Cost Accounting

and Control
Costs -
Behavior and Analysis
 Cost behavior means how a cost will react
as changes take place in the level
of business activity.

Cost analysis is an integral part of the planning

and control function. The key to effective cost
prediction lies in an understanding
of cost behavior patterns.

3
 Activity refers to a measure of the
organization's output of products or services.
In specifying cost behavior, the managerial
accountant often limits the description to
specific range of activity. This is called the
relevant range, a range activity within which
assumptions relative to variable cost and fixed
cost behavior are valid.
 Types of Cost Behavior Patterns
• A. Variable Costs items of cost which vary directly, in total,
in relation to volume of production.
• B. Fixed Costs items of cost which remain constant in
total, irrespective of the volume of production. Fixed costs
are not related to activity within the relevant range.
– Committed fixed costs are costs that represent relatively long-
term commitment on the part of management as a result of a
past decision.
– Managed fixed costs are costs that are incurred on a short-term
basis and can be more easily modified in response to changes in
management objectives
Costs classified as to Variability
• C. Mixed costs items of cost with fixed and
variable components.
 Variable vs. Fixed costs

Cost Behavior Patterns Example

Bicycles by the Sea buys a handlebar

at Php52 for each of its bicycles.
What is the total handlebar cost when
1,000 bicycles are assembled?

7
Cost Behavior Patterns Example

1,000 units × Php52 = Php52,000

What is the total handlebar cost
when 3,500 bicycles are assembled?
3,500 units × Php52 = Php182,000

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Cost Behavior Patterns Example

Bicycles by the Sea incurred Php94,500 in

a given year for the leasing of its plant.
This is an example of fixed costs with
respect to the number of bicycles assembled.

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Cost Behavior Patterns Example
What is the leasing (fixed) cost per bicycle
when Bicycles assembles 1,000 bicycles?
Php94,500 ÷ 1,000 = Php94.50
What is the leasing (fixed) cost per bicycle
when Bicycles assembles 3,500 bicycles?
Php94,500 ÷ 3,500 = Php27

10
 Cost Drivers
The cost driver of variable costs is the level
of activity or volume whose change causes
the (variable) costs to change proportionately.
The number of bicycles assembled is a
cost driver of the cost of handlebars.

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 Relevant Range Example
Assume that fixed (leasing) costs are Php94,500
for a year and that they remain the same for a
certain volume range (1,000 to 5,000 bicycles).
1,000 to 5,000 bicycles is the relevant range.

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 Relevant Range Example
120000
100000
Fixed Costs

80000
60000
40000 Php94,500
20000
0
0 1000 2000 3000 4000 5000 6000
Volume
 “Average Costs”

Interpret unit costs cautiously

 Total Costs and Unit Costs Example

What is the unit cost (leasing and handlebars)

when Bicycles assembles 1,000 bicycles?
Total fixed cost P94,500
+ Total variable cost P52,000 = P146,500
P146,500 ÷ 1,000 = P146.50
Total Costs and Unit Costs Example

200000 P146,500

150000
Total Costs 100000
P94,500
50000

0
0 500 1000 1500
Volume
 Use Unit Costs Cautiously
Assume that Bicycles management uses a
unit cost of P146.50 (leasing and wheels).
Management is budgeting costs for
different levels of production.
What is their budgeted cost for an
estimated production of 600 bicycles?
600 × P146.50 = P87,900
 Use Unit Costs Cautiously
What is their budgeted cost for an estimated
production of 3,500 bicycles?
3,500 × P146.50 = P512,750
What should the budgeted cost be for an
estimated production of 600 bicycles?
 Use Unit Costs Cautiously

Total fixed cost P 94,500

Total variable cost (P52 × 600) 31,200
Total P125,700
P125,700 ÷ 600 = P209.50
Using a cost of P146.50 per unit would
underestimate actual total costs if output
is below 1,000 units.
 Use Unit Costs Cautiously

What should the budgeted cost be for an

estimated production of 3,500 bicycles?
Total fixed cost P 94,500
Total variable cost (P52 × 3,500) 182,000
Total P276,500
P276,500 ÷ 3,500 = P79.00
 COST ESTIMATION
The Analysis of Mixed Costs
1. Account Analysis Method
2. Industrial Engineering Method or Work Measurement Method
3. Conference Method
4. Quantitative Analysis of Current and Past Costs Relationship
a. High-Low Method
b. Regression Analysis Method
1. Scatter graph or Visual Fit Method
2. The Least-squares Regression Method
 Account Analysis Method

Account analysis is considered a very useful and

easier way to estimate costs. It make use of the
experience and judgment of managers and accountants
who are familiar with company operations and the way
costs react to changes in activity level.
 Account Analysis Method
It involves the following steps:
1. Review each cost account used to record the costs that
are of interest. Each cost is identified as either fixed or
variable depending on the relationship between the cost
and some activity.
2. Each major class of manufacturing overhead or other
mixed cost is itemized. Each cost is then divided into its
estimated variable and fixed components. This is done
on the basis of the experience and judgment of
accounting and other personnel.
 Industrial Engineering Method

The industrial engineering method estimates cost

function by analyzing the relationship between inputs
and outputs in physical forms. It enables the company
to review its manufacturing productivity and identify
specific strengths and weaknesses by looking in each
step required to perform an operation.
 Industrial Engineering Method
It involves the following steps:
1. A study of the physical relation between the
quantities of inputs and each unit of output in done.
2. Costs are then assigned to each of the physical
inputs to estimate the costs of the outputs.
 Conference Method

Under conference method, cost functions are

estimated based on the analysis and opinions about
costs and their drivers obtained from various
departments of an organization. This information is used
to determine the selling price of the product, optimum
product mix and evaluate cost improvements over time.
Its credibility is gained through pooling of expert
knowledge from each value-chain area.
 High-Low Method

The High-Low method of analyzing mixed cost is

based on costs observed at both the high and low levels
of activity within the relevant range.
 High-Low Method
It involves the following steps:
1. Obtain relevant data on past costs and related actual
activity levels.
2. Estimate the variable cost per unit or rate using the
following equation.
Variable cost = Cost at highest activity – Cost at lowest activity
rate per unit Highest activity – lowest activity
3. Compute the fixed cost as follows:
Fixed Cost = Total cost at highest activity –
[VC/u x Highest activity stated in units]
OR
Fixed Cost = Total cost at lowest activity –
[VC/u x lowest activity stated in units]
 High-Low Method

Summary of electricity costs and direct labor hours

Month Direct Labor Hrs Cost of Electricity
January 28 625

February 24 565

March 30 630

April 33 640

May 47 726

June 43 700
 High-Low Method
DL Hrs Cost
Summary of electricity costs and
Highest 47 726
direct labor hours
Lowest 24 565
Month Direct Cost of
Labor Hrs Electricity Difference 23 161
January 28 625 Variable rate per DL hrs = Php161/23hrs
February 24 565 Variable rate per DL hrs = Php7 per DL hr
March 30 630 High Low
Total cost of electricity 726 565
April 33 640
Less: Variable portion
May 47 726
(P7 x 47) 329
June 43 700
(P7 x 24) 168
Monthly fixed cost 397 397
The formula for projecting the total monthly cost of electricity based on the
given data would be:
P397 plus P7 multiplied by the direct-labor hours expected
to be worked during the period
 Regression Analysis Method

Regression analysis uses all available data to

estimate the cost function. It is a statistical method that
measures the average amount of change in the
dependent variable (costs) that is associated with the
unit change of one or more independent variables.
 Regression Analysis Method

Simple regression
Y = a + bX
Multiple regression
Y = a + b1X1 + b2X2 ……+ u
Where:
Y = Costs to be predicted (dependent variable)
X, X1, X2 = Independent variables on which the prediction is to be based
a = Fixed cost
B, b1, b2 = Estimated coefficients of the regression model
u = Residual term that includes the net effect of other factors not in the
model and measurement errors in the dependent and independent
variables
 Least-Squares Regression Method

A statistical technique which is often used in separating

mixed costs into their fixed and variable components is
least-squares regression. Basically, a line of
regression is determined by solving two simultaneous
linear equations which are based on the condition that
the sum of deviations above the line equals the sum of
deviations below the line.
 Least-Squares Regression Method
The equation for the determination of a straight line is:
Y = a + bX
The two linear equations that are used to solve for a and b are:
Equation (1) ƩY = Na +bƩX
Equation (2) ƩXY = ƩXa +bƩX
2

Where:
Y = Total cost
a = Fixed cost
b = Variable cost rate
X = Measure of activity
N = Number if observations
Ʃ = Summation
 Least-Squares Regression Method
Summary of electricity costs and direct labor hours
Month Direct Labor Hrs Cost of Electricity 2
X Y XY X
January 28 625 17,500 784

February 24 565 13,560 576

March 30 630 18,900 900

April 33 640 21,120 1,089

May 47 726 34,122 2,209

June 43 700 30,100 1,849

ƩX= 205 ƩY= 3,886 ƩXY= 135,302 ƩX 2 = 7,407

 Least-Squares Regression Method
Equation (1) ƩY = Na +bƩX
2
Equation (2) ƩXY = ƩXa +bƩX
Equation (1) 3,886 = 6a + 205b
Equation (2) 135,302 = 205a +7,407b
To eliminate one unknown (a), and solve for b, find and multiply the equations to its least common
denominator and then subtract the equations.

Equation (1) x 205 796,630 = 1230a + 42,025b

Equation (2) x 6 811,812 = 1230a + 44,442b
- 15,182 = - 2,417b
Variable cost rate (b) = 6.28
Fixed cost (a) = 433.1
 Scattergraph or Visual Fit
This is rough guide for cost estimation which plot the cost
against past activity levels. These activities are referred to as
Kristal Lane (X) or independent variables, or the right-hand-side
of a regression equation. The cost to be estimated may be
called the dependent variables, (Y) or the left-hand-side of the
regression equation. The line is drawn, insofar as it is possible
by visual judgment, so that the distances of the observation
above the line are equal to the distances of the observations
below the line. This line called the line of regression represents
the data as a line of conditional expected values.
 Scattergraph or Visual Fit
It involves the following steps:
1. On a graph, plot actual costs (on vertical axis) during the period
under study against the volume levels (on horizontal axis).
2. The line of best fit is then drawn by visual inspection of the
plotted points, the line representing the trend shown by the
majority of the points.
3. The fixed cost is estimated by extending the left end of the line to
the vertical axis.
4. The variable cost rate or slope of the cost line is determined by
dividing the difference between any two level of activities by the
difference in costs corresponding to the same level of activities.
 Scattergraph or Visual Fit
750
740 726
730
720
Y
710 700
800
700
690
680
670
700
660
650 640
640 630
625
630
600
620
610
600
500
590
Cost

580 565
570
560
Cost

400
550
540
530
520
300
510
500
490
480
200
470
460
450
440
100
430
420
410
400
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50
0 5 10 15 20 25
Direct Labor Hours
30 35 40 45 50
Direct Labor Hours

VC/u = (700 – 640) / (43 – 33)

VC/u = 60/10
VC/u = 6
 Scattergraph or Visual Fit
750
740 726
730
720
710 700
700
690
680
670
660
650 640
640 630
625
630
620
610
600
590
Cost

580 565
570
560
550
540
530
520
510
500
490
480
470
460
450
440
430
420
410
400
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50
Direct Labor Hours

Fixed Cost = P430

 Correlation Analysis
• Correlation analysis is a statistical method used to
evaluate the strength and direction of the relationship
between two or more variables.
• Management must evaluate whether or not the factor
selected for estimating cost behavior is suitable for the
purpose.
• The degree of correlation between the level of activity and
cost may be measured by the coefficient of determination.
 Summary/Comparison
Method Strengths Weaknesses
Account Analysis Provides a detailed expert analysis of the cost Subjective
behavior in each account
Engineering Method Based on studies of what future costs should be Not particularly useful when the
rather than what past costs have been physical relation between inputs and
outputs in indirect.
High-Low Method Simple to apply Uses only two data points which may
not produce accurate results.
Scattergraph Method Uses all the observations of cost data. Relatively The fitting of the line to the
easy to understand and apply. observations is subjective.
Difficult to do where several
independent variables are to be
used.
Least-squares Uses all of the observations of cost data. The line is The regression model requires that
Regression Method statistically fit to the observations. several relatively strict assumptions
A measure of the goodness of fit of the line to the be satisfied for the results to be
observations is provided. valid.
Relatively easy to use with computers and
sophisticated calculators.
End of Chapter 3