Cost Behavior: Analysis and Use

Chapter 5

McGrawHill/Irwin

Copyright2010byTheMcGrawHillCompanies,Inc.Allrightsreserved.

The Activity Base (also called a cost driver)

Machine
hours

Units
produced
A measure of what
causes the
incurrence of a
variable cost
Miles
driven

Labor
hours
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True Variable Cost An Example

Total Overage
Charges on Cell
Phone Bill

As an example of an activity base, consider

overage charges on a cell phone bill. The activity
base is the number of minutes used above the
allowed minutes in the calling plan.

Minutes Talked
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Variable Cost Per Unit An Example

Per Minute
Overage Charge

Referring to the cell phone example, the cost per

overage minute is constant, for example 45 cents per
overage minute.

Minutes Talked
5-4

Examples of Variable Costs

1. Merchandising companies cost of goods sold.
2. Manufacturing companies direct materials,
direct labor, and variable overhead.
3. Merchandising and manufacturing companies
commissions, shipping costs, and clerical costs
such as invoicing.
4. Service companies supplies, travel, and
clerical.

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True Variable Costs

Cost

The amount of a true variable cost used during the

period varies in direct proportion to the activity level.
The overage charge on a cell phone bill was one
example of a true variable cost.

Volume

Direct material is
another example
of a cost that
behaves in a true
variable pattern.
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Step-Variable Costs

Cost

A step-variable cost is a resource that is obtainable only

in large chunks (such as maintenance workers) and
whose costs change only in response to fairly wide
changes in activity.

Volume
5-7

The Linearity Assumption and the Relevant Range

Total Cost

Economists
Curvilinear Cost
Function
Relevant
Range

A
A straight
straight line
line
closely
closely
approximates
approximates aa
curvilinear
curvilinear
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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Total Fixed Cost An Example

Monthly Basic
Cell Phone Bill

For example, your cell phone bill probably includes a

fixed amount related to the total minutes allowed in
your calling plan. The amount does not change when
you use more or less allowed minutes.

Number of Minutes Used

within Monthly Plan
5-9

Fixed Cost Per Unit Example

Cost Per Cell Phone Call

For example, the fixed cost per minute used

decreases as more allowed minutes are used.

Number of Minutes Used

within Monthly Plan
5-10

Is Labor a Variable or a Fixed Cost?

The behavior of wage and salary costs can differ
across countries, depending on labor regulations,
labor contracts, and custom.
In France, Germany, China, and Japan, management has
little flexibility in adjusting the size of the labor force.
Labor costs are more fixed in nature.
In the United States and the United Kingdom, management
has greater latitude. Labor costs are more variable in nature.
Within countries managers can view labor costs differently
depending upon their strategy. Most companies in the
United States continue to view direct labor as a variable cost.
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Rent Cost in Thousands

of Dollars

Fixed Costs and the Relevant Range

90
Relevant

60

Range

30
0

The
The relevant
relevant range
range
of
of activity
activity for
for aa fixed
fixed
cost
cost is
is the
the range
range of
of
activity
activity over
over which
which
the
the graph
graph of
of the
the
cost
cost is
is flat.
flat.

1,000
2,000
3,000
Rented Area (Square Feet)
5-12

Mixed Costs

Total Utility Cost

l
a
t
To

ed
x
i
m

t
s
o
c
Variable
Cost per KW

Activity (Kilowatt Hours)

Fixed Monthly
Utility Charge
5-13

The Scattergraph Method

Maintenance Cost
1,000s of Dollars

Use
Use one
one data
data point
point to
to estimate
estimate the
the total
total level
level of
of activity
activity
and
and the
the total
total cost.
cost.
Y Total maintenance cost = $11,000
20

* ** *
**

* *
* *

10

Intercept = Fixed cost: $10,000

Patient days = 800

Patient-days in 1,000s
5-14

The High-Low Method An Example

The variable cost
per hour of
maintenance is
equal to the change
in cost divided by
the change in hours.
$2,400
= $6.00/hour
400

5-15

The High-Low Method An Example

Total Fixed Cost = Total Cost Total Variable Cost

Total Fixed Cost = $9,800 ($6/hour 850 hours)
Total Fixed Cost = $9,800 $5,100
Total Fixed Cost = $4,700
5-16

The High-Low Method An Example

The Cost Equation for Maintenance

Y = $4,700 + $6.00X
5-17

Least-Squares Regression Method

A method used to analyze mixed costs if a
scattergraph plot reveals an approximately linear
relationship between the X and Y variables.
This method uses all of the
data points to estimate
the fixed and variable
cost components of a
mixed cost.

The goal of this method is

to fit a straight line to the
data that minimizes the
sum of the squared errors.
5-18

Least-Squares Regression Method

Software can be used to fit

a regression line through
the data points.

The cost analysis objective

is the same: Y = a + bX

Least-squares regression also provides a statistic, called

the R22, which is a measure of the goodness
of fit of the regression line to the data points.
5-19

End of Chapter 5

5-20