MANAGEMENT ACCOUNTING - Solutions Manual

CHAPTER 9
COST BEHAVIOR: ANALYSIS AND USE
I. Questions
1. a. Vaia!l" #ost: A variable cost is one that remains constant on a per
unit basis, but which changes in total in direct relationship to changes
in volume.
b. $i%"& #ost: A fixed cost is one that remains constant in total amount,
but which changes, if expressed on a per unit basis, inversely with
changes in volume.
c. Mi%"& #ost: A mixed cost is a cost that contains both variable and
fixed cost elements.
2. a. Unit fixed costs will decrease as volume increases.
b. Unit variable costs will remain constant as volume increases.
c. otal fixed costs will remain constant as volume increases.
d. otal variable costs will increase as volume increases.
!. a. Cost !"'a(io: "ost behavior can be defined as the way in which
costs change or respond to changes in some underlying activity, such
as sales volume, production volume, or orders processed.
b. R"l"(ant an)": he relevant range can be defined as that range of
activity within which assumptions relative to variable and fixed cost
behavior are valid.
#. Although the accountant recogni$es that many costs are not linear in
relationship to volume at some points, he concentrates on their behavior
within narrow bands of activity %nown as the relevant range. he relevant
range can be defined as that range of activity within which assumptions as
relative to variable and fixed cost behavior are valid. &enerally, within
this range an assumption of strict linearity can be used with insignificant
loss of accuracy.
'. he high(low method, the scattergraph method, and the least(s)uares
regression method are used to analy$e mixed costs. he least(s)uares
regression method is generally considered to be most accurate, since it
9-*
C'a+t" 9 Cost Behavior: Analysis and Use
derives the fixed and variable elements of a mixed cost by means of
statistical analysis. he scattergraph method derives these elements by
visual inspection only, and the high(low method utili$es only two points in
doing a cost analysis, ma%ing it the least accurate of the three methods.
*. he fixed cost element is represented by the point where the regression
line intersects the vertical axis on the graph. he variable cost per unit is
represented by the slope of the line.
+. he two assumptions are:
1. A linear cost function usually approximates cost behavior within the
relevant range of the cost driver.
2. "hanges in the total costs of a cost ob,ect are traceable to variations
or changes in a single cost driver.
-. .o. /igh correlation merely implies that the two variables move together
in the data examined. 0ithout economic plausibility for a relationship, it
is less li%ely that a high level of correlation observed in one set of data
will be found similarly in another set of data.
1. 2efer to page !12 of the textboo%.
13. he relevant range is the range of the cost driver in which a specific
relationship between cost and cost driver is valid. his concept enables
the use of linear cost functions when examining "45 relationships as long
as the volume levels are within that relevant range.
11. A unit cost is computed by dividing some amount of total costs 6the
numerator7 by the related number of units 6the denominator7. In many
cases, the numerator will include a fixed cost that will not change despite
changes in the denominator. It is erroneous in those cases to multiply the
unit cost by activity or volume change to predict changes in total costs at
different activity or volume levels.
12. "ost estimation is the process of developing a well(defined relationship
between a cost ob,ect and its cost driver for the purpose of predicting the
cost. he cost predictions are used in each of the management functions:
8trategic 9anagement: "ost estimation is used to predict costs of
alternative activities, predict financial impacts of alternative strategic
choices, and to predict the costs of alternative implementation strategies.
9-,
Cost Behavior: Analysis and Use C'a+t" 9
5lanning and :ecision 9a%ing: "ost estimation is used to predict costs
so that management can determine the desirability of alternative options
and to budget expenditures, profits, and cash flows.
9anagement and ;perational "ontrol: "ost estimation is used to develop
cost standards, as a basis for evaluating performance.
5roduct and 8ervice "osting: "ost estimation is used to allocate costs to
products and services or to charge users for ,ointly incurred costs.
1!. he five methods of cost estimation are:
a. Account "lassification. Advantages: simplicity and ease of use.
:isadvantages: sub,ectivity of method and some costs are a mix of
both variable and fixed.
b. 4isual fit. he visual fit method is easy to use, and re)uires only that
the data is graphed. :isadvantages are that the scale of the graph
may limit ability to estimate costs accurately and in both graphical
and tabular form, significant perceptual errors are common.
c. /igh(<ow. =ecause of the precision in the development of the
e)uation, it provides a more consistent estimate than the visual fit and
is not difficult to use. :isadvantages: uses only two selected data
points and is, therefore, sub,ective.
d. 0or% 9easurement. he advantage is accurate estimates through
detailed study of the different operations in the product process, but
li%e regression, it is more complex.
e. 2egression. >uantitative, ob,ective measures of the precision and
accuracy and reliability of the model are the advantages of this model?
disadvantages are its complexity: the effort, expense, and expertise
necessary to utili$e this method.
1#. Implementation problems with cost estimation include:
a. cost estimates outside of the relevant range may not be reliable.
b. sufficient and reliable data may not be available.
c. cost drivers may not be matched to dependent variables properly in
each observation.
d. the length of the time period for each observation may be too long, so
that the underlying relationship between the cost driver and the
variable to be estimated is difficult to isolate from the numerous
variables and events occurring in that period of time? alternatively the
period may be too short, so that the data is li%ely to be affected by
9--
C'a+t" 9 Cost Behavior: Analysis and Use
accounting errors in which transactions are not properly posted in the
period in which they occurred.
e. dependent variables and cost drivers may be affected by trend or
seasonality.
f. when extreme observations 6outliers7 are used the reliability of the
results will be diminished.
g. when there is a shift in the data, as, for example, a new product is
introduced or when there is a wor% stoppage, the data will be
unreliable for future estimates.
1'. he dependent variable is the cost ob,ect of interest in the cost estimation.
An important issue in selecting a dependent variable is the level of
aggregation in the variable. @or example, the company, plant, or
department may all be possible levels of data for the cost ob,ect. he
choice of aggregation level depends on the ob,ectives for the cost
estimation, data availability, reliability, and costAbenefit considerations. If
a %ey ob,ective is accuracy, then a detailed level of analysis is often
preferred. he detail cost estimates can then be aggregated if desired.
1*. .onlinear cost relationships are cost relationships that are not ade)uately
explained by a single linear relationship for the cost driver6s7. In
accounting data, a common type of nonlinear relationship is trend and
seasonality. @or a trend example, if sales increase by -B each year, the
plot of the data for sales with not be linear with the driver, the number of
years. 8imilarly, sales which fluctuate according to a seasonal pattern
will have a nonlinear behavior. A different type of nonlinearity is where
the cost driver and the dependent variable have an inherently nonlinear
relationship. @or example, payroll costs as a dependent variable estimated
by hours wor%ed and wage rates is nonlinear, since the relationship is
multiplicative and therefore not the additive linear model assumed in
regression analysis.
1+. he advantages of using regression analysis include that it:
a. provides an estimation model with best fit 6least s)uared error7 to the
data
b. provides measures of goodness of fit and of the reliability of the
model which can be used to assess the usefulness of the specific
model, in contrast to the other estimation methods which provide no
means of self(evaluation
c. can incorporate multiple independent variables
9-.
Cost Behavior: Analysis and Use C'a+t" 9
d. can be adapted to handle non(linear relationships in the data,
including trends, shifts and other discontinuities, seasonality, etc.
e. results in a model that is uni)ue for a given set of data
1-. /igh correlation exists when the changes in two variables occur together.
It is a measure of the degree of association between the two variables.
=ecause correlation is determined from a sample of values, there is no
assurance that it measures or describes a cause and effect relationship
between the variables.
11. An activity base is a measure of whatever causes the incurrence of a
variable cost. Cxamples of activity bases include units produced, units
sold, letters typed, beds in a hospital, meals served in a cafe, service calls
made, etc.
23. 6a7 4ariable cost: A variable cost remains constant on a per unit basis, but
increases or decreases in total in direct relation to changes in activity.
6b7 9ixed cost: A mixed cost is a cost that contains both variable and
fixed cost elements.
6c7 8tep(variable cost: A step(variable cost is a cost that is incurred in
large chun%s, and which increases or decreases only in response to
fairly wide changes in activity.
9-/
Cost
Activity
Mixed Cost
Variable Cost
Step-Variable Cost
C'a+t" 9 Cost Behavior: Analysis and Use
21. he linear assumption is reasonably valid providing that the cost formula
is used only within the relevant range.
22. A discretionary fixed cost has a fairly short planning hori$onDusually a
year. 8uch costs arise from annual decisions by management to spend on
certain fixed cost items, such as advertising, research, and management
development. A committed fixed cost has a long planning hori$onD
generally many years. 8uch costs relate to a companyEs investment in
facilities, e)uipment, and basic organi$ation. ;nce such costs have been
incurred, they are Floc%ed inG for many years.
2!. a. "ommitted d. "ommitted
b. :iscretionary e. "ommitted
c. :iscretionary f. :iscretionary
2#. he high(low method uses only two points to determine a cost formula.
hese two points are li%ely to be less than typical since they represent
extremes of activity.
2'. he term Fleast(s)uares regressionG means that the sum of the s)uares of
the deviations from the plotted points on a graph to the regression line is
smaller than could be obtained from any other line that could be fitted to
the data.
2*. ;rdinary single least(s)uares regression analysis is used when a variable
cost is a function of only a single factor. If a cost is a function of more
than one factor, multiple regression analysis should be used to analy$e the
behavior of the cost.
II. Exercises
E%"#is" * 0Cost Classi1i#ation2
1. b
2. f
!. e
#. i
'. e
*. h
+. l
-. a
1. ,
13. %
9-3
Cost Behavior: Analysis and Use C'a+t" 9
11. c or d
12. g
E%"#is" , 0Cost Esti4ation5 Hi)'-Lo6 M"t'o&2
Requirement (1)
"ost e)uation using s)uare fee as the cost driver:
4ariable costs:
@ixed costs:
5#,+33 H @ixed "ost I 51.1!# x #,3'3
@ixed "ost H 513+
C)uation ;ne: otal "ost H 513+ I 51.1!# x s)uare feet
here are two choices for the /igh(<ow points when using openings for the
cost driver. At 11 openings there is a cost of 52,-33 and at 13 openings there
is a cost of 52,-+'.
"ost e)uation using 11 openings as the cost driver:
4ariable costs:
@ixed costs:
5#,+33 H @ixed "ost I 52!+.'3 x 11
@ixed "ost H 51-+.'3
C)uation wo: otal "ost H 51-+.'3 I 52!+.'3 x openings
"ost e)uation using 13 openings as the cost driver:
4ariable costs:
9-7
5#,+33 J 52,-33
#,3'3 J 2,!+'
H 51.1!#
5#,+33 J 52,-33
11 J 11
H 52!+.'3
5#,+33 J 52,-+'
11 J 13
H 5232.+-
C'a+t" 9 Cost Behavior: Analysis and Use
@ixed costs:
5#,+33 H @ixed "ost I 5232.+- x 11
@ixed "ost H 5-#+.1-
C)uation hree: otal "ost H 5-#+.1- I 5232.+- x openings
5redicted total cost for a !,233 s)uare foot house with 1# openings using
e)uation one:
513+ I 51.1!# x !,233 H 5!,+!'.-3
5redicted total cost for a !,233 s)uare foot house with 1# openings using
e)uation two:
51-+.'3 I 52!+.'3 x 1# H 5!,'12.'3
5redicted total cost for a !,233 s)uare foot house with 1# openings using
e)uation three:
5-#+.1- I 5232.+- x 1# H 5!,*-*.13
here is no simple method to determine which prediction is best when using
the /igh(<ow method. In contrast, regression provides )uantitative measures
62(s)uared, standard error, t(values,K7 to help asses which regression
e)uation is best.
5redicted cost for a 2,#33 s)uare foot house with - openings, using e)uation
one:
513+ I 51.1!# x 2,#33 H 52,-2-.*3
0e cannot predict with e)uation 2 or e)uation ! since - openings are outside
the relevant range, the range for which the high(low e)uation was developed.
Requirement 2
$i)u" 9-A shows that the relationship between costs and s)uare feet is
relatively linear without outliers, while $i)u" 9-B shows a similar result for
9-8
Cost Behavior: Analysis and Use C'a+t" 9
the relationship between costs and number of openings. @rom this perspective,
both variables are good cost drivers.
$i)u" 9-A
P0
P500
P1,000
P1,500
P2,000
P2,500
P3,000
P3,500
P4,000
P4,500
P5,000
2
,
3
7
5
2
,
4
5
0
2
,
6
0
0
2
,
6
0
0
2
,
6
5
0
2
,
7
0
0
2
,
8
0
0
2
,
8
5
0
3
,
0
1
0
3
,
5
5
0
3
,
7
0
0
4
,
0
5
0
Square Feet
C
o
s
t
9-9
C'a+t" 9 Cost Behavior: Analysis and Use
$i)u" 9-B
Cost versus No. of Openings
P0
P500
P1,000
P1,500
P2,000
P2,500
P3,000
P3,500
P4,000
P4,500
P5,000
10 11 11 12 12 13 13 13 15 16 16 19
Nuber of Openings
C
o
s
t
E%"#is" - 0Cost Esti4ation5 A##ount Classi1i#ation2
Requirement 1
@ixed "osts:
2ent 513,2'3
:epreciation #33
9-*9
Cost Behavior: Analysis and Use C'a+t" 9
Insurance +'3
Advertising *'3
Utilities 1,2'3
9r. =lac%Es salary 1-,'33
otal 5!1,-33
4ariable "osts:
0ages 51+,-33
": Cxpense **,+'3
8hopping =ags 1-3
otal 5-#,+!3
4ariable "osts 5er Unit H 5-#,+!3 A -,133
H 51'.23
"ost @unction C)uation: y H 5!1,-33 I 51'.23 x 6":Es sold7
Requirement 2
.ew 8ales H -,133 x 1.2'
H 11,12' units
H round to 11,1!3
otal "osts H 5!1,-33 I 51'.23 x 611,1!37
H 51!+,+*3
5er Unit otal "osts H 51!+,+*3 A 11,1!3
H 512!.-3
Add 51 profit per disc: 512!.-3 I 513 H 51!!.-3
Requirement 3
Ad,usted .ew 8ales H -,133 x 11.'3
H 13,2#3 units
2evenue H 51!!.-3 x 613,2#37
H 51!+,313
otal "ost H 5!1,-33 I 51'.23 x 613,2#37
H 5121,2-3
"ost 5er :isc H 5121,2-3 A 13,2#3 H 512*.!3
9-**
C'a+t" 9 Cost Behavior: Analysis and Use
5rofit 5er :is% H 51!!.-3 J 512*.!3
H 5+.'3
E%"#is" . 0Cost Esti4ation Usin) Ga+'s5 S"(i#"2
Requirement 1
Sales and Advertising !xpense
P0
P20,000
P40,000
P60,000
P80,000
P100,000
P120,000
P140,000
P160,000
P
2
,
5
0
0
P
3
,
0
0
0
P
3
,
5
0
0
P
4
,
0
0
0
P
4
,
5
0
0
P
5
,
0
0
0
P
5
,
5
0
0
Advertising !xpense
S
a
l
e
s
Requirement 2
here seems to be a positive linear relationship for the data between 52,'33
and 5#,333 of advertising expense. <lanesE analysis is correct within this
relevant range but not outside of it. .otice that the relationship between
advertising expense and sales changes at 5#,333 of expense.
E%"#is" / 0$i%"& an& Vaia!l" Cost B"'a(io2
Requirement (1)
Cups of Coffee Served
in a Week
9-*,
Cost Behavior: Analysis and Use C'a+t" 9
1,800 1,900 2,000
@ixed cost 511,333 511,333 511,333
4ariable cost #,*-3 #,1#3 ',233
otal cost 51',*-3 51',1#3 51*,233
"ost per cup of coffee served L 5-.+1 5-.!1 5-.13
L otal cost M cups of coffee served in a wee%
Requirement (2)
he average cost of a cup of coffee declines as the number of cups of coffee
served increases because the fixed cost is spread over more cups of coffee.
E%"#is" 3 0S#att")a+' Anal:sis2
Requirement (1)
he completed scattergraph is presented below:
9-*-
C'a+t" 9 Cost Behavior: Analysis and Use
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
0 2,000 4,000 6,000 8,000 10,000
Units Processed
T
o
t
a
l

C
o
s
t
9-*.
Cost Behavior: Analysis and Use C'a+t" 9
Requirement (2)
68tudentsE answers will vary considerably due to the inherent imprecision and
sub,ectivity of the )uic%(and(dirty scattergraph method of estimating variable
and fixed costs.7
he approximate monthly fixed cost is 5*,333Dthe point where the straight
line intersects the cost axis.
he variable cost per unit processed can be estimated as follows using the
-,333(unit level of activity, which falls on the straight line:
otal cost at the -,333(unit level of activity.................................. 51#,333
<ess fixed costs............................................................................ *,333
4ariable costs at the -,333(unit level of activity............................ 5 -,333
5-,333 M -,333 units H 51 per unit.
;bserve from the scattergraph that if the company used the high(low method
to determine the slope of the line, the line would be too steep. his would
result in underestimating the fixed cost and overestimating the variable cost
per unit.
E%"#is" 7 0Hi)'-Lo6 M"t'o&2
Requirement (1)
ont! "##upan#$%&a$s
'le#tri#al
Costs
/igh activity level 6August7................... !,*3- 5-,111
<ow activity level 6;ctober7.................. 1-* 1,+12
"hange................................................... !,#22 5*,!11
4ariable cost H "hange in cost M "hange in activity
H 5*,!11 M !,#22 occupancy(days
H 51.-+ per occupancy(day
otal cost 6August7.............................................................. 5-,111
4ariable cost element
651.-+ per occupancy(day N !,*3- occupancy(days7....... *,+#+
@ixed cost element................................................................ 51,!*#
Requirement (2)
Clectrical costs may reflect seasonal factors other than ,ust the variation in
9-*/
C'a+t" 9 Cost Behavior: Analysis and Use
occupancy days. @or example, common areas such as the reception area must
be lighted for longer periods during the winter. his will result in seasonal
effects on the fixed electrical costs.
Additionally, fixed costs will be affected by how many days are in a month. In
other words, costs li%e the costs of lighting common areas are variable with
respect to the number of days in the month, but are fixed with respect to how
many rooms are occupied during the month.
;ther, less systematic, factors may also affect electrical costs such as the
frugality of individual guests. 8ome guests will turn off lights when they leave
a room. ;thers will not.
E%"#is" 8 0L"ast-S;ua"s R")"ssion2
he least(s)uares regression estimates of fixed and variable costs can be
computed using any of a variety of statistical and mathematical software
pac%ages or even by hand.
ont! Rental Returns Car Was! Costs
Oanuary...................................... 2,!13 513,11!
@ebruary.................................... 2,#'! 512,*11
9arch........................................ 2,*#1 513,13'
April.......................................... 2,-+# 512,1#1
9ay........................................... !,'#3 51',!!#
Oune........................................... #,-*1 521,#''
Ouly............................................ ',#!2 521,2+3
August....................................... ',2*- 511,1!3
8eptember.................................. #,*2- 521,-*3
;ctober...................................... !,+23 51-,!-!
.ovember.................................. 2,13* 5 1,-!3
:ecember................................... 2,#1' 511,3-1
Intercept 52,21*
8lope 5!.+#
28> 3.12
he intercept provides the estimate of the fixed cost element, 52,21* per
month, and the slope provides the estimate of the variable cost element, 5!.+#
per rental return. Cxpressed as an e)uation, the relation between car wash
costs and rental returns is
P H 52,21* I 5!.+#Q
9-*3
Cost Behavior: Analysis and Use C'a+t" 9
where Q is the number of rental returns.
.ote that the 2
2
is 3.12, which is )uite high, and indicates a strong linear
relationship between car wash costs and rental returns.
0hile not a re)uirement of the exercise, it is always a good to plot the data on
a scattergraph. he scattergraph can help spot nonlinearities or other
problems with the data. In this case, the regression line 6shown below7 is a
reasonably good approximation to the relationship between car wash costs and
rental returns.
Php0
Php5,000
Php10,000
Php15,000
Php20,000
Php25,000
0 1,000 2,000 3,000 4,000 5,000 6,000
Rental Returns
III. Problems
Po!l"4 *
Requirement (a) iles
&riven
(otal )nnual
Cost*
/igh level of activity.......................... 123,333 51!,123
9-*7
C'a+t" 9 Cost Behavior: Analysis and Use
<ow level of activity........................... -3,333 13,--3
:ifference...................................... #3,333 5 !,3#3
L 123,333 miles x 53.11* H 51!,123.
-3,333 miles x 53.1!* H 513,--3.
4ariable cost per mile:
"hange in cost, 5!,3#3
"hange in activity,#3,333
@ixed cost per year:
otal cost at 123,333 miles.................................... 51!,123
<ess variable cost element: 123,333 x 53.3+*...... 1,123
@ixed cost per year............................................. 5 #,-33
Requirement (+)
P H 5#,-33 I 53.3+*Q
Requirement (#)
@ixed cost..................................................................... 5 #,-33
4ariable cost: 133,333 miles x 53.3+*........................ +,*33
otal annual cost................................................... 512,#33
Po!l"4 ,
Requirement 1
"ost of goods sold...................................................... 4ariable
8hipping expense........................................................ 9ixed
Advertising expense.................................................... @ixed
8alaries and commissions........................................... 9ixed
Insurance expense....................................................... @ixed
:epreciation expense.................................................. @ixed
Requirement 2
Analysis of the mixed expenses:
,nits
S!ippin-
'.pense
Salaries
and Comm/
'.pense
/igh level of activity................ #,'33 5'*,333 51#!,333
<ow level of activity................. !,333 ##,333 13+,333
:ifference.......................... 1,'33 512,333 5 !*,333
9-*8
H 53.3+* per mile.
Cost Behavior: Analysis and Use C'a+t" 9
4ariable cost element:
"hange in cost
"hange in activity
8hipping expense:
8alaries and comm. expense:
@ixed cost element:
S!ippin-
'.pense
Salaries and
Comm/
'.pense
"ost at high level of activity................ 5'*,333 51#!,333
<ess variable cost element:
#,'33 units x 5-............................ !*,333
#,'33 units x 52#..........................

13-,333
@ixed cost element............................... 523,333 5 !',333
he cost elements are:
8hipping expense: 523,333 per month plus 5- per unit or P H
523,333 I 5-Q.
8alaries and comm. expense: 5!',333 per month plus 52# per unit or
P H 5!',333 I 52#Q.
Requirement 3
<I<P ";95A.P
Income 8tatement
@or the 9onth Cnded Oune !3
8ales in units................................................... #,'33
8ales revenues................................................. 5*!3,333
<ess variable expenses:
"ost of goods sold 6R5'*7......................... 52'2,333
9-*9
H 4ariable rate
512,333
1,'33 units
H 5- per unit.
5!*,333
1,'33 units
H 52# per unit.
C'a+t" 9 Cost Behavior: Analysis and Use
8hipping expense 6R5-7............................ !*,333
8alaries and commission expense
6R52#7................................................... 13-,333 !1*,333
"ontribution margin........................................ 2!#,333
<ess fixed expense:
8hipping expense........................................ 23,333
Advertising................................................. +3,333
8alaries and commissions........................... !',333
Insurance.................................................... 1,333
:epreciation............................................... #2,333 1+*,333
.et income...................................................... 5 '-,333
Po!l"4 -
Requirement 1
0ear
1um+er of
2ea-ues (3)
(otal Cost
(0) 30 3
2
233# ' 51!,333 5 *',333 2'
233' 2 +,333 1#,333 #
233* # 13,'33 #2,333 1*
233+ * 1#,333 -#,333 !*
233- ! 13,333 !3,333 1
23 5'#,'33 52!',333 13
n 6 QP7 ( 6 Q7 6 P7
n 6Q
2
7 ( 6Q7
2
' 62!',3337 ( 6237 6'#,'337
' 6137 ( 6237
2
H 1,+33
6 P7 ( b6 Q7
n
6'#,'337 ( 1,+33 6237
'
H 5#,133
herefore, the variable cost per league is 51,+33 and the fixed cost is
5#,133 per year.
Requirement 2
9-,9
b H
H
a H
H
Cost Behavior: Analysis and Use C'a+t" 9
P H 5#,133 I 51,+33Q
Requirement 3
he expected value total would be:
@ixed cost.............................................................. 5 #,133
4ariable cost 6+ leagues x 51,+337........................ 11,133
otal cost.......................................................... 51*,333
he problem with using the cost formula from 627 to derive this total cost
figure is that an activity level of + sections lies outside the relevant range from
which the cost formula was derived. She relevant range is represented by a
solid line on the graph in re)uirement # below.T
Although an activity figure may lie outside the relevant range, managers will
often use the cost formula anyway to compute expected total cost as we have
done above. he reason is that the cost formula fre)uently is the only basis
that the manager has to go on. Using the cost formula as the starting point
should not present a problem so long as the manager is alert for any unusual
problems that the higher activity level might bring about.
Requirement 4
9-,*
51*,333
51#,333
512,333
513,333
5-,333
5*,333
5#,333
52,333
5(
3 1 2 ! - * ' # +
Y
X
C'a+t" 9 Cost Behavior: Analysis and Use
Po!l"4 . 0R")"ssion Anal:sis< S"(i#" Co4+an:2
Requirement 1
$i)u" 9-C plots the relationship between labor(hours and overhead costs and
shows the regression line.
y H 5#-,2+1 I 5!.1! Q
'#onomi# plausi+ilit$. <abor(hours appears to be an economically plausible
driver of overhead cost for a catering company. ;verhead costs such as
scheduling, hiring and training of wor%ers, and managing the wor%force are
largely incurred to support labor.
5oodness of fit. he vertical differences between actual and predicted costs
are extremely small, indicating a very good fit. he good fit indicates a strong
relationship between the labor(hour cost driver and overhead costs.
Slope of re-ression line. he regression line has a reasonably steep slope
from left to right. he positive slope indicates that, on average, overhead
costs increase as labor(hours increase.
Requirement 2
he regression analysis indicates that, within the relevant range of 2,'33 to
+,'33 labor(hours, the variable cost per person for a coc%tail party e)uals:
@ood and beverages 51'.33
<abor 63.' hrs. x 513 per hour7 '.33
4ariable overhead 63.' hrs. x 5!.1! per labor(hour7 1.1+
otal variable cost per person 521.1+
Requirement 3
o earn a positive contribution margin, the minimum bid for a 233(person
coc%tail party would be any amount greater than 5#,!1#. his amount is
calculated by multiplying the variable cost per person of 521.1+ by the 233
9-,,
Cost Behavior: Analysis and Use C'a+t" 9
people. At a price above the variable costs of 5#,!1#, =obby &on$ales will
be earning a contribution margin toward coverage of his fixed costs.
;f course, =obby &on$ales will consider other factors in developing his bid
including 6a7 an analysis of the competition J vigorous competition will limit
&on$alesE ability to obtain a higher price 6b7 a determination of whether or not
his bid will set a precedent for lower prices J overall, the prices =obby
&on$ales charges should generate enough contribution to cover fixed costs
and earn a reasonable profit, and 6c7 a ,udgment of how representative past
historical data 6used in the regression analysis7 is about future costs.
$i)u" 9-C
2egression <ine of <abor(/ours on ;verhead "osts for =obby &on$alesE
"atering "ompany
9-,-
C'a+t" 9 Cost Behavior: Analysis and Use
P0
P10,000
P20,000
P30,000
P40,000
P50,000
P60,000
P70,000
P80,000
P90,000
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000
Cost "river# $abor-%ours
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Po!l"4 / 0Lin"a Cost A++o%i4ation2
Requirement 1
he linear cost function is plotted in $i)u" 9-D.
.o, the constant component of the cost function does not represent the fixed
overhead cost of the A=8 &roup. he relevant range of professional labor(
hours is from !,333 to -,333. he constant component provides the best
available starting point for a straight line that approximates how a cost
behaves within the !,333 to -,333 relevant range.
Requirement 2
9-,.
8lope coefficient 6+7 H
:ifference in cost
:ifference in labor(hours
H
5'21,333 J 5#33,333
+,333 J #,333
H 5#!.33
Constant (a) H 5'21,333 J 5#!.33 6+,3337
H 522-,333
"ost function H 522-,333 I 5#!.33 6professional labor(hours7
Cost Behavior: Analysis and Use C'a+t" 9
A comparison at various levels of professional labor(hours follows. he
linear cost function is based on formula of 522-,333 per month plus 5#!.33
per professional labor(hours.
otal overhead cost behavior:
9onth 1 9onth 2 9onth ! 9onth # 9onth ' 9onth *
Actual total overhead
costs 5!#3,333 5#33,333 5#!',333 5#++,333 5'21,333 5'-+,333
<inear approximation !'+,333 #33,333 ##!,333 #-*,333 '21,333 '+2,333
Actual minus linear
approximation 561+,3337 5 3 5 6-,3337 5 61,3337 5 3 51',333
5rofessional labor(hours !,333 #,333 ',333 *,333 +,333 -,333
he data are shown in $i)u" 9-D. he linear cost function overstates costs
by 5-,333 at the ',333(hour level and understates costs by 51',333 at the
-,333(hour level.
Requirement 3
6ased on
)#tual
6ased on
2inear Cost
7un#tion
"ontribution before deducting incremental
overhead 5!-,333 5!-,333
Incremental overhead !',333 #!,333
"ontribution after incremental overhead 5 !,333 5 6',3337
he total contribution margin actually forgone is 5!,333.
$i)u" 9-D
<inear "ost @unction 5lot of 5rofessional <abor(/ours
on otal ;verhead "osts for A=8 "onsulting &roup
9-,/
C'a+t" 9 Cost Behavior: Analysis and Use
P0
P100,000
P200,000
P300,000
P400,000
P500,000
P600,000
P700,000
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000
'rofessional $abor-%ours (illed
)
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Po!l"4 3 0Cost B"'a(io2
he variable cost per hour can be computed as follows:
523,333 A ',333 hours H 5# per hour
herefore, the missing amounts are as follows:
/ours of ;perating ime
',333 *,333 +,333 -,333
otal costs:
4ariable costs
6R 5# per hour7 5 23,333 5 2#,333 5 2-,333 5 !2,333
@ixed costs 1*-,333 1*-,333 1*-,333 1*-,333
otal costs 5 1--,333 5 112,333 5 11*,333 5 233,333
/ours of ;perating ime
',333 *,333 +,333 -,333
"ost per hour:
4ariable cost 5 #.33 5 #.33 5 #.33 5 #.33
9-,3
Cost Behavior: Analysis and Use C'a+t" 9
@ixed cost !!.*3 2-.33 2#.33 21.33
otal cost per hour 5 !+.*3 5 !2.33 5 2-.33 5 2'.33
;bserve that the total variable costs increase in proportion to the number of
hours of operating time, but that these costs remain constant at 5# if
expressed on a per hour basis.
In contrast, the total fixed costs do not change with changes in the level of
activity. hey remain constant at 51*-,333 within the relevant range. 0ith
increases in activity, however, the fixed cost per hour decreases, dropping
from 5!!.*3 per hour when the boats are operated ',333 hours a period to
only 521.33 per hour when the boats are operated -,333 hours a period.
6e#ause of t!is trou+lesome aspe#t of fi.ed #osts, t!e$ are most easil$ (and
most safel$) dealt 8it! on a total +asis, rat!er t!an on a unit +asis, in #ost
anal$sis 8ork/
Po!l"4 7 0Hi)'-Lo6 M"t'o&2
Requirement (1)
he first step in the high(low method is to identify the periods of the lowest
and highest activity. hose periods are .ovember 61,133 patients admitted7
and Oune 61,133 patients admitted7.
he second step is to compute the variable cost per unit using those two data
points:
ont!
1um+er of
9atients )dmitted
)dmittin-
&epartment Costs
/igh activity level 6Oune7 1,133 51',233
<ow activity level 6.ovember7 1,133 12,-33
"hange -33 5 2,#33
9-,7
4ariable cost H
"hange in cost
"hange in activity
H
52#3,333
-33 patients admitted
5! per patient admitted H
C'a+t" 9 Cost Behavior: Analysis and Use
he third step is to compute the fixed cost element by deducting the variable
cost element from the total cost at either the high or low activity. In the
computation below, the high point of activity is used:
@ixed cost element H otal cost J 4ariable cost element
H 51',233 J 65! per patient admitted
x 1,133 patients admitted7
H 51,'33
Requirement (2)
he cost formula is P H 51,'33 I 5!Q.
Po!l"4 8 0S#att")a+' Anal:sis5 S"l"#tion o1 an A#ti(it: Bas"2
Requirement (1)
he completed scattergraph for the number of units produced as the activity
base is presented below:
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
5,000
0 20 40 60 80 100 120 140
Units Produced

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Requirement (2)
he completed scattergraph for the number of wor%days as the activity base is
presented below:
9-,8
Cost Behavior: Analysis and Use C'a+t" 9
he number of wor%days should be used as the activity base rather than the
9-,9
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
5,000
0 2 4 6 8 10 12 14 16 18 20 22 24
#u$"er o% anitorial &or'da(s

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Requirement (3)
C'a+t" 9 Cost Behavior: Analysis and Use
number of units produced. here are several reasons for this. @irst, the
scattergraphs reveal that there is a much stronger relationship 6i.e., higher
correlation7 between ,anitorial costs and number of wor%days than between
,anitorial costs and number of units produced. 8econd, from the description of
the ,anitorial costs, one would expect that variations in those costs have little
to do with the number of units produced. wo ,anitors each wor% an eight(
hour shiftDapparently irrespective of the number of units produced or how
busy the company is. 4ariations in the ,anitorial labor costs apparently occur
because of the number of wor%days in the month and the number of days the
,anitors call in sic%. hird, for planning purposes, the company is li%ely to be
able to predict the number of wor%ing days in the month with much greater
accuracy than the number of units that will be produced.
.ote that the scattergraph in part 617 seems to suggest that the ,anitorial labor
costs are variable with respect to the number of units produced. his is false.
Oanitorial labor costs do vary, but the number of units produced isnEt the cause
of the variation. /owever, since the number of units produced tends to go up
and down with the number of wor%days and since the ,anitorial labor costs are
driven by the number of wor%days, it appears on the scattergraph that the
number of units drives the ,anitorial labor costs to some extent. Analysts must
be careful not to fall into this trap of using the wrong measure of activity as
the activity base ,ust because it appears there is some relationship between
cost and the measure of activity. "areful thought and analysis should go into
the selection of the activity base.
I4. Multiple Choice Questions
1. A 11. " L 21. " !1. : #1. =
2. : 11. " L 22. : !2. = #2. :
!. = 12. " 2!. " !!. A #!. "
#. A 1!. A 2#. A !#. =
'. = 1#. : 2'. : !'. A
*. = 1'. " 2*. = !*. :
+. " 1*. : 2+. : !+. =
-. : 1+. = 2-. = !-. "
1. " 1-. " 21. A !1. =
13. A 11. " !3. : #3. :
L Supportin- Computations:
11. 613,333 x 27 J 65!,333 x 27 J 5',333 H 51,333
12. S6523 I 5! I 5*7 x 2,333 unitsT I 6513 x 1,333 units7 H 5*-,333
9--9