Chapter Two

Managerial Accounting
and Cost Concepts

Cost classification
Part 1
Lecture One
 Revenue – Cost = Profit/Loss

How you calculate How you calculate

Revenue? Profit/Loss?

Our Course:
How you can calculate Cost?
 Assume
you're the owner
of a car factory
 Summary of the Types of Cost Classifications:

Assigning Costs to
Financial Reporting
Cost Objects

Predicting Cost Making Business

Behavior Decisions
 General Classification
Manufacturing Costs Non-Manufacturing Costs

Dir. Mat Dir. Lab Mfg. OH Selling Administrative

Indir. Mat Indir. Lab Other OH

Classifications of Manufacturing Costs
(Inside the factory)
Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labor
Labor Overhead
Overhead

The Product
 Direct Materials
Raw materials that become an integral part
of the product and that can be easily traced
directly to it.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile
 Direct Labor
Those labor costs that can be easily traced
to individual units of product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers
 Manufacturing Overhead
Manufacturing costs that cannot be easily
traced directly to specific units produced.

Indirect materials / indirect labor / Other Overhead

Materials used to Wages paid to employees who Costs used to support

support the production are not directly involved in the production process.
process. production work.

Examples: lubricants, Glue

Examples: maintenance workers Examples: insurance,
& cleaning supplies used in
Supervisors, materials handlers depreciation, heat and
the automobile assembly
and security guards. light, maintenance, rent,
plant.
factory utilities
 Nonmanufacturing Costs
(outside the factory)

Selling Costs Administrative Costs

Costs necessary to secure the order

All organizational costs.
and deliver the product.
All executive, organizational,
advertising, shipping, sales travel,
and clerical costs
sales commission, sales salaries
Administrative costs can be
Selling costs can be either direct or
either direct or indirect costs.
indirect costs.
 Understand cost
classifications used for
assigning costs to cost
objects: Direct costs and
Indirect costs.
 Assigning Costs to Cost Objects
Direct Costs Indirect Costs
Costs that can be easily Costs that cannot be easily
traced to a unit of product or traced to a unit of product or
other cost object. other cost object.

Examples: Example:
Direct material / Direct labor Manufacturing overhead
Understand cost classifications used
to prepare financial statements:
Product costs and Period costs.
Cost Classifications for Preparing
Financial Statements
Product Costs Period Costs
(Mfg. Cost) (Non-Mfg. Cost)

include direct materials, include all selling costs and

direct labor, and administrative costs.
manufacturing overhead.
Quick Check 

Which of the following costs would be considered a

period rather than a product cost in a manufacturing
company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
Quick Check 

Which of the following costs would be considered a

period rather than a product cost in a manufacturing
company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
 REMEMBER

Cost:
Measures the economic sacrifice to achieve organizational goals (your final product)
Direct Cost: Indirect Cost:
Costs that can be easily traced Costs that cannot be easily traced
to a unit of product or other cost object. to a unit of product or other cost object.

Direct Materials: (DM) Direct Labour: (DL)

Raw materials that become an integral part Those labor costs that can be easily traced
of the product and that can be easily traced to individual units of product.
directly to it.

Manufacturing Overhead: (MOH)

Manufacturing costs that cannot be easily traced directly to specific units produced.
( Indirect Materials / Indirect Labour / Other OH )
 REMEMBER
Indirect materials indirect labour
Materials used to support the production Wages paid to employees who are not
process. directly involved in production work.
Other Overhead Mfg. Cost = DM + DL + MOH
Costs used to support the production process Non-Mfg. Cost = Selling + Administrative.

Selling Cost: Administrative Cost:

Costs necessary to secure the order and All organizational costs.
deliver the product. Administrative costs can be
Selling costs can be either direct or indirect costs.
either direct or indirect costs.

Product Cost: Period Cost:

Product costs include Period costs include
DM + DL + MOH. Selling costs + Administrative costs.
Prime Cost = DM + DL Conversion Cost = DL + MOH
LECTURE TWO
Prime Costs and Conversion Costs
Manufacturing costs are often classified as follows:

Direct Material Direct Labor Mfg. Overhead

Prime Cost Conversion Cost

Maged company reported the following costs and expenses for the most recent month:
Direct Materials 10,000 Selling Cost 3,000
Indirect Materials 3,000 Administrative Cost 4,000
Direct Labour 15,000 Depreciation 1,000
Indirect Labour 5,000 Insurance 2,000
Rent 500 Power & Heat 500

1. What is the total amount of MOH?

2. What is the total amount of Mfg. Cost?
3. What is the total amount of Product Cost?
4. What is the total amount of Non-Mfg. Cost?
5. What is the total amount of Period Cost?
6. What is the total amount of Prime Cost?
Maged company reported the following costs and expenses for the most recent month:
Direct Materials 20,000 Advertising expenses 3,000
Lubricants 3,000 Sales commissions 4,000
Glue 2,000 Shipping expenses 1,000
Direct Labour 30,000 Accountant’s Salary 2,000
Rent (Factory Building) 500 Charmian’s salary 10,000
Rent (HQ Building) 200 Material Handler’s Salary 7,000
Insurance 300 Supervisor’s Salary 5,000
Power & Heat 200 Security’s Salary 3,000

What is the total amount of

MOH, Mfg. Cost, Non-Mfg. Cost, Prime Cost and Conversion cost ?
Listed below are some of the costs that are incurred at PC world company:
1. The cost of a hard drive installed in a computer.
2. The cost of advertising in the newspaper.
3. The salaries of employees who assemble computer from components
4. Sales commissions paid to the company’s sales persons.
5. The salaries of the assembly shop’s supervisors
6. The salaries of the company’s accountants
7. Depreciation on equipment used to test assembled computers before
release to costumers
8. Rent on the facility in the industrial park.
Required: for each cost, indicate whether it would be classified as Direct
materials, Direct Labour, Mfg. overhead, selling or an administrative cost
 Model answer
Manufacturing costs (Product) Non-manufacturing Cost (Period)
Num. DM DL MOH Selling Administrative

1 ×
2 ×
3 ×
4 ×
5 ×
6 ×
7 ×
8 × × ×

The rent would most likely be prorated on the basis of the amount of space
occupied by manufacturing, selling, and administrative operations.
number answer number answer
1 Period 9 Period
2 Product 10 Product
3 Product 11 Product
4 Period 12 Period
5 Product 13 Period
6 product 14 Period
7 product 15 Period
8 Period
 True & False

No. Statement T&F

1 Selling costs can be either direct or indirect costs. T
2 A direct cost is a cost that cannot be easily traced to the particular cost F
object under consideration.
3 Power & Heat paid on a factory building are examples of period costs F
4 Conversion cost equals product cost less direct labor cost F
5 Thread that is used in the production of mattresses is an indirect F
material that is therefore classified as manufacturing overhead
6 Direct labour is a part of prime cost, but not conversion cost F
7 Conversion cost is the sum of direct labour and direct materials cost. F
 True & False

No. Statement T&F

8 Depreciation on manufacturing equipment is a product cost T
9 Manufacturing salaries incurred in the factory are period costs F
10 Depreciation on office equipment in HQ would be included in product F
costs
11 Rent on a factory building would be classified as a product cost T
12 Rent on a HQ building would be classified as a product cost F
13 In a manufacturing company, DL Cost combined with DM Cost are F
known Conversion Cost
14 The salaries of Carpenters in a furniture factory would be classified as T
a product cost
 General Classification
First Classification: Cost Object
Second Classification: Financial Reporting

Third Classification: Cost Behaviour

Variable Cost, Fixed Cost and Mixed Cost
Remember your Mobile Bill
Understand cost classifications used to
predict cost behavior: Variable costs,
Fixed costs, and Mixed costs.
 Cost behavior refers to how a cost will react to changes in the level of activity.
Variable Cost Fixed Cost
Costs that respond to changes in activity level Refer to cost with zero response to changes in
activity level
A cost that varies, in total, in direct proportion A cost that remains constant, in total,
to changes in the activity level regardless of changes in the activity level
However, variable cost per unit is constant. However, if expressed on a per unit basis, the
average fixed cost per unit varies inversely
with changes in activity.
Total Var. Cost

Unit Var. Cost

Total Fixed

Unit Fixed
Activity Level Activity Level Activity Level Activity Level
 Cost Variable Cost Fixed Cost
Activity Level Respond Zero Response
Cost Per Unit Constant Varies
Cost In Total Varies Constant
 Types of Fixed Costs

Committed Discretionary
Long-term, cannot be significantly May be altered in the short term by
reduced in the short term. current managerial decisions

Examples: Examples:
Depreciation (Buildings and Equipment) Advertising Exp.
Real Estate Taxes Research and Development Exp.
Quick Check 
Which of the following costs would be variable with
respect to the number of cones sold at a Baskins &
Robbins shop? (There may be more than one correct
answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.
Quick Check 
Which of the following costs would be variable with
respect to the number of cones sold at a Baskins &
Robbins shop? (There may be more than one correct
answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.
A
A mixed
mixed cost
cost contains
contains both
both variable
variable and
and fixed
fixed elements.
elements.
M = F + VL M = Mixed Cost
F = Fixed Cost
V = Variable Cost
L = Level of Activity
Y

o s t
Total Cost

d c
x e
mi Mixed Cost
Variable Cost

X Fixed Cost
Activity Level
 If your fixed monthly utility charge is $40, your
variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what is
the amount of your utility bill?

M = F + VL
M = $40 + ($0.03 × 2,000)
M = $100
 If your fixed monthly mobile charge is $60, your
minutes cost is $0.1 per minute, and your monthly
activity level is 1,000 minutes,
what is the amount of your mobile bill?

M = F + VL
M = $60 + ($0.1 × 1,000)
M = $160
 Model Answer
Cups of coffee
2,000 2,100 2,200
Fixed cost 1,200 1,200 1,200
Variable cost (0.22 × 2,000) (0.22 × 2,100) (0.22 × 2,200)
440 462 484
Mixed cost 1,640 1,662 1,684
Average cost per cup 0.84 0.79 0.77
 Model answer
Variable cost per unit = 180,000 / 30,000 = 6
Activity Level
30,000 40,000 50,000
Total Cost:
Variable Cost 180,000 240,000 300,000
Fixed Cost 300,000 300,000 300,000
Total cost (Mixed) 480,000 540,000 600,000
Cost per unit:
Variable Cost 6 6 6
Fixed Cost 10 7.5 6
Total cost (Mixed) Per unit 16 13.5 12
Maged company information:

Cost analysis 1,000

Activity Level
2,000 5,000 10,000

Total Cost:
Variable Cost ? ? 50,000 ?
Fixed Cost ? ? 200,000 ?
Total cost (Mixed) ? ? ? ?
Cost per unit:
Variable Cost ? ? ? ?
Fixed Cost ? ? ? ?
Total cost (Mixed) Per unit ? ? ? ?

Required: Complete the schedule of the company’s total and unit cost above.
Variable cost per unit = 50,000 / 5,000 = 10

Cost analysis 1,000

Activity Level
2,000 5,000 10,000

Total Cost:
Variable Cost 10,000 20,000 50,000 100,000
Fixed Cost 200,000 200,000 200,000 200,000
Total cost (Mixed) 210,000 220,000 250,000 300,000
Cost per unit:
Variable Cost 10 10 10 10
Fixed Cost 200 100 40 20
Total cost (Mixed) Per unit 210 110 50 30
Lecture Three
 Analysis of Mixed Costs
High-Low Method

Note: For Mixed Cost Only

Fixed Cost = €2,000 Activity Level
Variable Cost = €2 1,000 1,200 1,500 2,500

Fixed cost
Variable cost
Mixed cost 4,000 4,400 5,000 7,000
Fixed Cost = €2,000 Activity Level
Variable Cost = €2 1,000 1,200 1,500 2,500

Fixed cost 2,000 2,000 2,000 2,000

Variable cost 2,000 2,400 3,000 5,000
(2×1,000) (2×1,200) (2×1,500) (2×2,500)
Mixed cost 4,000 4,400 5,000 7,000
Fixed Cost = € Activity Level
Variable Cost = € 1,000 1,200 1,500 2,500

Fixed cost
Variable cost
Mixed cost 4,000 4,400 5,000 7,000

Required: Estimate a cost formula

( M = F + VL )
Fixed Cost = € Activity Level
Variable Cost = € 1,000 1,200 1,500 2,500

Fixed cost 2,000 2,000 2,000 2,000

Variable cost ( 2 × 1,000) ( 2 × 1,200) ( 2 × 1,500) ( 2 × 2,500)
2,000 2,400 3,000 5,000
Mixed cost 4,000 4,400 5,000 7,000
Δ Cost 7,000 – 4,000
(1) Var. Cost = = = 2 Per
Unit
Δ Activity 2,500 – 1,000

(2) Fixed Cost: M = F + VL

7,000 = F + ( 2 × 2,500 )
F = 2,000
 (1) Fixed Cost
Total Fixed Cost .… (Constant) Under any activity level
(2) Variable Cost
Var. cost per unit = Total variable cost / Activity level
Total Var. Cost = Var. Cost per unit × Activity Level
(3) Mixed Cost
= Total Fixed Cost + Total Variable Cost
OR …. High-Low Method
Step One: Determine Variable Cost:

Variable Cost = = Per Unit

Step Two: Determine Fixed Cost:

Mixed Cost = Fixed Cost + Variable Cost
M = F + VL

Step Three: Cost Formula:

Maged’s Invoice:
Month Minutes invoice
(Activity Level) (Mixed Cost)
January 1000 1200
February 1600 1700
March 1800 1900
April 1500 1640
May 1,200 1,375

Required: Using the High-Low Method, estimate a cost formula for

Maged’s invoice.
 Model Answer
Step One: Determine Variable Cost:

Δ Cost 1,900 – 1,200

Variable Cost = = = 0.875 Per Unit
Δ Activity Level 1,800 – 1,000

Step Two: Determine Fixed Cost:

Mixed Cost = Fixed Cost + Variable Cost
M = F + VL
1900 = F + 0.875 × 1800
Fixed Cost (F) = 325

Step Three: Cost Formula:

M = 325 + 0.875 L
The administration of Albaz Corporation would like a cost formula linking the utilities cost to
the number of scans. The utilities cost and use of scanner since the first of the year:
month Number of Utilities cost
scans MIXED COST
January 60 2200
February 70 2600
March 90 2900
April 120 3300
May 100 3000
June 130 3600
July 150 4000
August 140 3600
September 110 3100
October 80 2500

Required: Using the High-Low Method, estimate a cost formula for utilities.
 Model Answer
Step One: Determine Variable Cost:

Δ Cost 4000 – 2200

Variable Cost = = = 20 Per Unit
Δ Activity Level 150 - 60

Step Two: Determine Fixed Cost:

Mixed Cost = Fixed Cost + Variable Cost
M = F + VL
4000 = F + 20 × 150
Fixed Cost (F) = 1,000

Step Three: Cost Formula:

M = 1,000 + 20 L
The administration of Albaz Corporation would like a cost formula linking the Units Sold to the
Shipping Expense. The Units Sold and Shipping Expense since the first of the year:

Month Units Sold Shipping Expense

(Mixed Cost)
January 10000 120,000
February 16000 175,000
March 18000 190,000
April 15000 164,000
May 11000 128,750
June 13000 146,250
July 14000 155,000

Required: Using the High-Low Method, estimate a cost formula for Shipping Expense.
 Model Answer
Step One: Determine Variable Cost:

Δ Cost 190,000 – 120,000

Variable Cost = = = 8.75 Per Unit
Δ Activity Level 18,000 – 10,000

Step Two: Determine Fixed Cost:

Mixed Cost = Fixed Cost + Variable Cost
M = F + VL
190,000 = F + 8.75 × 18,000
Fixed Cost (F) = 32,500

Step Three: Cost Formula:

M = 32,500 + 8.75 L
 Remember
(1) Fixed Cost
Total Fixed Cost .… (Constant) Under any activity level
(2) Variable Cost
Var. cost per unit = Total variable cost / Activity level
Total Var. Cost = Var. Cost per unit × Activity Level
(3) Mixed Cost
= Total Fixed Cost + Total Variable Cost
OR …. High-Low Method
Given below the total factory overhead costs of a manufacturing company, at high and low
levels of activity over recent years:

Overhead costs Level of activity

low High
Machine-hours 15,000 20,000
Factory overhead costs:
Indirect materials (Variable) 22,500 ?
Rent (Fixed) 32,500 ?
Maintenance (Mixed) .. (Includes Var. & Fixed) 13,500 ?
Total factory overhead costs 68,000 78,000

Required:
1. Estimate indirect material, rent and maintenance costs at the high level of activity
2. Estimate factory overhead costs for 25,000 machine hours, using the linear equation from
M = F + VL
 Overhead costs Level of activity
low High New level
Machine-hours 15,000 20,000 25,000
Factory overhead costs:
Indirect materials (Variable) 22,500 30,000 37,500
Rent (Fixed) 32,500 32,500 32,500
Maintenance (Mixed) 13,500 15,500 17,500

total factory overhead costs 68,000 78,000 87,500

Variable cost …. (Constant per unit & Varies in total)
Fixed cost ……… (Constant in total & Varies per unit)

Indir.Mat .. Variable cost = constant per unit Indir.Mat = 22,500/15,000 = 1.5 per unit
Indir.Mat (20,000 unit) = 1.5 × 20,000 = 30,000

Rent .. Fixed cost = constant in total So, Rent (20,000 unit) = 32,500
Maintenance (20,000 unit) = 78,000 – (30,000 + 32,500) = 15,500
Using High-Low method to analysis Mixed Cost (Maintenance)
Step One: Determine Variable Cost (Maintenance):
2,000
Variable Cost = = = 0.4 Per Unit
5,000
Step Two: Determine Fixed Cost (Maintenance):
Mixed Cost = Fixed Cost + Variable Cost
M = F + VL
15,500 = F + 0.4 × 20,000
Fixed Cost (F) = 7,500
Step Three: Cost Formula: M = 7,500 + 0.4 × L
So, Maintenance (25,000 units) M = 7,500 + (0.4 × 25,000) = 17,500
Given below the total factory overhead costs of a manufacturing company, at high and low
levels of activity over recent years:

Overhead costs Level of activity

low High
Operating Hours 20,000 30,000
Factory overhead costs:
Indirect Labour (Variable) 40,000 ?
Insurance (Fixed) 50,000 ?
Power and Heat (Mixed) 10,000 ?
Total factory overhead costs 100,000 123,000

Required:
1. Estimate indirect material, rent and maintenance costs at the high level of activity
2. Estimate factory overhead costs for 40,000 machine hours, using the linear equation from
M = F + VL
 Overhead costs Level of activity
low High New level
Operating-hours 20,000 30,000 40,000
Factory overhead costs:
Indirect Labour (Variable) 40,000 60,000 80,000
Insurance (Fixed) 50,000 50,000 50,000
Power and Heat (Mixed) 10,000 13,000 16,000

total factory overhead costs 100,000 123,000 146,000

Variable cost …. (Constant per unit & Varies in total)
Fixed cost ……… (Constant in total & Varies per unit)

Indir.Lab .. Variable cost = constant per unit Indir.Lab = 40,000/20,000 = 2 per unit
Indir.Lab (30,000 unit) = 2 × 30,000 = 60,000

Insurance .. Fixed cost = constant in total So, Insurance (30,000 unit) = 50,000
Power and Heat (30,000 unit) = 123,000 – (60,000 + 50,000) = 13,000
Using High-Low method to analysis Mixed Cost (Maintenance)
Step One: Determine Variable Cost (Heat & Power):
13,000 – 10,000
Variable Cost = = = 0.3 Per Unit
30,000 – 20,000
Step Two: Determine Fixed Cost (Heat & Power):
Mixed Cost = Fixed Cost + Variable Cost
M = F + VL
13,000 = F + (0.3 × 30,000)
Fixed Cost (F) = 4,000
Step Three: Cost Formula: M = 4,000 + 0.3 × L
So, Heat & Power (40,000 units) M = 4,000 + (0.3 × 40,000) = 16,000
Lecture Four
Revision
 General Classification
Manufacturing Costs Non-Manufacturing Costs

Dir. Mat Dir. Lab Mfg. OH Selling Administrative

Indir. Mat Indir. Lab Other OH

(1) Cost Objects:

Direct Cost Indirect Cost

 (2) Financial Statement:
Product Costs Period Costs

Dir. Mat Dir. Lab Mfg. OH Selling Administrative

Indir. Mat Indir. Lab Other OH

(3) Cost Behaviour:

Variable Cost Fixed Cost Mixed Cost

 (4) Making Decision:

Opportunity Cost Sunk Cost Differential Cost & Rev

The potential benefit Costs and revenues that
that is given up when Sunk costs have already differ among alternatives
one alternative is been incurred and Example:
cannot be changed now You have a job paying $1,500
selected over another.
or in the future. These per month in your town. and
Example: costs should be ignored You have a job offer in a
instead of producing the when making decisions. neighbouring city that pays
tables, the company $2,000 per month, The
commuting cost to the city is
could rent its factory for Example: $300 per month.
50,000 per year Depreciation
 Problem One:
Cost Classification
Albaz Company manufactures Cars, Selected cost are given below:
1. The cars are made of tires that costs €1000 per car.
2. The cars are assembled by workers. At a wage cost of €20 per car.
3. Workers assembling the cars are supervised by a factory supervisors
who is paid €50,000 per year.
4. Power cost are €5 per machine-hour. Five machine-hours are
required to produce an car.
5. The depreciation on the machines used to make the cars totals
€300,000 per year, the machines have no resale value.
6. The salary of the Chairman of the company is €1000,000 per year
7. the company spends €60,000 per year to advertise its products.
8. Salespersons are paid a commission of €2000 for each car sold.
9. Instead of producing the cars, the company could rent its factory
space for €800,000 per year.

Required:
Classify these costs, (prepare an answer sheet with column heading as
shown below, for each cost item, indicate whether it would be variable
or fixed cost, and then whether it would be a period cost (selling &
administrative) or a manufacturing cost (direct materials / direct labour
/ mfg. overhead), finally if any other cost classification found.
Maged company reported the following costs and expenses for the most recent month:
Direct Materials 20,000 Advertising expenses 3,000
Lubricants 3,000 Sales commissions 4,000
Glue 2,000 Shipping expenses 1,000
Direct Labour 30,000 Accountant’s Salary 2,000
Rent Bill 500 Charmian’s salary 10,000
Depreciation 200 Material Handler’s Salary 7,000
Insurance 300 Supervisor’s Salary 5,000
Electricity Bill 200 Security’s Salary 3,000

What is the total amount of

MOH, Mfg. Cost, Non-Mfg. Cost, Prime Cost and Conversion cost ?
 Problem Two:
Cost Analysis
Variable, Fixed and
Mixed Cost
Maged company information:

Cost analysis 10,000

Activity Level
20,000 30,000 60,000

Total Cost:
Variable Cost ? 80,000 ? ?
Fixed Cost ? 200,000 ? ?
Total cost (Mixed) ? ? ? ?
Cost per unit:
Variable Cost ? ? ? ?
Fixed Cost ? ? ? ?
Total cost (Mixed) Per unit ? ? ? ?

Required: Complete the schedule of the company’s total and unit cost above.
Variable cost per unit = 80,000 / 20,000 = 4

Cost analysis 10,000

Activity Level
20,000 30,000 60,000

Total Cost:
Variable Cost 40,000 80,000 120,000 240,000
Fixed Cost 200,000 200,000 200,000 200,000
Total cost (Mixed) 240,000 280,000 320,000 440,000
Cost per unit:
Variable Cost 4 4 4 4
Fixed Cost 20 10 6.7 3.3
Total cost (Mixed) Per unit 24 14 10.7 7.3
 Problem Three:
High-Low Method
 High-Low Method
Step One: Determine Variable Cost:
15,200 – 12,800
Variable Cost = = = 3 Per Unit
1,900 – 1,100

Step Two: Determine Fixed Cost:

Mixed Cost = Fixed Cost + Variable Cost
M = F + VL
15,200 = F + ( 3 × 1,900)
F = 9,500

Step Three: Cost Formula: M = 9,500 + 3 L

 Problem Four:
Cost Analysis & High-
Low Method
Given below the total factory overhead costs of a manufacturing company, at high and low
levels of activity over recent years:
Overhead costs Level of activity
low High
Operating Hours 10,000 30,000
Factory overhead costs:
Indirect Mat. (Variable) 200,000 ?
Indirect Lab. (Fixed) 150,000 ?
Insurance (Mixed) 100,000 ?
Total factory overhead costs 450,000 875,000

Required:
1. Estimate indirect material, rent and maintenance costs at the high level of activity
2. Estimate factory overhead costs for 50,000 & 60,000 Operating hours, using the linear
equation from M = F + VL
 Overhead costs Level of activity
low High New level
Operating-hours 10,000 30,000 50,000
Factory overhead costs:
Indirect Mat. (Variable) 200,000 600,000 1000,000
Indirect Lab. (Fixed) 150,000 150,000 150,000
Insurance (Mixed) 100,000 125,000 150,000

total factory overhead costs 450,000 875,000 1,300,000

Variable cost …. (Constant per unit & Varies in total)
Fixed cost ……… (Constant in total & Varies per unit)

Indir.Mat .. Variable cost = constant per unit Indir.Lab = 200,000/10,000 = 20 per unit
Indir.Mat (30,000 unit) = 20 × 30,000 = 600,000

Indirect Lab. .. Fixed cost = constant in total So, Insurance (30,000 unit) = 150,000
Insurance (30,000 unit) = 875,000 – (600,000 + 150,000) = 125,000
Using High-Low method to analysis Mixed Cost (Maintenance)
Step One: Determine Variable Cost (Insurance):
125,000 – 100,000
Variable Cost = = = 1.25 Per Unit
30,000 – 10,000
Step Two: Determine Fixed Cost (Insurance):
Mixed Cost = Fixed Cost + Variable Cost
M = F + VL
125,000 = F + (1.25 × 30,000)
Fixed Cost (F) = 87,500
Step Three: Cost Formula: M = 87,500 + 1.25 × L
So, insurance (50,000 units) M = 87,500 + (1.25 × 50,000) = 150,000
So, insurance (60,000 units) M = 87,500 + (1.25 × 60,000) = 162,500