Management Advisory Services
COSTS AND COST BEHAVIOR ANALYSIS
Cost – the monetary amount of the resources given up or sacrificed to attain some objective such as
acquiring goods and services. When notified by a term that defines the purpose, cost becomes
operational (e.g., selling cost, acquisition cost, production cost)
Cost Pool – an account in which a variety of similar costs are accumulated prior to allocation to cost
objects. It is group of costs associated with an activity (overhead account).
Cost object – the intermediate and final disposition of cost pools (product, job)
Cost driver – a factor that causes a change in the cost pool for a particular activity. It is used as a basis
for cost allocation.
Activity – any event, action, transaction, or work sequence that incur costs when producing a product
or providing a service.
Cost Behavior
Cost Behavior – is the relationship between cost and activity. It describes how a cost behaves or
changes as the amount of activity level or cost driver changes.
Types of Costs As to Behavior:
Type of Cost Total Cost Per unit Cost
1. Variable Varies Constant
2. Fixed Constant Varies
3. Mixed Cost – has both fixed and variable costs.
Cost Formula: y = a + b(x)
where: y = total cost
a = fixed cost
b = variable cost
x = activity or cost driver
Cost Behavior Assumptions:
1. Relevant Range Assumption – refers to the range of activity within which the cost behavior patterns
are valid. Any level of activity outside this range may have different cost behavior pattern.
2. Time PeriodAssumption – the cost behavior patterns identified are true only over a specified period
of time.
Segregation of Mixed Cost: Variable and Fixed Cost
1. High-Low Points Method – the fixed and variable elements of the mixed costs are computed from
two data points (periods) – the high and the low periods as activity level or cost driver.
2. Scattergraph Method – All observed costs at different activity levels are plotted on a graph. Various
costs are plotted on y-axis and activity levels or cost drivers are plotted on the x-axis.
3. Least Squares (Regression Analysis) Method – mathematically determines a line of best fit or a
linear regression line through a set of plotted points so that the sum of the squared deviations of each
actual plotted point from the point directly above or below it on the regression line is at minimum.
Equations used in Least Squares:
Equation 1: Σy = na + bΣx
Equation 2: Vxy = aΣx + bΣx²
Problems:
1. The management of Samuel Manufacturing Corporation believes that machine-hours is an
appropriate measure of activity for overhead cost Shown below are machine-hours and total overhead
costs for the past six months:
Machine Overhead
Hours Costs
Jan 150,000 P339,000
Feb 140,000 328,000
Mar 160,000 350,000
Apr 130,000 319,500
May 170,000 362,500
Jun 200,000 400,000
Using the High-Low method, determine the following:
a. Variable cost per unit
b. Monthly fixed costs
c. Monthly cost function
d. If Samuel expects to incur 185,000 machine hours next month, what will the estimated total
overhead cost.
2. Jessa is examining customer-service costs of Kidlat Company. Kidlat has more than 400 separate
electrical products that are sold with a six month- guarantee of full repair or replacement with a new
product. When a product is returned by a customer, a service report is prepared. This service report
includes details of the problem and the time and cost of resolving the problem.
Monthly data for the most recent months are as follows:
Month CS Department Costs Number of Service Reports
April P27,400 380
May 41,800 550
June 26,000 230
July 44,000 790
August 28,000 530
September 43,000 910
October 33,800 680
November 42,000 610
December 150,000 2,064
Compute for the following, using High-Low Method
a. Variable cost per unit.
b. Annual fixed cost.
3. Yani Company would like to estimate the variable and fixed components of its maintenance costs
and has compiled the following data for the last five months of operations.
Labor Maintenance
Hours Cost
January 160 P617
February 130 553
March 180 596
April 190 623
May 110 532
Compute the following, using Lease Squares Regression Method:
a. Estimated variable cost per labor hour for maintenance.
b. Estimated total fixed cost per month for maintenance.
c. What is the total cost if 170 labor hours will be used for the month of June?
4. Edwin would like you to estimate the fixed and variable components of a particular cost. Actual data
for this cost over four recent periods appear below.
Activity Cost
Period 1 .................... 22 235
Period 2 .................... 23 243
Period 3 .................... 25 255
Period 4 .................... 20 227
Using the least-squares regression method, what is the cost formula for this cost?
5. Ace Sales Company is a distributor that has an exclusive franchise to sell a particular product made
by another company. Ace Sales Company's income statements for the last two years are given below:
This Year Last
Year
Units sold ................................................... 200,000 160,000
Sales revenue ............................................. P1,000,000 P800,000
Less cost of goods sold .............................. 700,000 560,000
Gross margin ............................................. 300,000 240,000
Less operating expenses ............................ 210,000 198,000
Net operating income ................................ P90,000 P42,000
Operating expenses are a mixture of fixed costs and variable and mixed costs that vary with respect to
the number of units sold.
Required:
a. Estimate the company's variable operating expenses per unit, and its total fixed operating expenses
per year.
b. Compute the company's contribution margin for this year.
6. Abigail Company’s total overhead cost at various level of activity are presented below:
Month Machine hours Total Overhead Costs
August 35,000 P49,500
September 30,000 43,500
October 40,000 55,500
November 45,000 61,500
Assume that the total overhead cost above consist of supplies, supervisory salaries and maintenance.
The breakdown of these costs at the 30,000 machine hours is:
Supplies (V) P12,000
Salaries (F) 5,250
Maintenance (M) 26,250
Total P43,500
a. How much of November’s overhead cost of P61,500 consisted of maintenance cost?
b. Using high-low method, estimate a cost formula for maintenance cost.
c. Using high-low method, estimate a cost formula for total overhead cost.
d. What would be the total overhead costs if 50,000 machine hours was used?
Theories:
1. As the level of activity increases, how will a mixed cost in total and per unit behave?
In Total Per Unit
A) Increase Decrease
B) Increase Increase
C) Increase No effect
D) Decrease Increase
E) Decrease No effect
2. When the activity level is expected to decline within the relevant range, what effects would be
anticipated with respect to each of the following?
Fixed costs per unit Variable costs per unit
A) Increase Increase
B) Increase No change
C) No change No change
D) No change Increase
3. Within the relevant range, variable costs can be expected to:
A) vary in total in direct proportion to changes in the activity level.
B) remain constant in total as the activity level changes.
C) increase on a per unit basis as the activity level increases.
D) increase on a per unit basis as the activity level decreases.
E) none of these.
4. Which of the following statements is true when referring to fixed costs?
A) Committed fixed costs arise from the annual decisions by management.
B) As volume increases, unit fixed cost and total fixed cost will change.
C) Fixed costs increase in total throughout the relevant range.
D ) Discretionary fixed costs can often be reduced to zero for short periods of time without seriously
impairing the long-run goals of the company.
5. An example of a committed fixed cost is:
A) management training seminars. B) a long-term equipment lease.
C) research and development. D) advertising.
6. Which of the following would usually be considered a discretionary fixed cost for a financial
planning company?
A) the cost of the annual employee picnic B) property taxes on its corporate office
building
C) the cost of internships for selected college seniors D) both a and c above
7. The following data have been collected for four different cost items.
Cost at 100 units Cost at 140 units
Cost Item
A P8,000 P10,560
B 5,000 5,000
C 6,500 9,100
D 6,700 8,580
Which of the following classifications of these cost items by cost behavior is correct?
Cost A Cost B Cost C Cost D
A) variable fixed mixed variable
B) mixed fixed variable mixed
C) variable fixed variable variable
D) mixed fixed mixed mixed
8. In describing the cost formula equation, Y = a + bX, which of the following is correct:
A) “Y” is the independent variable.
B) “a” is the variable cost per unit.
C) “a” and “b” are valid for all levels of activity.
D) in the high-low method, “b” equals the change in cost divided by the change in activity.
9. The contribution approach to income statement preparation:
A) organizes costs according to the functions of production, administration, and sales.
B) is used for external reporting.
C) organizes costs according to their variable and fixed cost behavior.
D) both b and c are true.
E) both a and b are true
10. The contribution approach income statement:
A) organizes costs on a functional basis.
B) provides owners with more cash flows.
C) is particularly helpful to the manager in planning and decision making.
D) provides a gross margin figure from which selling and administrative expenses are deducted.
