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4 - Cost Behavior

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Thanh Lam
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33 views

4 - Cost Behavior

Uploaded by

Thanh Lam
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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MA2

CH APTER 04: CO ST BEH AVIO UR


Topic list
§Cost behaviour
§Cost behaviour patterns
§The high-low method
1. Cost behaviour
The major influence to costs is volume of output, or the level of activity. The level of
activity may refer to:
◦ Value of items sold
◦ Number of items sold
◦ Number of units of electricity consumed
◦ Number of invoices issued
◦ Number of units produced
Example
Hans Bratch Co has a fleet of company cars for sales representatives. Running costs have been
estimated as follows.
◦ Cars costs $12,000 when new, and have a guaranteed trade in value of $6,000 at the end of
two years. Depreciation is charged on a straight-line basis.
◦ Petrol and oil cost 15 cent per kilometre.
◦ Tyres cost $300 per set to replace; replacement occurs after 30,000 kilometres.
◦ Hans Bratch has an agreement with a local garage to perform routine maintenance on each
car each year. Routine maintenance costs $200 per car in the first year and $450 in the
second year.
◦ Repairs average $400 per car over two years and are thought to vary with the number of
kilometers travelled. The average car travels 25,000 km per annum
◦ Tax, insurance, membership of motoring organisations and so on cost $400 per annum per car
Calculate the average cost per annum of cars which travel 10,000 kilometres per annum and
40,000 kilometres per annum
2. Cost behaviour patterns
Key terms:
◦ Fixed costs or period costs: are not affected by the level of activity
◦ Stepped cost: are fixed within a certain range of activity
◦ Variable cost: increase or decrease in total with the level of activity
(assumed linear relationship)
◦ Semi-variable/semi-fixed or mixed costs: are part fixed, part variable
2. Cost behaviour patterns
Fixed cost example:
◦ Salary of the managing director (per month or per annum)
◦ The rent of a single factory building (per month or per annum)
◦ Straight line depreciation of a single machine (per month or per annum)
Total Cost
cost Per
Unit
Fixed cost

Level of activity Level of activity


2. Cost behaviour patterns
Stepped-fixed costs example:
If production remains below 1,000 units per month, one machine is required. If production
exceed 1,000 units, a second machine may be required. è Depreciation is a stepped cost

Total Cost
cost Per
Unit

Level of activity Level of activity


2. Cost behaviour patterns
Variable cost:

Total Cost
cost per
unit

Level of activity Level of activity


2. Cost behaviour patterns
Variable cost:

Total
cost
n us
Bo

Level of activity
2. Cost behaviour patterns
Semi-variable cost:

Total
cost

Variable part

Fixed part

Level of activity

Electricity bill (standing charge + charge per unit), gas bill, salesman’s salary (basic salary +
commission)…
Question
Are the following likely to be fixed, variable or semi-variable costs?
◦ Telephone bill
◦ Annual salary of the chief accountant
◦ The management accountant’s annual membership fee to CIMA (paid by the
company)
◦ Cost of material used to pack 20 units of product X into a box
Other Cost behaviour patterns

Total Total
cost cost

Maximum Minimum
cost charge

Level of activity Level of activity


Total Total
cost cost

Level of activity Level of activity


3. High-low method
Assumption about cost behaviour:
Within the normal or relevant range of output
◦ Costs are often assumed to be either fixed for variable or semi-variable
◦ Costs often rise in a straight line as the level of activity increase. Such
costs are said to be linear.
3. High-low method
Step 1: Review record of activity and costs in previous periods
◦ Select the period with the highest activity level
◦ Select the period with the lowest activity level

Step 2: Determine:
◦ Total cost and total units at highest activities level
◦ Total cost and total units at lowest activities level

Step 3: Calculate the Variable cost per unit:


!"#$% &"'# $# ()*(+'# $&#),)#- %+,+% .!"#$% &"'# $# %"/+'# $&)#),)#- %+,+%
◦ 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 =
!"#$% 01)#' $# ()*(+'# $&#),)#- %+,+% .!"#$% 01)# $# %"/+'# $&)#),)#- %+,+%

Step 4: Calculate the Fixed cost:


◦ Fixed cost = Total cost at highest activity level – (total units at highest activity level × variable cost per unit)
Example
DG Co has recorded the following total costs during last five years

Year Output volume Total cost


Units $
20X0 65,000 145,000
20X1 80,000 165,000
20X2 90,000 170,000
20X3 60,000 140,000
20X4 75,000 155,000

Calculate the total cost that should be expected in 20X5 if output is 85,000
Question
The Valuation Department of a large firm of surveyors wishes to develop a method of predicting
its total costs in a period. The following past costs have been recorded at two activity levels
Number of
valuations Total cost
(V) (TC)
Period 1 420 82,200
Period 2 515 90,275

The total cost model for a period could be represented as follows.


A. TC = $46,500 +85V
B. TC = $42,000 +95V
C. TC = $46,500 - 85V
D. TC = $51,500 - 95V

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