Cost Behavior

and
Cost Estimation

1

Types of Cost Behavior Patterns
Summary of VC and FC Behavior
Cost

In Total

Per Unit

VC

Total VC is
proportional to the activity
level within the RR.
RR

VC per unit remains
the same over wide ranges
of activity.
activity

Total FC remains the
same even when the activity
level changes within the
RR.

FC per unit goes
down as activity level goes up.

FC

2

Minutes Talked 4 .The Activity Base Units p produced Machine hours A measure off what h t causes the i incurrence off a VC Miles driven Labor hours 3 True VC Example Total Phone e Bill $$ $ A VC is a cost whose total dollar amount varies in direct proportion to changes in the activity level. Supposed you had a phone bill that is based on the number of minutes talked.

Volume 5 VC Per Unit Example P Min Per nute Phon ne Cha arge $$ $ A VC remains constant if expressed on a per unit basis. constant For example. The cost per minute talked is constant. minute Minutes Talked 6 .True Variable Costs Total DM Co ost $$ Direct materials is a true or proportionately VC because the total cost of direct material used during a period will vary in direct proportion to the level of production activity. example 10 cents per minute.

A service company will normally have a high proportion of VCs. 3. A public utility with large investments in equipment will tend to have fewer VCs. Merchandising and manufacturing companies – commissions. clerical 8 . and clerical costs. A manufacturing company will often have many VCs. labor and variable overhead overhead. like cost of sales. Service companies – supplies. A merchandising company usually will have a high proportion of VCs. For example . 4. . 7 Examples of Variable Costs 1. Merchandising companies – cost of goods sold. travel. and clerical. such as invoicing. shipping costs. . direct labor. 2.Extent of Variable Costs The proportion of VCs differs across organizations. Manufacturing companies – direct materials.

Suppose your monthly phone bill is fixed and does not change.Total C T Cost $$ Step-Variable Costs Volume 9 Total Fixed Costs Example Tota al Phon ne Bill $ $$ A FC is a cost whose total dollar amount remains constant as the activity level changes. no matter how many calls you make. Number of Calls 10 .

FC Per Unit Example Phone Ch harge p per Call $$ Average FCs per unit decrease as the activity level increases. cannot be g y reduced significantly in the short term. The FC per local call decreases as more local calls are made made. May be altered in the y current short-term by managerial decisions Examples Examples Depreciation on Equipment and R lE Real Estate t t T Taxes Advertising and Research and D Development l t 12 . Number of Local Calls 11 Types of Fixed Costs Committed Discretionary y Long-term.

h i CM covers FCs and provides for Net Income.Tottal Cos st $$ The Linearity Assumption g and the Relevant Range Relevant Range R Activity 13 Prepare an Income Statement Using the CM Format Revenue Less: VC CM Total $ 100.000 $ 40.000 60 000 60.000 $ 10.000 Unit $ 50 30 $ 20 The CM fformatt emphasizes Th h i costt b behavior. 14 .000 Less: FC Net Income 30.

Uses off this thi approach h iinclude: l d 1. 16 . Segmented reporting of profit data 4 Special decisions ssuch 4.Uses of the Contribution (CM) Format Th CM iincome statement The t t t fformatt iis used d as an internal planning and decision making tool. ch as pricing and make make--ororbuy analysis 15 Contribution (CM) Format Used primarily for external reporting reporting. Used primarily by management management. Budgeting 3. CVP analysis y 2.

kwh. and your monthly activity level is 2.03 per kwh.Mixed Costs The total mixed cost line can be expressed as an equation: Y = a + bX Where: Y = the total mixed cost a = the total FC (the Y intercept) Y Tota al Utilitty Cost b = the VC p per unit of activity y (the slope of the line) X = the level of activity Variable C t per KW Cost X Activity (Kilowatt Hours) Fixed Monthly Utility Charge 17 Mixed Costs Example If your fixed monthly utility charge is $40. kwh. what is the amount of your utility bill? Y = a + bX Y = $40 + ($0.03 × 2.000) Y = $100 18 .000 kwh. your VC is $0.

000’s s Patient days = 800 19 Scattergraph Method Make a quick estimate of VC per unit and determine the cost equation. Total maintenance at 800 patients Less: Fixed cost Estimated total variable cost for 800 patients VC per unit = $1.000 800 $ 11 11.Scattergraph Method Mainte enance Cost 1.25/patient $1 25/patient25/patient-day Y = $10 $10.000 = $1.000 000 + $1 $1.000 1.000 $ 1. Y Total maintenance cost = $11 $11.000 0 0 1 2 3 4 X Patient-days Patient days in 1.25X 25X Total maintenance cost Number of patient days 20 .000 000 20 * * * * 10 * ** * ** Intercept = FC: $10.000 000 10.000’s s of Do ollars Use one data point to estimate the total level of activity and the total cost.

400 Total FC = $3.High-Low Method The VC per hour of maintenance is equal to the change in cost divided y the change g in hours.800 – ($8/hour × 800 hours) Total FC = $9. by $2.400 $2 400 = $8.00/hour 300 21 High-Low Method Total FC = Total Cost – Total VC Total FC = $9.800 – $6.400 22 .

errors. The goal of this method is t fit a straight to t i ht line li to t the th data that minimizes the q errors.00 $8.400 $3 400 + $8 $8. sum of the squared 24 . This method uses all of the data points to estimate the fixed and variable costt components t off a mixed cost.High-Low Method The Cost Equation for Maintenance Y = $3.00X 00X 00X 23 Regression Method A method used to analyze mixed costs if a scattergraph plot reveals an approximately linear relationship between the X and Y variables.

25 Regression Method R2 is i the th percentage t off the th variation i ti in i total t t l costt explained by the activity. and the higher the percentage the better better. called the R2. Y Total Cost 20 * * * *2 10 * ** * ** R varies from 0% to 100%. 0 0 1 2 3 Activity 4 X 26 .Regression Method • Software can be used to fit a regression line through the data points. which is a measure of the goodness of fit of the regression line to the data points. • The cost analysis objective is the same: Y = a + bX Regression also provides a statistic.