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# o Cost behaviour is the way in which a

## cost changes in relation to changes in

activity usage.
1. Variable costs: vary in direct
proportion with activity.
2. Fixed costs: remain constant over
wide ranges of activity.
3. Mixed costs: include both a fixed
and a variable component.
Variable and Fixed Cost behaviour (within the
relevant range):
Cost In Total Per Unit
Variable Changes in Remains
costs direct constant
proportion
Fixed Remains Changes
costs constant inversely
No. of Total Total Variable Fixed
units variable fixed Costs per Costs per
produced costs costs unit unit
1 200 500 200 500
2 400 500 200 250
4 800 500 200 125
8 1600 500 200 62.5
Methods of Separating Mixed
Costs

##  While some costs can be easy to classify as variable, or

fixed, others fall into the mixed-cost category.

##  This mixed cost needs to be separate into fixed and

variable components.

##  There are three widely used methods of separating a

mixed cost into its fixed and variable components: the
accounting method, the high-low method, and the
method of least squares.
Cost Equation
Costs can be represented by the following equation:

Y = a + bX
whereas:
Y = Total costs (dependent variable)
a = Fixed costs
b = Variable cost per unit
X = Volume of activity (output) (independent
variable)
Accounting Method OR
Mana gerial Judgment

##  Many accountants and managers use their

experience and prior knowledge of cost
relationships to determine fixed and variable
costs.
Accounting Method
Example:
Assume the following data, which are extracted from the
records of a certain company:
Cost items Total costs
Raw materials SDG 30000
Direct labour 45000
Electricity (supply) 9000
Building Rental 10000
Depreciation (St. line) 12000
Required:
Classify costs into fixed and variable cost using the accounting
method and formulate the cost equation, assuming that x =
3000 units.
Accounting Method
Cost items Total costs Variable costs Fixed costs
D. Materials SDG 30000 30000
D. Labour 45000 45000
Electricity 9000 9000
Build. Rent 10000 10000
Depreciation 12000 12000
Total 106000 84000 22000
Accounting Method

The equation = Y = a + bX
Y = 22000+28X
 In spite of its simplicity, the accounting method
ignores the possibility of mixed costs.
 In addition, this method suffers from a subjectivity
problem. Different results might be gained from
different accountants’ background and experiences.
High-Low Method

## o The high-low method is a very simple method which

depends on identifying the period with the lowest level of
activity and the period with the highest level of activity
(Dependent variables).
o Both these high and the low point are determined by the
high amount and the low amount of costs (Independent
variables).
High-Low Method

follows:

##  Second, we compute the fixed-cost component using

the total cost at either the high point or the low point.
High-Low Method
Example:
Below are the economic volume activity levels and related costs
in a certain company:

## Cost items Volume activity Volume activity

(5000 units) (10000 units)
Insurance expenses SDG 300 SDG 300
Depreciation expenses 400 800
Electricity 450 700
High-Low Method
Required:
Determine the cost structure using the high-low method.
 We can observed that insurance expenses are fixed costs
(remain constant when volumes changes).
 Depreciation expenses in direct proportion with the activity
(variable costs).
 However, electric. expenses are mixed costs, which need to
be separate into fixed and variables components using high-
low method.
High-Low Method
b = Change in cost/Change in output
b = (High cost - Low cost)/(High output - Low output)
=700-450/10000-5000
=250/5000
= 0.05
Y = a + bX
For high level,
700 = a + 0.05×10000
a =200
High-Low Method
 The high-low method has the advantage of
objectivity, i.e., any two people using this method on a
particular data set will arrive at the same result.
 However, the high-low has the following
 Volume of activity is not the only factor that
influence cost behaviour (there are other
factors???).
 The cost formula computed using these two
points might not represent what usually takes
place (inaccurate results).
 The difference between high and low cost points
might be high, and this might lead to abnormal
results.
High-Low Method
Example:

## 30000 units SDG 24000

50000 42000

You are required to separate the total costs into fixed and
variable components; using the high-low method.
High-Low Method
b = Change in cost/Change in output
b = (High cost - Low cost)/(High output - Low output)
=42000-24000/50000-30000
=18000/20000
b = 0.9
Y = a + bX
For high level,
42000 = a + 0.9×50000
a =-3000
M u l t i p l e Re g r e s s i o n A n a l y s i s
Method Or (LS)
o This statistical method. The idea of this method based on
computing an average of cost to represent the cost data, and
an average of output to represent the output data.
o Then we calculate the variable cost per unit as follows:
b = ∑̅x̅ y̅/ ∑̅ x̅² whereas,
x̅ = deviation scores of output, which show how much each
value differs the mean.
y̅ = deviation scores of costs, which show how much each value
differs the mean.
Multiple Reg r ession Anal ysis
Method

## Period Output Costs

(in units) (in thousands
of SDG)
2009 200 20
2010 200 30
2011 300 30
2012 300 40
2013 400 40
2014 400 50
Multiple Regression Analysis
Method
Yr. X Y x̅ y̅ x̅ y̅ x̅²

## 2010 200 30 -100 -5 500 10000

2011 300 30 0 -5 0 0

2012 300 40 0 5 0 0

## Tot. 1800 210 0 0 4000 40000

Multiple Regression Analysis
Method

## b = ∑̅x̅ y̅/ ∑̅ x̅² = 4000/40000 = SDG 0.1

Y = a + bX

35 = a + 0.1×300

a=5
M u l t i p l e Re g r e s s i o n A n a l y s i s
Method

## o The least-squares regression method, unlike the

high-low method, uses all of the data to separate
a mixed cost into fixed and variable components.
However,
o The formula that accomplish this are fairly
complex and involve numerous calculations.
EXERCISE
Pioneer Shipping Company decided to estimate the fixed and
variable components associated with the company’s shipping
activity. The following data are collected for the past six months:

## Packages Shipped Total Shipping Costs

10 € 800
20 1100
15 900
12 900
18 1050
25 1250
Multiple Regression Analysis
Method

Required:

## Estimate the fixed and variable cost from the

mixed shipping costs using the high-low
method. Using the formula, predict the total
cost of shipping if 14 packages are shipped.
THANK YOU