MAS - 1301

MANAGEMENT ADVISORY SERVICES

COST CONCEPTS
Cost – reflects the monetary measure of resources given up to attain an objective such as acquiring a
good or service.
Expense – is the portion of an asset’s value consumed or sacrificed during a period.
Different cost classifications:
1. As to function – e.g., cost of sale, distribution cost, administrative cost, finance cost.
2. As to nature – e.g., employee benefits, depreciation and amortization
3. As to behavior – fixed cost, variable cost, mixed cost
4. as to traceability to cost objects – direct or indirect
5. Relevant cost and Irrelevant cost
6. Controllable and non controllable cost
7. Direct and indirect departmental cost
8. Opportunity and imputed cost
9. Out-of-pocket cost and non-cash cost
10. Sunk cost and future cost
11. Incremental cost and marginal cost

COSTS SENSITIVITY
Example 1.
MAHAL Co. has the following data:

Total fixed cost ……………………………………P200,000

Variable cost per unit……………………………… 20

What will happen to fixed cost and variable costs, per total and per unit, if production and sales are zero,
5,000 units, 10,000 units, and 15,000 units.

Production Total fixed Total variable Unit fixed Unit variable Total cost Total unit
cost cost cost cost cost
0
5,000
10,000
15,000

Costs Fixed costs Variable costs

Total cost Constant, regardless of levels
of production and sales
Unit costs Changes, decreases as
production increases and
vice-versa
Changes, in direct proportion
to the change in the level of
production and sales
Constant, regardless of levels
of production and sales

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Mixed Costs – are costs that could not be perfectly classified as pure fixed costs or pure variable costs.
It could either be semi-variable costs, semi-fixed costs, or step costs.
Relevant range – is a band of activity where the behavior of costs, expenses and revenues is valid. That
is total fixed cost is constant and total variable cost changes.

SEGRAGATION OF FIXED AND VARIABLE ELEMENTS OF MIXED COST

Basic formula:
Y = a + bx
Where: Y – total cost
a – fixed cost
b – variable cost
x – level of activity

HIGH-LOW METHOD – the principle used in this method resides on the assumption that any change in
total cost is attributable to the change in variable cost.

Formula:

b = Cost at High activity level – Cost at Low activity level or Change in total costs
High activity level – Low activity level Change in activity level

Example 2.
MAHAL Co. provided the following information:

Month Machine Hours Utility Cost

January 4,800 P 192.00
February 9,000 350.00
March 18,000 452.00
April 4,900 186.00
May 4,600 218.00
June 8,900 347.00
July 5,900 248.00
August 5,500 231.00

Required: Compute for the fixed cost and variable cost.

If the company expects to use 9,100 machine hours in September, how much is the
budgeted utility cost in September?

SCATTERGRAPH METHOD – plots observation on a graph and draws conclusion on the relationships
depicted by such observations. This method uses the principles found in a regression line. A
regression line is a straight line that depicts the relationship of two variables – one is
independent and the other is dependent.

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Example 3.
MAHAL Co. is analyzing the fixed and variable components of its materials handling cost in relation to
number of shipments received. The following data were taken from the historical records of the
company:

No.of shipments Materials No.of shipments Materials

Months received handling cost Months received handling cost
January 50 P 45,000 July 45 P45,000
February 60 52,000 August 55 54,000
March 90 70,000 September 65 50,000
April 70 55,000 October 80 60,000
May 40 37,000 November 75 58,000
June 60 58,000 December 70 60,000

Using the scattergraph technique, compute the fixed costs and the variable cost rate.

THE LEAST-SQUARES METHOD – this method extends the regression line to the other quadrant in
the wholistic quadrant analysis.

Formulas: Equation 1: Y = a + bx
Equation 2: ΣY = na + bΣx
Equation 3. ΣxY = aΣx + bΣx²

Example 4.

The chief finance officer of MAHAL Co. is analyzing the relationship of its electricity costs and the
number of batches produced. The following data are assembled for this purpose.

No.of Electricity No.of Electricity

Months batches cost Months batches cost
January 4 P 22,000 May 3 P 21,500
February 7 30,000 June 6 29,000
March 5 25,000 July 8 36,000
April 2 15,000

Determine the total fixed cost and variable cost rate of electricity using the least-squares method.

Coefficient of correlation (r) and coefficient of determination (r²)

Coefficient of correlation (r) – reflects the relationship between two variables, the dependent variable
”Y” and the independent variable “X”.

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