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CHAPTER 9
I. Questions
4. Although the accountant recognizes that many costs are not linear in
relationship to volume at some points, he concentrates on their behavior
within narrow bands of activity known as the relevant range. The relevant
range can be defined as that range of activity within which assumptions as
relative to variable and fixed cost behavior are valid. Generally, within
this range an assumption of strict linearity can be used with insignificant
loss of accuracy.
5. The high-low method, the scattergraph method, and the least-squares
regression method are used to analyze mixed costs. The least-squares
regression method is generally considered to be most accurate, since it
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Chapter 9 Cost Behavior: Analysis and Use
6. The fixed cost element is represented by the point where the regression
line intersects the vertical axis on the graph. The variable cost per unit is
represented by the slope of the line.
8. No. High correlation merely implies that the two variables move together
in the data examined. Without economic plausibility for a relationship, it
is less likely that a high level of correlation observed in one set of data will
be found similarly in another set of data.
10. The relevant range is the range of the cost driver in which a specific
relationship between cost and cost driver is valid. This concept enables
the use of linear cost functions when examining CVP relationships as long
as the volume levels are within that relevant range.
11. A unit cost is computed by dividing some amount of total costs (the
numerator) by the related number of units (the denominator). In many
cases, the numerator will include a fixed cost that will not change despite
changes in the denominator. It is erroneous in those cases to multiply the
unit cost by activity or volume change to predict changes in total costs at
different activity or volume levels.
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15. The dependent variable is the cost object of interest in the cost estimation.
An important issue in selecting a dependent variable is the level of
aggregation in the variable. For example, the company, plant, or
department may all be possible levels of data for the cost object. The
choice of aggregation level depends on the objectives for the cost
estimation, data availability, reliability, and cost/benefit considerations. If
a key objective is accuracy, then a detailed level of analysis is often
preferred. The detail cost estimates can then be aggregated if desired.
16. Nonlinear cost relationships are cost relationships that are not adequately
explained by a single linear relationship for the cost driver(s). In
accounting data, a common type of nonlinear relationship is trend and
seasonality. For a trend example, if sales increase by 8% each year, the
plot of the data for sales with not be linear with the driver, the number of
years. Similarly, sales which fluctuate according to a seasonal pattern
will have a nonlinear behavior. A different type of nonlinearity is where
the cost driver and the dependent variable have an inherently nonlinear
relationship. For example, payroll costs as a dependent variable estimated
by hours worked and wage rates is nonlinear, since the relationship is
multiplicative and therefore not the additive linear model assumed in
regression analysis.
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Cost Behavior: Analysis and Use Chapter 9
18. High correlation exists when the changes in two variables occur together.
It is a measure of the degree of association between the two variables.
Because correlation is determined from a sample of values, there is no
assurance that it measures or describes a cause and effect relationship
between the variables.
II. Exercises
1. b
2. f
3. e
4. i
5. e
6. h
7. l
8. a
9. j
10. k
11. c or d
12. g
Requirement (1)
Variable costs:
P4,700 – P2,800
4,050 – 2,375 = P1.134
Fixed costs:
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Chapter 9 Cost Behavior: Analysis and Use
There are two choices for the High-Low points when using openings for the
cost driver. At 11 openings there is a cost of P2,800 and at 10 openings there
is a cost of P2,875.
Variable costs:
P4,700 – P2,800
19 – 11 = P237.50
Fixed costs:
Variable costs:
P4,700 – P2,875
19 – 10 = P202.78
Fixed costs:
Predicted total cost for a 3,200 square foot house with 14 openings using
equation one:
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Predicted total cost for a 3,200 square foot house with 14 openings using
equation two:
Predicted total cost for a 3,200 square foot house with 14 openings using
equation three:
Predicted cost for a 2,400 square foot house with 8 openings, using equation
one:
Requirement 2
Figure 9-A shows that the relationship between costs and square feet is
relatively linear without outliers, while Figure 9-B shows a similar result for
the relationship between costs and number of openings. From this perspective,
both variables are good cost drivers.
Figure 9-A
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Chapter 9 Cost Behavior: Analysis and Use
Figure 9-B
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Requirement 1
Fixed Costs:
Rent P10,250
Depreciation 400
Insurance 750
Advertising 650
Utilities 1,250
Mr. Black’s salary 18,500
Total P31,800
Variable Costs:
Wages P17,800
CD Expense 66,750
Shopping Bags 180
Total P84,730
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Requirement 2
Requirement 3
Requirement 1
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Requirement 2
There seems to be a positive linear relationship for the data between P2,500
and P4,000 of advertising expense. Llanes’ analysis is correct within this
relevant range but not outside of it. Notice that the relationship between
advertising expense and sales changes at P4,000 of expense.
III. Problems
Problem 1
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Problem 2
Requirement 1
Requirement 2
P36,000
Salaries and comm. expense: 1,500 units = P24 per unit.
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Requirement 3
LILY COMPANY
Income Statement
For the Month Ended June 30
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Problem 3
Requirement 1
a = (Y) - b(X)
n
(54,500) - 1,700 (20)
=
5
= P4,100
Therefore, the variable cost per league is P1,700 and the fixed cost is
P4,100 per year.
Requirement 2
Y = P4,100 + P1,700X
Requirement 3
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The problem with using the cost formula from (2) to derive this total cost
figure is that an activity level of 7 sections lies outside the relevant range from
which the cost formula was derived. [The relevant range is represented by a
solid line on the graph in requirement 4 below.]
Although an activity figure may lie outside the relevant range, managers will
often use the cost formula anyway to compute expected total cost as we have
done above. The reason is that the cost formula frequently is the only basis
that the manager has to go on. Using the cost formula as the starting point
should not present a problem so long as the manager is alert for any unusual
problems that the higher activity level might bring about.
Requirement 4
P16,000 Y
P14,000
P12,000
P10,000
P8,000
P6,000
P4,000
P2,000
X
P-
0 1 2 3 4 5 6 7 8
Problem 4 (Regression Analysis, Service Company)
Requirement 1
Figure 9-C plots the relationship between labor-hours and overhead costs and
shows the regression line.
y = P48,271 + P3.93 X
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Chapter 9 Cost Behavior: Analysis and Use
scheduling, hiring and training of workers, and managing the workforce are
largely incurred to support labor.
Goodness of fit. The vertical differences between actual and predicted costs
are extremely small, indicating a very good fit. The good fit indicates a strong
relationship between the labor-hour cost driver and overhead costs.
Slope of regression line. The regression line has a reasonably steep slope
from left to right. The positive slope indicates that, on average, overhead
costs increase as labor-hours increase.
Requirement 2
The regression analysis indicates that, within the relevant range of 2,500 to
7,500 labor-hours, the variable cost per person for a cocktail party equals:
Food and beverages P15.00
Labor (0.5 hrs. x P10 per hour) 5.00
Variable overhead (0.5 hrs. x P3.93 per labor-hour) 1.97
Total variable cost per person P21.97
Requirement 3
Of course, Bobby Gonzales will consider other factors in developing his bid
including (a) an analysis of the competition – vigorous competition will limit
Gonzales’ ability to obtain a higher price (b) a determination of whether or not
his bid will set a precedent for lower prices – overall, the prices Bobby
Gonzales charges should generate enough contribution to cover fixed costs and
earn a reasonable profit, and (c) a judgment of how representative past
historical data (used in the regression analysis) is about future costs.
Figure 9-C
Regression Line of Labor-Hours on Overhead Costs for Bobby Gonzales’
Catering Company
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Cost Behavior: Analysis and Use Chapter 9
Requirement 1
Difference in cost
Slope coefficient (b) =
Difference in labor-hours
= P529,000 – P400,000 = P43.00
7,000 – 4,000
Constant (a) = P529,000 – P43.00 (7,000)
= P228,000
No, the constant component of the cost function does not represent the fixed
overhead cost of the ABS Group. The relevant range of professional labor-
hours is from 3,000 to 8,000. The constant component provides the best
available starting point for a straight line that approximates how a cost
behaves within the 3,000 to 8,000 relevant range.
Requirement 2
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The data are shown in Figure 9-D. The linear cost function overstates costs
by P8,000 at the 5,000-hour level and understates costs by P15,000 at the
8,000-hour level.
Requirement 3
Based on
Based on Linear Cost
Actual Function
Contribution before deducting incremental
overhead P38,000 P38,000
Incremental overhead 35,000 43,000
Contribution after incremental overhead P 3,000 P (5,000)
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* Supporting Computations:
11. (10,000 x 2) – (P3,000 x 2) – P5,000 = P9,000
12. [(P20 + P3 + P6) x 2,000 units] + (P10 x 1,000 units) = P68,000
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