Mastery of Management Services

Costs Concepts and Behavior

COST - a measurement, in monetary terms, of the amount of resources used for some
purpose. When notified by a term that defines the purpose, cost becomes operational,
e.g., selling cost, acquisition cost, variable cost, etc.

COST POOL - an account in which a variety of similar costs are accumulated prior to allocation to
cost objects. It is a group of costs associated with an activity. Example: overhead
account.

COST OBJECT - the intermediate and final disposition of cost pools.

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; any factor or activity that has a direct cause-effect
relationship

ACTIVITY - any event, action, transaction, or work sequence that incurs costs when producing a
product or providing a service

FUNCTIONAL COSTS – Manufacturing Costs, Selling and Administrative

COST BEHAVIOR

COST BEHAVIOR – describes how a cost behaves or changes as the amount of cost driver changes

TYPES OF COSTS AS TO BEHAVIOR:

1. FIXED COST – in total: constant within the relevant range as activity output changes; per
unit: changes as activity level changes
2. VARIABLE COST – in total: varies in direct proportion to changes in activity output; per unit:
remain constant
3. MIXED COST – has both fixed and variable components. Increases less proportionately (vs.
total variable costs) as production increases. Decreases less proportionately (vs. fixed costs
per unit) as production increases.
4. SEMIVARIABLE COSTS
5. SEMIFIXED COSTS

COST BEHAVIOR ASSUMPTIONS:

1. Relevant Range Assumption
Relevant range refers to the band of activity within which the identified cost behavior
patterns are valid. Any level of activity outside this range may have a different cost
behavior pattern.

2. Time Assumption
The cost behavior patterns identified are true only over a specified period of time.
Beyond this, the cost may show a different behavior.

3. Linearity Assumption
The cost is assumed to manifest a linear relationship over a relevant range despite its
tendency to show otherwise over the long run.

SEGREGATION OF FIXED AND VARIABLE ELEMENTS OF MIXED COSTS

1. High-Low Points Method – the fixed and variable elements of the mixed costs are computed
from two data points (periods) – the high and low periods as to activity level or cost driver

2. Statistical Scattergraph Method –various costs (the dependent variable) are plotted on a
vertical line (y-axis) and measurement figures (cost driver or activity levels) are plotted on a
horizontal line (x-axis). A straight line is drawn through the points and, using this line, the
rate of variability and the fixed cost are computed

3. Method of Least Squares (Regression Analysis) – 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.
 If there is only one independent variable, the analysis is known as Simple Regression
 If the analysis involves multiple independent variables, it is known as Multiple
Regression

This method uses the following equations in computing for the values of unit variable cost and
fixed cost:

Equation 1: ∑Y = na + b∑x

Equation 2: ∑xy = a∑x + b∑x2

Jasmin May P. Baniaga, CPA, CMA, MBA Page 1

Mastery of Management Services
Costs Concepts and Behavior

COST FORMULA: y = a + bx

Where y = denotes total cost. It is called the dependent variable because it is dependent on the value
of another variable, the activity level x

a = is an estimate of the fixed cost

b = is an estimate of the variable cost per unit of activity

4. Other Cost-Estimation Methods

Industrial Engineering Method – based on the relationship between inputs and outputs in
physical forms; engineering estimates indicate what and how much costs should be

Account Analysis Method – each account is classified as either fixed or variable based on
experience and judgment of accounting and other qualified personnel in the organization

Conference Method – costs are classified based on opinions from various company
departments such as purchasing, process engineering, manufacturing, employee relations and
so on

CORRELATIONAL ANALYSIS
Correlation analysis is used to measure the strength of linear relationship between two or
more variables.
 If the points seem to form a straight line, there is a high correlation
 If the points form a random pattern, there is a low correlation or no correlation at all

Coefficients of Correlation (r) measures the relative strength of linear relationship between 2
variables. The range of the coefficient “r” is from -1.0 to +1.0:
 If r = -1.0, there is perfect inverse linear relationship between x and y
 If r = 0, no linear relationship
 If r = +1.0, there is a perfect direct relationship between x and y

Problem 1. Winnie’s Storage ran its freezer in February, a slow month, for 360 hours for a total cost
of P 57,600. In July, a peak month, the freezer ran for 720 hours for a total of P 82,080.

Required:
a. What is the cost estimating equation for the department if hours of freezer use are used as the
cost driver?
b. What is the estimated total cost at an operating level of 500 hours?

Problem 2. As part of her job as cost analyst, Marie Cruz collected the following information
concerning the operations of the Machining Department:
Machine Total Operating
Observation Hours Costs
January 4,000 P 45,000
February 4,600 49,500
March 3,800 45,750
April 4,400 48,000
May 4,500 49,800

Required:
a. Use the high-low method to determine the estimating cost function with machine-hours as the
cost driver.
b. If June’s estimated machine-hours total 4,200, what are the total estimated costs of the
Machining Department?

Problem 3. The new cost analyst in your accounting department has just received a computer-
generated report that contains the results of a simple regression program for cost estimation. The
summary results of the report appear as follows:
Standard
Variable Coefficient Error t-Value
Constant P 35.92 P 16.02 2.24
Independent variable P 563.80 P 205.40 2.74
r2 = 0.75

Required:
a. What is the cost estimation equation according to the report?
b. What is the goodness of fit? What does it tell about the estimating equation?

Problem 4. Newton Company used least squares regression analysis to obtain the following output:
Payroll Department Cost Explained by Number of Employees
Constant = P 5,800

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Mastery of Management Services
Costs Concepts and Behavior

Standard error of Y estimate = 630

r2 = 0.8924
Number of observations = 20
X coefficient(s) = P 1.902
Standard error of coefficient(s) = 0.966

Required:
a. What is the total fixed cost?
b. What is the variable cost per employee?
c. Prepare the linear cost function
d. What is the coefficient of determination? Comment on the goodness of fit.

Problem 5. Reliable Movers Inc. documented the miles driven and total moving van costs for the
past five months as follows:
Number Total vehicle
of miles Costs
January 3,000 P 4,800
February 3,500 5,200
March 5,000 6,100
April 4,000 5,000
May 6,000 6,000

In order to budget total vehicle costs for the upcoming summer months, Reliable wished to estimate
total vehicle costs using the high-low method.

Required:
1. What is the equation to predict estimated total vehicle costs?
2. If the company expects to drive 9,000 miles in June, what will be the estimated total vehicle
costs?

Problem 6. St. Andrew Hospital contains 500 beds. The average occupancy rate is 80% per month.
In other words, on average, 80% of the hospital’s beds are occupied by patients. At this level of
occupancy, the hospital\s operating costs are P 40 per occupied bed per day, assuming a 30-day
month. This P 40 figure contains both variable and fixed cost elements.
During June, the hospital’s occupancy rate was only 60%. A total of P 405,000 in operating cost was
incurred during the month.
1. Using the high-low method, estimate:
a. The variable cost per occupied bed on a daily basis.
b. The total fixed operating costs per month.

2. Assume an occupancy rate of 75% per month. What amount of total operating cost would you
expect the hospital to incur?

Problem 7. Given the following mixed costs at various levels of production, complete the
requirements:
Month Units Produced Mixed Costs
January 20 P 150
February 30 180
March 10 110
April 50 220
May 30 130

1. Using the least squares method, calculate the monthly fixed and variable components of
mixed costs.
2. Using the estimates made in number 1, compute the total cost of producing forty units in a
month.

Problem 8. The following selected data were taken from the accounting records of Metcalf
Manufacturing. The company uses direct-labor hours as its cost driver for overhead costs.
Direct-Labor Manufacturing
Month Hours Overhead
January 23,000 P 454,000
February 30,000 517,000
March 34,000 586,000
April 26,000 499,500
May 25,000 480,000
June 28,000 515,000

March’s costs consisted of machine supplies (P 102,000), depreciation (15,000), and plant
maintenance (P 469,000). These costs exhibit the following respective behavior: variable, fixed, and
semi-variable.

Jasmin May P. Baniaga, CPA, CMA, MBA Page 3

Mastery of Management Services
Costs Concepts and Behavior

The manufacturing overhead figures presented in the preceding table do not include Metcalf’s
supervisory labor cost, which step-fixed in nature. For volume levels of less than 15,000 hours,
supervisory labor amounts to P 45,000. The cost is P 90,000 from 15,000 - 29,999 hours and P
135,000 when activity reaches 30,000 hours or more.

Required:
1. Determine the machine supplies cost and depreciation for January.
2. Using the high-low method, analyze Metcalf’s plant maintenance cost and calculate the
monthly fixed portion and the variable cost per direct-labor hour.
3. Assume that present cost behavior patterns continue into the latter of the years. Estimate the
total amount of manufacturing overhead the company can expect in November if 29,500
direct-labor hours are worked.
4. Briefly explain in difference between a fixed cost and a step-fixed cost.
5. Assume that a company has a step-fixed cost. Generally speaking, where on a step should
the firm attempt to operate if it desires to achieve a maximum return on its investments?

Jasmin May P. Baniaga, CPA, CMA, MBA Page 4