 $ 50 Less: Variable costs 60,000 30 Contribution margin $ 40,000 $ 20 Less: Fixed costs 30,000 Net operating income $ 10,000 The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and provides for income.
  52. 52. Uses of the Contribution Format The contribution income statement format is used as an internal planning and decision making tool. We will use this approach for: 1. Cost-volume-profit analysis (Chapter 6). 2. Budgeting (Chapter 9). 3. Segmented reporting of profit data (Chapter 12). 4. Special decisions such as pricing and make-or-buy analysis (Chapter 13).
  53. 53. The Contribution Format Comparison of the Contribution Income Statement with the Traditional Income Statement Traditional Approach Contribution Approach (costs organized by function) (costs organized by behavior) Sales $ 100,000 Sales $ 100,000 Less cost of goods sold 70,000 Less variable expenses 60,000 Gross margin $ 30,000 Contribution margin $ 40,000 Less operating expenses 20,000 Less fixed expenses 30,000 Net operating income $ 10,000 Net operating income $ 10,000 Used primarily for external reporting. Used primarily by management.
  54. 54. Practice question 3 • Sales for a retail store were $250,000. Net operating income totaled $30,000 and cost of goods sold was $110,000. If the contribution margin was $100,000, total variable selling and administrative expenses must have been: • A) $40,000 • B) $100,000 • C) $70,000 • D) $150,000
  55. 55. Practice question 4 • In January, Verba Corporation, a manufacturing company, reported the following financial data: • Sales .......................................................... $460,000 Variable production expense..................... $84,000 Fixed production expense ......................... $100,000 Variable selling expense ........................... $12,000 Fixed selling expense ................................ $47,000 Variable administrative expense ............... $33,000 Fixed administrative expense.................... $132,000 • Required: • Prepare an income statement in good form for January using the traditional approach. • Prepare an income statement in good form for January using the contribution approach.
  56. 56. End of Chapter 5

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