chapter 7 Activity Analysis, Cost Behavior, and Cost

Estimation

The relationship between cost and activity is called cost behavior.

True
A)

False
B)

Feedback:
Cost behavior is the relationship between cost and activity and is relevant to the management
functions of planning, control, and decision making. LO 1
2 2

Knowledge of cost behavior is a key to

cost prediction.

True
A)

False
B)

Feedback:
A cost prediction is a forecast of cost at a particular level of activity. Knowledge of cost behavior will
help the manager to make the desired cost prediction.  LO 1
3 2

3 CORRECT
The process of determining how a
particular cost behaves is called cost
prediction.

True
A)

False
B)

Feedback:
Cost estimation is the process of determining cost behavior. Cost prediction is a forecast of cost at a
particular level of activity. LO 1, 4
4 2

4
INCORREC Cost estimation often focuses on historical
T data and cost prediction focuses on the
future.
True
 A)

False
B)

5
INCORREC A variable cost changes in total in direct
T proportion to changes in activity level.

True
A)

False
B)

Feedback:
The term variable cost is used to describe a cost's behavior. Variable costs increase in total in direct
proportion to increases in activity levels, but the per-unit cost remains constant. This is an important
concept in terms of cost control and planning. LO 2
6 2

6
INCORREC A cost that does not change in total as
T activity changes but changes inversely per
unit as activity changes is called a fixed
cost.

True
A)

False
B)

Feedback:
A fixed cost does not change in total as activity increases or decreases, but unit fixed cost changes
inversely with changes in levels of activity—an increase in activity will reduce the fixed cost per
unit and a decrease in activity will increase the fixed cost per unit. LO 2
7 2

7 CORRECT
A step-variable cost is a cost that
increases in large steps instead of
continuously, like a variable cost.

True
A)

False
B)
 Feedback:
A step-variable cost is a cost that increases in small steps instead of continuously, as does a variable
cost. For that reason, a step-variable cost may be approximated by a variable cost function without
much loss in accuracy. LO 2
8 2

8 CORRECT
A fixed cost remains unchanged in total as
activity level varies and remains
unchanged per unit of activity.

True
A)

False
B)

Feedback: The fixed cost per unit varies inversely to changes in activity. For this reason, it is
preferable to work with total fixed cost rather than fixed cost per unit in any cost analysis. LO 2

9 2

9
INCORREC The major difference between a step-fixed
T cost and a step-variable cost is the
change in the level of activity relative to
the change in cost.

True
A)

False
B)

Feedback:
Step-fixed costs are costs that remain fixed over a wide range of activity, but jump to a different
amount for activity levels outside that range. The pattern of step-variable costs is such that they can
be treated as variable costs without much loss in accuracy. LO 2
10 2

10
INCORREC A Salaries Expense account that includes
T both salaries and commissions is an
example of a semivariable cost.

True
A)

False
B)

Feedback:
A semivariable cost has both a fixed and variable component. The salaries are a fixed cost and the
 commissions are a variable cost. LO 2
11 2

11
INCORREC A mixed cost is a cost that has both a
T fixed cost and a variable cost component.

True
A)

False
B)

Feedback:
Also known as semivariable costs, mixed costs contain both a fixed cost and a variable cost
component. For analysis, it is necessary to separate the components through visual fit, high-low,
least-squares regression, multiple-regression, or engineering methods of cost estimation. LO 2, 5, 6
12 2

12
INCORREC A curvilinear cost behavior pattern is a
T curved graph.

True
A)

False
B)

Feedback:
At low levels of activity, the curvilinear cost exhibits decreasing marginal costs, which is the cost of
producing the next unit. LO 2
13 2

13
CORRECT Methods of cost estimation cannot be
applied to curvilinear cost patterns.

True
A)

False
B)

Feedback:
While some costs may have a curvilinear cost pattern, within a relevant range of that pattern the cost
tends to behave as a semivariable cost (the slope of the regression line is a straight line). Within that
relevant range, cost estimation techniques can be applied. LO 2
14 2

14
INCORREC A relevant range is the range of activity
T within which management expects the
 organization to operate.

True
A)

False
B)

Feedback: Management usually does not expect a company to do nothing or to exceed normal
outputs; there is a range of activity that is expected. This is the relevant range; and within that range
15 2

curvilinear costs tend to be linear, mimicking variable costs. LO 3

15
CORRECT Direct-labor costs, like direct-material
costs, are always treated as variable
costs.

True
A)

False
B)

Feedback: When contracts or other circumstances make it difficult to lay off workers during an
economic downturn, or if top management adopts a policy of maintaining a stable workforce, direct-
16 2

labor costs will tend to be largely fixed. LO 3

16
INCORREC Costs that result from an organization's
T ownership or use of facilities and its basic
organization structure are called
committed costs.

True
A)

False
B)

Feedback:
Committed costs result from an organization's ownership or use of facilities and its basic organization
structure. LO 4
17 2

17
INCORREC Costs that arise as a result of a
T management decision to spend a
particular amount of money for some
purpose are called discretionary costs.

True
A)
 False
B)

18
INCORREC A cost that results from a definitive
T physical relationship with the activity
measure is called an engineered cost.

True
A)

False
B)

Feedback:
An engineered cost results from a definitive physical relationship to the activity measure. LO 4
19 2

19
CORRECT Depreciation on buildings is an example of
an engineered cost.

True
A)

False
B)

Feedback:
Engineered costs bear a definite physical relationship to the activity measure. It is impossible to
increase activity without increasing total engineered costs. Direct-material cost is an example of an
engineered cost; that is, it is impossible to produce more units without incurring greater material
costs. LO 4
20 2

20
INCORREC Committed costs can be changed only
T through relatively major decisions that
have long-term implications.

True
A)

False
B)

Feedback: These types of decision will generally influence costs incurred over a long period time. In
contrast, discretionary costs can be more easily changed in the short run without incurring long-term
21 2

effects on production. LO 4

21
CORRECT Variable costs are becoming more
prevalent in many industries.
 True
A)

False
B)

Feedback: Fixed costs are becoming more prevalent in many industries because (1) automation is
replacing labor (a variable cost) to an increasing extent and (2) labor unions have been increasingly
22

successful in negotiating agreements that result in a relatively stable workforce. LO 4

2

22
INCORREC Computer-integrated manufacturing (CIM)
T and flexible manufacturing system (FMS)
have resulted in increases in committed
fixed costs.

True
A)

False
B)

Feedback: The investments and maintenance costs of CIM and FMS constitute very large committed
fixed costs. The compensation for the highly skilled personnel necessary to maintain CIM and FMS are
23 2

largely committed fixed costs. LO 4

23
CORRECT Usually, there are few differences between
operations-based cost drivers and
volume-based cost drivers.

True
A)

False
B)

Feedback: As the number of operations required to produce a particular volume of production

increases, the cost per unit will increase. However, reducing the number of operations required for a
24 2

particular volume of production will decrease the cost per unit. LO 4

24
INCORREC Cost behavior patterns are applicable to
T service industries as well as
manufacturing industries.

True
A)
False
 B)

Feedback: The cost behavior patterns are found in all types of industries. All industries have fixed
costs, variable costs, and semi-variable costs. The choice of cost driver, however, is not always
25

obvious, and the cost behavior pattern can depend on the cost driver selected. LO 4
2

25
INCORREC Cost estimation is the process of
T determining how a particular cost
behaves.

True
A)

False
B)

Feedback:
Cost estimation involves selecting one or more of several methods that are commonly used to
estimate the relationship between cost and activity. LO 5
26 2

26
CORRECT Another term for account-classification is
account analysis.

True
A)

False
B)

Feedback:
Account-classification involves careful examination of the ledger cost accounts for the purpose of
classifying each cost as variable, fixed, or semivariable. Account-classification is also called account
analysis. LO 5
27 2

27
CORRECT Because each cost has its own behavioral
characteristics it is impossible to
determine from ledger accounts whether a
cost is fixed, variable, or curvilinear.

True
A)

False
B)

Feedback:
The account-classification method (or account analysis) of cost estimation can be used to determine
 the behavior of some costs. One would expect, for example, that the Deprecation Expense account
would disclose whether depreciation is fixed (straight-line) or variable (units of production). LO 5
28 2

28
INCORREC A scatter diagram is the result of using
T the visual-fit method to plot recent
observations of a cost at various levels of
activity.

True
A)

False
B)

Feedback:
The visual-fit method requires plotting recent observations of cost and activity on a graph with the
vertical axis scaled for increasing levels of cost and the horizontal axis scaled for increasing levels of
activity (a scatter diagram), and drawing a line through the plotted observations is such a fashion as
to have an equal number of plotted observations above and below the line. LO 5
29 2

29
INCORREC A weakness of the visual-fit method of
T determining cost behavior is that when
the visual-fit cost line is drawn on the
scatter diagram there is no way to
determine if the cost is curvilinear.

True
A)

False
B)

Feedback: Most curvilinear costs tend to be straight within the relevant range of activity which is the
30

range shown for the data points on a scatter diagram with a visual-fit cost line. LO 5
2

30
INCORREC A data point that falls far away from the
T other points in a scatter diagram is called
an outlier.

True
A)

False
B)

Feedback:
An outlier is a data point that falls far away from the other points in a scatter diagram and is not
 representative of the data. LO 5
31 2

31
INCORREC
T

Using the high-low method of cost

estimations, the variable cost per unit is
$1.20.

True
A)

False
B)

Feedback: The difference between the cost corresponding to the highest and lowest activity levels is
$18,000 (= $50,000 - $32,000). The difference between the highest and lowest activity levels is
15,000 (= 35,000 – 20,000). The variable cost per unit is $1,20 (= $18,000/15,000). LO 5
32 2

32
CORRECT The high-low method of cost estimation is
superior to the visual-fit method of cost
estimation.

True
A)

False
B)

Feedback: The major weakness of the high-low method is that it considers only two activity levels,
either of which may be outside the relevant range. The visual-fit method is superior since
consideration is given to all available data (every activity level at which cost is measured). LO 5
33 2

33
INCORREC A method used to estimate objectively a
T cost behavior pattern that minimizes the
sum of the squared deviations between
the cost line and the data points is called
least squares regression method.

True
A)

False
B)
 Feedback:
The least-squares regressionmethod is used to estimate objectively a cost behavior pattern that
minimizes the sum of the squared deviations between the cost line and the data points. LO 5
34 2

34
INCORREC In the linear equation of Y = a + bX, Y is
T referred to as a dependent variable.

True
A)

False
B)

35
INCORREC The cost line fit to the data using least-
T squares regression is called the regression
line.

True
A)

False
B)

Feedback:
Unlike the visual-fit method of estimating cost behavior where a line is 'visually fitted' to the data, the
least-squares regression defines the line specifically. This line is called the regression line. LO 5
36 2

36
INCORREC In the equation of Y = a + bX, X is
T referred to as independent variable.

True
A)

False
B)

Feedback:
X is an independent variable, independent of both a and b. X represents the level of activity. LO 5
37 2

37
INCORREC If, in the equation of Y = a + bX, b =
T $2.40, Y = $36,000, and X = 5,000, then
fixed costs are $24,000.

True
A)
 False
B)

Feedback:
Substituting values, $36,000 = a + $2.40(5,000). The fixed costs (a) are $24,000 (= ($36,000
– ($2.40 x 5,000)). LO 5
38 2

38
CORRECT The perspective of economic plausibility is
of secondary concern when evaluating a
regression line.

True
A)

False
B)

Feedback:
Evaluation of a regression line would include, among other criteria, economic plausibility and
goodness of fit. The cost analyst should always evaluate a regression line from the perspective of
economic plausibility. LO 5

39 2

39
CORRECT When there is one dependent variable and
two or more independent variables,
simple-regression analysis can be used to
estimate a cost behavior pattern.

True
A)

False
B)

Feedback:
When there is one dependent variable and two or more independent variables, multiple regression
methods are used to estimate the relationships between the dependent variable and the independent
variables. LO 6
40 2

40
INCORREC The equation of Y = a + b1X1 + b2X2 is
T likely to be solved using multiple
 regression, rather than least-squares
regression.

True
A)

False
B)

Feedback:
Multiple-regression refers to a statistical method that estimates a linear (straight-line) relationship
between a dependent variable and two or more independent variables. LO 6
41 2

41
CORRECT The collection of data appropriate for cost
estimation often requires little skill or
experience.

True
A)

False
B)

Feedback: The collection of data appropriate for cost estimation requires a skilled and experienced
cost analyst who can deal with the problems that frequently complicate the process of data collection.
42 2

LO 7

42
INCORREC A major difference between the
T engineering method and other methods of
cost estimation (visual-fit, high-low, least-
squares regression, and multiple
regression) is that the engineering
method deals with cost incurrence rather
than cost history.

True
A)

False
B)

Feedback:
With the engineering method, questions of past or historical results are not the focus. The focus is on
what costs should be and how they will affect the organization's goals. LO 6
43 2

43
INCORREC A learning curve is a graphical
T presentation of the average time a
process is required for cumulative
production of output.
 True
A)

False
B)

Feedback:
As an example, a learning curve may be a graphical expression of the decline in the average labor
time required per unit as cumulative output increases. LO 6
44 2

44
INCORREC The experience curve is a graph (or other
T mathematical representation) that shows
how a broad set of costs decline as
cumulative production output increases.

True
A)

False
B)

Feedback:
An experience curve is a broadened application of the learning curve idea by including costs other
than direct labor. LO 6
45 2

45
INCORREC The use of temporary contract workers
T has recently been the fastest-growing
sector of employment.

True
A)

False
B)