MANAGEMENT ACCOUNTING - Solutions Manual

CHAPTER 11

COST ESTIMATION

I. Questions

1. a. Variable cost: 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. Fixed cost: 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. Mixed cost: 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. Total fixed costs will remain constant as volume increases.
d. Total variable costs will increase as volume increases.

3. a. Cost behavior: Cost 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. Relevant range: The relevant range can be defined as that range of
activity within which assumptions relative to variable and fixed cost
behavior are valid.

4. Although the accountant recognizes that many costs are not linear in
relationship to volume at some points, he concentrates on their behavior
within narrow bands of activity known as the relevant range. The relevant
range can be defined as that range of activity within which assumptions as
relative to variable and fixed cost behavior are valid. Generally, within
this range an assumption of strict linearity can be used with insignificant
loss of accuracy.
5. The high-low method, the scattergraph method, and the least-squares
regression method are used to analyze mixed costs. The least-squares
regression method is generally considered to be most accurate, since it
derives the fixed and variable elements of a mixed cost by means of

9-1
Chapter 9 Cost Behavior: Analysis and Use

statistical analysis. The scattergraph method derives these elements by

visual inspection only, and the high-low method utilizes only two points in
doing a cost analysis, making it the least accurate of the three methods.

6. The fixed cost element is represented by the point where the regression
line intersects the vertical axis on the graph. The variable cost per unit is
represented by the slope of the line.

7. The two assumptions are:

1. A linear cost function usually approximates cost behavior within the
relevant range of the cost driver.
2. Changes in the total costs of a cost object are traceable to variations
or changes in a single cost driver.

8. No. High correlation merely implies that the two variables move together
in the data examined. Without economic plausibility for a relationship, it
is less likely that a high level of correlation observed in one set of data will
be found similarly in another set of data.

9. Refer to page 312 of the textbook.

10. The relevant range is the range of the cost driver in which a specific
relationship between cost and cost driver is valid. This concept enables
the use of linear cost functions when examining CVP 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 (the
numerator) by the related number of units (the denominator). 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. Cost estimation is the process of developing a well-defined relationship

between a cost object and its cost driver for the purpose of predicting the
cost. The cost predictions are used in each of the management functions:
Strategic Management: Cost 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.

9-2
 Cost Behavior: Analysis and Use Chapter 9

Planning and Decision Making: Cost estimation is used to predict costs

so that management can determine the desirability of alternative options
and to budget expenditures, profits, and cash flows.
Management and Operational Control: Cost estimation is used to develop
cost standards, as a basis for evaluating performance.
Product and Service Costing: Cost estimation is used to allocate costs to
products and services or to charge users for jointly incurred costs.

13. The five methods of cost estimation are:

a. Account Classification. Advantages: simplicity and ease of use.
Disadvantages: subjectivity of method and some costs are a mix of
both variable and fixed.
b. Visual fit. The visual fit method is easy to use, and requires only that
the data is graphed. Disadvantages 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. High-Low. Because of the precision in the development of the
equation, it provides a more consistent estimate than the visual fit and
is not difficult to use. Disadvantages: uses only two selected data
points and is, therefore, subjective.
d. Work Measurement. The advantage is accurate estimates through
detailed study of the different operations in the product process, but
like regression, it is more complex.
e. Regression. Quantitative, objective 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 utilize this method.

14. 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 likely to be affected by

9-3
Chapter 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 (outliers) 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 work stoppage, the data will be
unreliable for future estimates.

15. The dependent variable is the cost object of interest in the cost estimation.
An important issue in selecting a dependent variable is the level of
aggregation in the variable. For example, the company, plant, or
department may all be possible levels of data for the cost object. The
choice of aggregation level depends on the objectives for the cost
estimation, data availability, reliability, and cost/benefit considerations. If
a key objective is accuracy, then a detailed level of analysis is often
preferred. The detail cost estimates can then be aggregated if desired.

16. Nonlinear cost relationships are cost relationships that are not adequately
explained by a single linear relationship for the cost driver(s). In
accounting data, a common type of nonlinear relationship is trend and
seasonality. For a trend example, if sales increase by 8% each year, the
plot of the data for sales with not be linear with the driver, the number of
years. Similarly, 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. For example, payroll costs as a dependent variable estimated
by hours worked and wage rates is nonlinear, since the relationship is
multiplicative and therefore not the additive linear model assumed in
regression analysis.

17. The advantages of using regression analysis include that it:

a. provides an estimation model with best fit (least squared error) 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

9-4
 Cost Behavior: Analysis and Use Chapter 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 unique for a given set of data

18. High correlation exists when the changes in two variables occur together.
It is a measure of the degree of association between the two variables.
Because 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.

19. An activity base is a measure of whatever causes the incurrence of a

variable cost. Examples of activity bases include units produced, units
sold, letters typed, beds in a hospital, meals served in a cafe, service calls
made, etc.

20. (a) Variable cost: A variable cost remains constant on a per unit basis, but
increases or decreases in total in direct relation to changes in activity.
(b) Mixed cost: A mixed cost is a cost that contains both variable and
fixed cost elements.
(c) Step-variable cost: A step-variable cost is a cost that is incurred in
large chunks, and which increases or decreases only in response to
fairly wide changes in activity.

Mixed Cost

Variable Cost

Cost

Step-Variable Cost

Activity

9-5
Chapter 9 Cost Behavior: Analysis and Use

21. The 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 horizon—usually a

year. Such 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 horizon—
generally many years. Such costs relate to a company’s investment in
facilities, equipment, and basic organization. Once such costs have been
incurred, they are “locked in” for many years.

23. a. Committed d. Committed

b. Discretionary e. Committed
c. Discretionary f. Discretionary

24. The high-low method uses only two points to determine a cost formula.
These two points are likely to be less than typical since they represent
extremes of activity.

25. The term “least-squares regression” means that the sum of the squares 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.

26. Ordinary single least-squares 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 analyze the
behavior of the cost.

II. Exercises

Exercise 1 (Cost Classification)

1. b
2. f
3. e
4. i
5. e
6. h
7. l
8. a
9. j
10. k
9-6
 Cost Behavior: Analysis and Use Chapter 9

11. c or d
12. g

Exercise 2 (Cost Estimation; High-Low Method)

Requirement (1)

Cost equation using square fee as the cost driver:

Variable costs:

P4,700 – P2,800
4,050 – 2,375 = P1.134

Fixed costs:

P4,700 = Fixed Cost + P1.134 x 4,050

Fixed Cost = P107

Equation One: Total Cost = P107 + P1.134 x square feet

There are two choices for the High-Low points when using openings for the
cost driver. At 11 openings there is a cost of P2,800 and at 10 openings there
is a cost of P2,875.

Cost equation using 11 openings as the cost driver:

Variable costs:

P4,700 – P2,800
19 – 11 = P237.50

Fixed costs:

P4,700 = Fixed Cost + P237.50 x 19

Fixed Cost = P187.50

Equation Two: Total Cost = P187.50 + P237.50 x openings

Cost equation using 10 openings as the cost driver:

Variable costs:

P4,700 – P2,875
19 – 10 = P202.78
9-7
Chapter 9 Cost Behavior: Analysis and Use

Fixed costs:

P4,700 = Fixed Cost + P202.78 x 19

Fixed Cost = P847.18

Equation Three: Total Cost = P847.18 + P202.78 x openings

Predicted total cost for a 3,200 square foot house with 14 openings using
equation one:

P107 + P1.134 x 3,200 = P3,735.80

Predicted total cost for a 3,200 square foot house with 14 openings using
equation two:

P187.50 + P237.50 x 14 = P3,512.50

Predicted total cost for a 3,200 square foot house with 14 openings using
equation three:

P847.18 + P202.78 x 14 = P3,686.10

There is no simple method to determine which prediction is best when using

the High-Low method. In contrast, regression provides quantitative measures
(R-squared, standard error, t-values,…) to help asses which regression
equation is best.

Predicted cost for a 2,400 square foot house with 8 openings, using equation
one:

P107 + P1.134 x 2,400 = P2,828.60

We cannot predict with equation 2 or equation 3 since 8 openings are outside

the relevant range, the range for which the high-low equation was developed.

Requirement 2

Figure 9-A shows that the relationship between costs and square feet is
relatively linear without outliers, while Figure 9-B shows a similar result for
9-8
 Cost Behavior: Analysis and Use Chapter 9

the relationship between costs and number of openings. From this perspective,
both variables are good cost drivers.

Figure 9-A

9-9
Chapter 9 Cost Behavior: Analysis and Use

Figure 9-B

Exercise 3 (Cost Estimation; Account Classification)

Requirement 1

Fixed Costs:
Rent P10,250
Depreciation 400

9-10
 Cost Behavior: Analysis and Use Chapter 9

Insurance 750
Advertising 650
Utilities 1,250
Mr. Black’s salary 18,500
Total P31,800
Variable Costs:
Wages P17,800
CD Expense 66,750
Shopping Bags 180
Total P84,730

Variable Costs Per Unit = P84,730 / 8,900

= P95.20

Cost Function Equation: y = P31,800 + P95.20 x (CD’s sold)

Requirement 2

New Sales = 8,900 x 1.25

= 11,125 units
= round to 11,130

Total Costs = P31,800 + P95.20 x (11,130)

= P137,760

Per Unit Total Costs = P137,760 / 11,130

= P123.80

Add P1 profit per disc: P123.80 + P10 = P133.80

Requirement 3

Adjusted New Sales = 8,900 x 11.50

= 10,240 units

Revenue = P133.80 x (10,240)

= P137,010

Total Cost = P31,800 + P95.20 x (10,240)

= P129,280

Cost Per Disc = P129,280 / 10,240 = P126.30

9-11
Chapter 9 Cost Behavior: Analysis and Use

Profit Per Disk = P133.80 – P126.30

= P7.50

Exercise 4 (Cost Estimation Using Graphs; Service)

Requirement 1

Requirement 2
There seems to be a positive linear relationship for the data between P2,500
and P4,000 of advertising expense. Llanes’ analysis is correct within this
relevant range but not outside of it. Notice that the relationship between
advertising expense and sales changes at P4,000 of expense.

Exercise 5 (Fixed and Variable Cost Behavior)

Requirement (1)
Cups of Coffee Served
in a Week

9-12
 Cost Behavior: Analysis and Use Chapter 9

1,800 1,900 2,000

Fixed cost P11,000 P11,000 P11,000
Variable cost 4,680 4,940 5,200
Total cost P15,680 P15,940 P16,200
Cost per cup of coffee served * P8.71 P8.39 P8.10
* Total cost ÷ cups of coffee served in a week
Requirement (2)

The 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.

Exercise 6 (Scattergraph Analysis)

Requirement (1)

The completed scattergraph is presented below:

9-13
Chapter 9 Cost Behavior: Analysis and Use

16,000

14,000

12,000

10,000
Total Cost

8,000

6,000

4,000

2,000

0
0 2,000 4,000 6,000 8,000 10,000
Units Processed

9-14
 Cost Behavior: Analysis and Use Chapter 9

Requirement (2)
(Students’ answers will vary considerably due to the inherent imprecision and
subjectivity of the quick-and-dirty scattergraph method of estimating variable
and fixed costs.)
The approximate monthly fixed cost is P6,000—the point where the straight
line intersects the cost axis.
The variable cost per unit processed can be estimated as follows using the
8,000-unit level of activity, which falls on the straight line:
Total cost at the 8,000-unit level of activity............................................. P14,000
Less fixed costs........................................................................................6,000
Variable costs at the 8,000-unit level of activity....................................... P 8,000
P8,000 ÷ 8,000 units = P1 per unit.
Observe 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. This would
result in underestimating the fixed cost and overestimating the variable cost
per unit.

Exercise 7 (High-Low Method)

Requirement (1)
Electrical
Month Occupancy-Days Costs
High activity level (August).................... 3,608 P8,111
Low activity level (October)................... 186 1,712
Change.................................................... 3,422 P6,399
Variable cost = Change in cost ÷ Change in activity
= P6,399 ÷ 3,422 occupancy-days
= P1.87 per occupancy-day
Total cost (August)...........................................................................................
P8,111
Variable cost element
(P1.87 per occupancy-day × 3,608 occupancy-days).................................... 6,747
Fixed cost element............................................................................................
P1,364

Requirement (2)

Electrical costs may reflect seasonal factors other than just the variation in

9-15
Chapter 9 Cost Behavior: Analysis and Use

occupancy days. For example, common areas such as the reception area must
be lighted for longer periods during the winter. This 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 like 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.

Other, less systematic, factors may also affect electrical costs such as the
frugality of individual guests. Some guests will turn off lights when they leave
a room. Others will not.

Exercise 8 (Least-Squares Regression)

The least-squares regression estimates of fixed and variable costs can be

computed using any of a variety of statistical and mathematical software
packages or even by hand.

Month Rental Returns Car Wash Costs

January...................................... 2,310 P10,113
February.................................... 2,453 P12,691
March........................................ 2,641 P10,905
April.......................................... 2,874 P12,949
May........................................... 3,540 P15,334
June........................................... 4,861 P21,455
July............................................ 5,432 P21,270
August....................................... 5,268 P19,930
September.................................. 4,628 P21,860
October...................................... 3,720 P18,383
November.................................. 2,106 P 9,830
December................................... 2,495 P11,081

Intercept P2,296
Slope P3.74
RSQ 0.92
The intercept provides the estimate of the fixed cost element, P2,296 per
month, and the slope provides the estimate of the variable cost element, P3.74
per rental return. Expressed as an equation, the relation between car wash
costs and rental returns is
Y = P2,296 + P3.74X

9-16
 Cost Behavior: Analysis and Use Chapter 9

where X is the number of rental returns.

Note that the R2 is 0.92, which is quite high, and indicates a strong linear
relationship between car wash costs and rental returns.

While not a requirement of the exercise, it is always a good to plot the data on
a scattergraph. The scattergraph can help spot nonlinearities or other problems
with the data. In this case, the regression line (shown below) is a reasonably
good approximation to the relationship between car wash costs and rental
returns.

III. Problems

Problem 1

Requirement (a) Miles Total Annual

Driven Cost*
High level of activity.......................... 120,000 P13,920

9-17
Chapter 9 Cost Behavior: Analysis and Use

Low level of activity........................... 80,000 10,880

Difference...................................... 40,000 P 3,040

* 120,000 miles x P0.116 = P13,920.

80,000 miles x P0.136 = P10,880.
Variable cost per mile:
Change in cost, P3,040
Change in activity,40,000 = P0.076 per mile.
Fixed cost per year:
Total cost at 120,000 miles.................................... P13,920
Less variable cost element: 120,000 x P0.076...... 9,120
Fixed cost per year............................................. P 4,800
Requirement (b)
Y = P4,800 + P0.076X
Requirement (c)

Fixed cost..................................................................... P 4,800

Variable cost: 100,000 miles x P0.076........................ 7,600
Total annual cost.................................................... P12,400

Problem 2

Requirement 1

Cost of goods sold...................................................... Variable

Shipping expense........................................................ Mixed
Advertising expense.................................................... Fixed
Salaries and commissions........................................... Mixed
Insurance expense....................................................... Fixed
Depreciation expense.................................................. Fixed

Requirement 2

Analysis of the mixed expenses:

Salaries
Shipping and Comm.
Units Expense Expense
High level of activity................ 4,500 P56,000 P143,000
Low level of activity................. 3,000 44,000 107,000
Difference.......................... 1,500 P12,000 P 36,000

9-18
 Cost Behavior: Analysis and Use Chapter 9

Variable cost element:

Change in cost
= Variable rate
Change in activity

Shipping expense: P12,000 = P8 per unit.

1,500 units

P36,000
Salaries and comm. expense: 1,500 units = P24 per unit.

Fixed cost element:

Shipping Salaries and
Expense Comm.
Expense
Cost at high level of activity................ P56,000 P143,000
Less variable cost element:
4,500 units x P8............................ 36,000
4,500 units x P24.......................... 108,000

Fixed cost element............................... P20,000 P 35,000

The cost elements are:

Shipping expense: P20,000 per month plus P8 per unit or Y =
P20,000 + P8X.
Salaries and comm. expense: P35,000 per month plus P24 per unit or
Y = P35,000 + P24X.

Requirement 3
LILY COMPANY
Income Statement
For the Month Ended June 30

Sales in units................................................... 4,500

Sales revenues................................................. P630,000
Less variable expenses:
Cost of goods sold (@P56)......................... P252,000

9-19
Chapter 9 Cost Behavior: Analysis and Use

Shipping expense (@P8)............................ 36,000

Salaries and commission expense
(@P24)................................................... 108,000 396,000
Contribution margin........................................ 234,000
Less fixed expense:
Shipping expense........................................ 20,000
Advertising................................................. 70,000
Salaries and commissions........................... 35,000
Insurance.................................................... 9,000
Depreciation............................................... 42,000 176,000
Net income...................................................... P 58,000

Problem 3
Requirement 1

Number of Total Cost

Year Leagues (X) (Y) XY X2
2004 5 P13,000 P 65,000 25
2005 2 7,000 14,000 4
2006 4 10,500 42,000 16
2007 6 14,000 84,000 36
2008 3 10,000 30,000 9
20 P54,500 P235,000 90

n (XY) - (X) (Y)

b =
n (X2) - (X)2
5 (235,000) - (20) (54,500)
=
5 (90) - (20)2
= 1,700

a = (Y) - b(X)
n
(54,500) - 1,700 (20)
=
5
= P4,100

Therefore, the variable cost per league is P1,700 and the fixed cost is
P4,100 per year.

Requirement 2

9-20
 Cost Behavior: Analysis and Use Chapter 9

Y = P4,100 + P1,700X

Requirement 3

The expected value total would be:

Fixed cost.............................................................. P 4,100
Variable cost (7 leagues x P1,700)......................... 11,900
Total cost.......................................................... P16,000

The problem with using the cost formula from (2) to derive this total cost
figure is that an activity level of 7 sections lies outside the relevant range from
which the cost formula was derived. [The relevant range is represented by a
solid line on the graph in requirement 4 below.]

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. The reason is that the cost formula frequently 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
P16,000 Y

P14,000

P12,000

P10,000

P8,000

P6,000

P4,000

P2,000 9-21 X
P-
0 1 2 3 4 5 6 7 8
Chapter 9 Cost Behavior: Analysis and Use

Problem 4 (Regression Analysis, Service Company)

Requirement 1

Figure 9-C plots the relationship between labor-hours and overhead costs and
shows the regression line.

y = P48,271 + P3.93 X

Economic plausibility. Labor-hours appears to be an economically plausible

driver of overhead cost for a catering company. Overhead costs such as
scheduling, hiring and training of workers, and managing the workforce are
largely incurred to support labor.

Goodness of fit. The vertical differences between actual and predicted costs
are extremely small, indicating a very good fit. The good fit indicates a strong
relationship between the labor-hour cost driver and overhead costs.

Slope of regression line. The regression line has a reasonably steep slope
from left to right. The positive slope indicates that, on average, overhead
costs increase as labor-hours increase.

Requirement 2

The regression analysis indicates that, within the relevant range of 2,500 to
7,500 labor-hours, the variable cost per person for a cocktail party equals:
Food and beverages P15.00
Labor (0.5 hrs. x P10 per hour) 5.00
Variable overhead (0.5 hrs. x P3.93 per labor-hour) 1.97
Total variable cost per person P21.97

Requirement 3

To earn a positive contribution margin, the minimum bid for a 200-person

cocktail party would be any amount greater than P4,394. This amount is
calculated by multiplying the variable cost per person of P21.97 by the 200

9-22
 Cost Behavior: Analysis and Use Chapter 9

people. At a price above the variable costs of P4,394, Bobby Gonzales will be
earning a contribution margin toward coverage of his fixed costs.

Of course, Bobby Gonzales will consider other factors in developing his bid
including (a) an analysis of the competition – vigorous competition will limit
Gonzales’ ability to obtain a higher price (b) a determination of whether or not
his bid will set a precedent for lower prices – overall, the prices Bobby
Gonzales charges should generate enough contribution to cover fixed costs and
earn a reasonable profit, and (c) a judgment of how representative past
historical data (used in the regression analysis) is about future costs.

Figure 9-C
Regression Line of Labor-Hours on Overhead Costs for Bobby Gonzales’
Catering Company

9-23
Chapter 9 Cost Behavior: Analysis and Use

Problem 5 (Linear Cost Approximation)

Requirement 1
Difference in cost
Slope coefficient (b) =
Difference in labor-hours
= P529,000 – P400,000 = P43.00
7,000 – 4,000
Constant (a) = P529,000 – P43.00 (7,000)
= P228,000

Cost function = P228,000 + P43.00 (professional labor-hours)

The linear cost function is plotted in Figure 9-D.

No, the constant component of the cost function does not represent the fixed
overhead cost of the ABS Group. The relevant range of professional labor-
hours is from 3,000 to 8,000. The constant component provides the best
available starting point for a straight line that approximates how a cost
behaves within the 3,000 to 8,000 relevant range.

Requirement 2

9-24
 Cost Behavior: Analysis and Use Chapter 9

A comparison at various levels of professional labor-hours follows. The linear

cost function is based on formula of P228,000 per month plus P43.00 per
professional labor-hours.

Total overhead cost behavior:

Month 1 Month 2 Month 3 Month 4 Month 5 Month 6
Actual total overhead
costs P340,000 P400,000 P435,000 P477,000 P529,000 P587,000
Linear approximation 357,000 400,000 443,000 486,000 529,000 572,000
Actual minus linear
approximation P(17,000) P 0 P (8,000) P (9,000) P 0 P15,000
Professional labor-hours 3,000 4,000 5,000 6,000 7,000 8,000

The data are shown in Figure 9-D. The linear cost function overstates costs
by P8,000 at the 5,000-hour level and understates costs by P15,000 at the
8,000-hour level.

Requirement 3
Based on
Based on Linear Cost
Actual Function
Contribution before deducting incremental
overhead P38,000 P38,000
Incremental overhead 35,000 43,000
Contribution after incremental overhead P 3,000 P (5,000)

The total contribution margin actually forgone is P3,000.

Figure 9-D
Linear Cost Function Plot of Professional Labor-Hours
on Total Overhead Costs for ABS Consulting Group

9-25
Chapter 9 Cost Behavior: Analysis and Use

Problem 6 (Cost Behavior)

The variable cost per hour can be computed as follows:

P20,000 / 5,000 hours = P4 per hour

Therefore, the missing amounts are as follows:

Hours of Operating Time

5,000 6,000 7,000 8,000
Total costs:
Variable costs
(@ P4 per hour) P 20,000 P 24,000 P 28,000 P 32,000
Fixed costs 168,000 168,000 168,000 168,000
Total costs P 188,000 P 192,000 P 196,000 P 200,000

Hours of Operating Time

5,000 6,000 7,000 8,000
Cost per hour:
Variable cost P 4.00 P 4.00 P 4.00 P 4.00

9-26
 Cost Behavior: Analysis and Use Chapter 9

Fixed cost 33.60 28.00 24.00 21.00

Total cost per hour P 37.60 P 32.00 P 28.00 P 25.00

Observe that the total variable costs increase in proportion to the number of
hours of operating time, but that these costs remain constant at P4 if
expressed on a per hour basis.

In contrast, the total fixed costs do not change with changes in the level of
activity. They remain constant at P168,000 within the relevant range. With
increases in activity, however, the fixed cost per hour decreases, dropping
from P33.60 per hour when the boats are operated 5,000 hours a period to
only P21.00 per hour when the boats are operated 8,000 hours a period.
Because of this troublesome aspect of fixed costs, they are most easily (and
most safely) dealt with on a total basis, rather than on a unit basis, in cost
analysis work.

Problem 7 (High-Low Method)

Requirement (1)

The first step in the high-low method is to identify the periods of the lowest
and highest activity. Those periods are November (1,100 patients admitted)
and June (1,900 patients admitted).

The second step is to compute the variable cost per unit using those two data
points:

Number of Admitting
Month Patients Admitted Department Costs
High activity level (June) 1,900 P15,200
Low activity level (November) 1,100 12,800
Change 800 P 2,400

Change in cost
Variable cost =
Change in activity
= P240,000
800 patients admitted
= P3 per patient admitted

9-27
Chapter 9 Cost Behavior: Analysis and Use

The 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:
Fixed cost element = Total cost – Variable cost element
= P15,200 – (P3 per patient admitted
x 1,900 patients admitted)
= P9,500
Requirement (2)
The cost formula is Y = P9,500 + P3X.
Problem 8 (Scattergraph Analysis; Selection of an Activity Base)
Requirement (1)
The completed scattergraph for the number of units produced as the activity
base is presented below:

5,000

4,500

4,000

3,500
Janitorial Labor Cost

3,000

2,500

2,000

1,500

1,000

500

0
0 20 40 60 80 100 120 140
Units Produced

Requirement (2)

The completed scattergraph for the number of workdays as the activity base is
presented below:

9-28
 Cost Behavior: Analysis and Use Chapter 9

Requirement (3)

5,000

4,500

4,000

3,500
Janitorial Labor Cost

3,000

2,500

2,000

1,500

1,000

500

0
0 2 4 6 8 10 12 14 16 18 20 22 24
Number of Janitorial Workdays

The number of workdays should be used as the activity base rather than the

9-29
Chapter 9 Cost Behavior: Analysis and Use

number of units produced. There are several reasons for this. First, the
scattergraphs reveal that there is a much stronger relationship (i.e., higher
correlation) between janitorial costs and number of workdays than between
janitorial costs and number of units produced. Second, from the description of
the janitorial costs, one would expect that variations in those costs have little
to do with the number of units produced. Two janitors each work an eight-
hour shift—apparently irrespective of the number of units produced or how
busy the company is. Variations in the janitorial labor costs apparently occur
because of the number of workdays in the month and the number of days the
janitors call in sick. Third, for planning purposes, the company is likely to be
able to predict the number of working days in the month with much greater
accuracy than the number of units that will be produced.

Note that the scattergraph in part (1) seems to suggest that the janitorial labor
costs are variable with respect to the number of units produced. This is false.
Janitorial labor costs do vary, but the number of units produced isn’t the cause
of the variation. However, since the number of units produced tends to go up
and down with the number of workdays and since the janitorial labor costs are
driven by the number of workdays, it appears on the scattergraph that the
number of units drives the janitorial 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 just because it appears there is some relationship between
cost and the measure of activity. Careful thought and analysis should go into
the selection of the activity base.

IV. Multiple Choice Questions

1. A 11. C* 21. C 31. D 41. B

2. D 11. C* 22. D 32. B 42. D
3. B 12. C 23. C 33. A 43. C
4. A 13. A 24. A 34. B
5. B 14. D 25. D 35. A
6. B 15. C 26. B 36. D
7. C 16. D 27. D 37. B
8. D 17. B 28. B 38. C
9. C 18. C 29. A 39. B
10. A 19. C 30. D 40. D

* Supporting Computations:
11. (10,000 x 2) – (P3,000 x 2) – P5,000 = P9,000
12. [(P20 + P3 + P6) x 2,000 units] + (P10 x 1,000 units) = P68,000

9-30