Cost

behaviour:
Analysis and
Use

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Types of Cost behaviour

Patterns

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Total Variable Cost

Example

Total Long Distance

Telephone Bill

Your total long distance telephone bill is

based on how many minutes you talk.

Minutes Talked
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Variable Cost Per Unit

Example

Per Minute
Telephone Charge

The cost per minute talked is constant.

For example, 10 pence per minute.

Minutes Talked
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Total Fixed Cost Example

Monthly Basic
Telephone Bill

Your monthly basic telephone bill is

probably fixed and does not change
when you make more local calls.

Number of Local Calls

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Fixed Cost Per Unit

Example
Monthly Basic Telephone
Bill per Local Call

The fixed cost per local call decreases as

more local calls are made.

Number of Local Calls

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Cost behaviour
Examples of normally variable costs
Merchandisers

Service Organizations

Cost of Goods Sold

Supplies and travel

Manufacturers

Merchandisers and
Manufacturers

Direct Material, Direct

labour, and Variable
Manufacturing Overhead

Sales commissions and

shipping costs

Examples of normally fixed costs

Merchandisers, manufacturers, and
service organizations
Real estate taxes, Insurance, Sales salaries
Depreciation, Advertising
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The Activity Base

Units
produced

Machine
hours

A measure of the event

causing the incurrence of a
variable cost a cost driver

Miles
driven

Labour
hours
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Step-Variable Costs

Cost

Total cost remains

constant within a
narrow range of
activity.

Activity
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Step Costs

Cost

Total cost increases to a

new higher cost for the
next higher range of
activity.

Activity
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The Linearity Assumption

and the Relevant Range

Total Cost

Economists
Curvilinear Cost
Function

Activity

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The Linearity Assumption

and the Relevant Range

Total Cost

Economists
Curvilinear Cost
Function

Accountants Straight-Line
Approximation (constant
unit variable cost)
Activity

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Total Cost

The Linearity Assumption

and the Relevant Range

Relevant
Range

AAstraight
straight line
line
closely
closely
Economists
approximates
Curvilinear Cost approximates
aa curvilinear
curvilinear
Function
variable
variable cost
cost
line
line within
within the
the
relevant
relevant
range.
range.
Accountants Straight-Line
Approximation (constant
unit variable cost)

Activity

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Types of Fixed Costs

Fixed Costs
Committed

Discretionary

Long-term, cannot be
reduced in the short
term.

May be altered in the

short-term by current
managerial decisions

Examples

Examples

Depreciation on
Buildings and
Equipment

Advertising and
Research and
Development
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Trend Toward Fixed Costs

Increased automation.
Increase in salaried knowledge
workers who are difficult to train
and
replace.
Implications
Implications
Managers
Managersare
aremore
morelocked-in
locked-inwith
with fewer
fewer decision
decision
alternatives.
alternatives.
Planning
Planningbecomes
becomesmore
morecrucial
crucial because
becausefixed
fixedcosts
costsare
are
difficult
difficult to
tochange
changewith
withcurrent
current operating
operatingdecisions.
decisions.
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Fixed Costs and Relevant

Range
Example: Office space
is available at a rental
rate of 30,000 per
year in increments of
1,000 square metres.
As the business grows
more space is rented,
increasing the total
cost.

Continue
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Rent Cost in
Thousands of pounds

Fixed Costs and Relevant

Range
90

60

30
00

Relevant
Range

Total cost doesnt

change for a wide
range of activity,
and then jumps to a
new higher cost for
the next higher
range of activity.

1,000
2,000
3,000
Rented Area (Square metres)
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Semi-variable Costs
(also called mixed cost)
A semi-variable
cost
has both fixed
and variable
components.

Consider the
following electric
utility example.
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Mixed Costs

Total Utility Cost

l
a
t
To

os
c
d
e
x
i

Variable
Utility Charge
Fixed Monthly

Activity (Kilowatt Hours)

Utility Charge

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Mixed Costs
The total mixed cost line can be expressed
as an equation: Y = a + bX

Total Utility Cost

Where:

l
a
t
To

os
c
d
e
x
i

a
=
Y

Y = the total mixed cost

X
b
+

a = the total fixed cost (the

vertical intercept of the line)
b = the variable Variable
cost per unit of
activity (the
slopeCharge
of the line)
Utility
X = the level of activity

Fixed Monthly
Activity (Kilowatt Hours)

Utility Charge

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Mixed Costs

Total Utility Cost

m
l
a
t
To

os
c
d
e
x
i

a
=
Y

X
b
+

Variable

bX

Utility Charge
Fixed Monthly

a
Activity (Kilowatt Hours)

Utility Charge

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The Analysis of Mixed

Costs
Account Analysis
Engineering Approach
High-Low Method
Scattergraph Method
Least-Square Regression Method
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Account Analysis

Each account is classified as either

variable or fixed based on the analysts
knowledge of how the account behaves.
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Engineering Estimates

Cost estimates are based on an evaluation

of production methods, and material, labour
and overhead requirements.
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The High-Low Method

WiseCo recorded the following production activity and
maintenance costs for two months:

Using these two levels of activity, compute:

the variable cost per unit;
the fixed cost; and then
express the costs in equation form Y = a + bX.

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The High-Low Method

Unit variable cost =

Changein cost
Change in units

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The High-Low Method

Unit variable cost = 3,600 4,000 units = 0.90 per unit

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The High-Low Method

Unit variable cost = 3,600 4,000 units = 0.90 per unit

Fixed cost = Total cost Total variable cost
Fixed cost = 9,700 (0.90 per unit 9,000 units)
Fixed cost = 9,700 8,100 = 1,600

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The High-Low Method

Unit variable cost = 3,600 4,000 units = 0.90 per unit

Fixed cost = Total cost Total variable cost
Fixed cost = 9,700 (0.90 per unit 9,000 units)
Fixed cost = 9,700 8,100 = 1,600

Total cost = Fixed cost + Variable cost (Y = a + bX)

Y = 1,600 + 0.90X
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The High-Low Method

IfIf sales
sales salaries
salaries and
and commissions
commissions are
are
10,000
10,000 when
when 80,000
80,000 units
units are
are sold
sold and
and
14,000
14,000 when
when 120,000
120,000 units
units are
are sold,
sold, what
what is
is
the
the variable
variable portion
portion of
of sales
sales salaries
salaries and
and
commission?
commission?
a.
a. 0.08
0.08 per
per unit
unit
b.
b. 0.10
0.10 per
per unit
unit
c.
c. 0.12
0.12 per
per unit
unit
d.
d. 0.125
0.125 per
per unit
unit
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The High-Low Method

IfIf sales
sales salaries
salaries and
and commissions
commissions are
are
10,000
10,000 when
when 80,000
80,000 units
units are
are sold
sold and
and
14,000
14,000 when
when 120,000
120,000 units
units are
are sold,
sold, what
what
is
is the
the variable
variable portion
portion of
of sales
sales salaries
salaries and
and
commission?
commission?
a.
a. 0.08
0.08 per
per unit
unit
b.
b. 0.10
0.10 per
per unit
unit
c.
c. 0.12
0.12 per
per unit
unit
4,000 40,000 units
d.
d. 0.125
0.125 per
per unit
unit
= 0.10 per unit

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The High-Low Method

IfIf sales
sales salaries
salaries and
and commissions
commissions are
are
10,000
10,000 when
when 80,000
80,000 units
units are
are sold
sold and
and
14,000
14,000 when
when 120,000
120,000 units
units are
are sold,
sold, what
what
is
is the
the fixed
fixed portion
portion of
of sales
sales salaries
salaries and
and
commissions?
commissions?
a.
a. 2,000
2,000
b.
b. 4,000
4,000
c.
c. 10,000
10,000
d.
d. 12,000
12,000
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The High-Low Method

IfIf sales
sales salaries
salaries and
and commissions
commissions are
are
10,000
10,000 when
when 80,000
80,000 units
units are
are sold
sold and
and
14,000
14,000 when
when 120,000
120,000 units
units are
are sold,
sold, what
what
is
is the
the fixed
fixed portion
portion of
of sales
sales salaries
salaries and
and
commissions?
commissions?
a.
a. 2,000
2,000
b.
b. 4,000
4,000
c.
c. 10,000
10,000
d.
d. 12,000
12,000
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The Scattergraph Method

Plot the data points on a
graph (total cost vs. activity).

Total Cost in
1,000s of pounds

Y
20

10

* *
* *

* ** *
**
X

0
1
2
3
4
Activity, 1,000s of Units Produced
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The Scattergraph Method

Draw a line through the data points with about an
equal numbers of points above and below the line.
Total Cost in
1,000s of pounds

Y
20

10

* *
* *

* ** *
**
X

0
1
2
3
4
Activity, 1,000s of Units Produced
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The Scattergraph Method

Total Cost in
1,000s of pounds

The slope of this line is the variable unit

cost. (Slope is the change in total cost
for a one unit change in activity).

20

10

* *
* *

* ** *
**

Estimated fixed cost = 10,000

0

0
1
2
3
4
Activity, 1,000s of Units Produced
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The Scattergraph Method

Slope =
Total Cost in
1,000s of pounds

Y
20

10

* *
* *

Change in cost
Change in units

* ** *
**

Vertical
distance
is the
change
in cost.

Horizontal distance is
the change in activity.

0
1
2
3
4
Activity, 1,000s of Units Produced
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Least-Squares Regression
Method
Accountants and
managers may use
computer software to fit
a regression line
through the data points.
The cost analysis
objective is the same: Y
= a + bx regression
Least-squares
Least-squares
regressionalso
also provides
providesaastatistic,
statistic, called
called
22
the
adjusted
R
the adjusted R ,,that
thatis
is aameasure
measure of
of the
thegoodness
goodness
of
of fit
fitof
ofthe
theregression
regressionline
lineto
tothe
thedata
datapoints.
points.
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Least-Squares Regression
Method
R2 is the percentage of the variation
in total cost explained by the activity.

Total Cost

Y
20

* *
* *

10

* ** *
**

R2 for this relationship is near

100% since the data points are
very close to the regression line.
X
1
2
3
4
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Activity

The Contribution Format

Lets put our

knowledge of cost
behaviour to work
by preparing a
contribution format
profit statement.
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The Contribution Format

The contribution margin format emphasizes cost

behaviour. Contribution margin covers fixed costs
and provides for profit.
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The Contribution Format

Used primarily for

external reporting.

Used primarily by
management.
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