MANAGEMENT ACCOUNTING (VOLUME I) - Solutions Manual

CHAPTER 9

COST BEHAVIOR: ANALYSIS AND USE

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.

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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
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.

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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.
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.

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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 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
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 Cost Behavior: Analysis and Use Chapter 9

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
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.

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
11. c or d
12. g

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Exercise 2 (Cost Estimation; High-Low Method)

Requirement (1)

Cost equation using square fee as the cost driver:

Variable costs:

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

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
= P237.50
19 – 11

Fixed costs:

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

Fixed Cost = P187.50

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

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 Cost Behavior: Analysis and Use Chapter 9

Cost equation using 10 openings as the cost driver:

Variable costs:

P4,700 – P2,875
= P202.78
19 – 10

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

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Chapter 9 Cost Behavior: Analysis and Use

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

Figure 9-A

P5,000

P4,500

P4,000

P3,500

P3,000
Cost

P2,500

P2,000

P1,500

P1,000

P500
P0
2,375

2,450

2,600

2,600

2,650

2,700

2,800

2,850

3,010

3,550

3,700

4,050

Square Feet

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 Cost Behavior: Analysis and Use Chapter 9

Figure 9-B

Cost versus No. of Openings

P5,000
P4,500
P4,000
P3,500
P3,000
Cost

P2,500
P2,000
P1,500
P1,000
P500
P0
10 11 11 12 12 13 13 13 15 16 16 19
Num ber of Openings

Exercise 3 (Cost Estimation; Account Classification)

Requirement 1

Fixed Costs:
Rent P10,250
Depreciation 400
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

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Chapter 9 Cost Behavior: Analysis and Use

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

Profit Per Disk = P133.80 – P126.30

= P7.50

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 Cost Behavior: Analysis and Use Chapter 9

Exercise 4 (Cost Estimation Using Graphs; Service)

Requirement 1

Sales and Advertising Expense

P160,000
P140,000
P120,000
P100,000
Sales

P80,000
P60,000
P40,000
P20,000
P0
P2,500

P3,000

P3,500

P4,000

P4,500

P5,000

P5,500
Advertising Expense

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.

III. Problems

Problem 1

Requirement (a) Miles Total Annual

Driven Cost*
High level of activity ......................... 120,000 P13,920
Low level of activity.......................... 80,000 10,880
Difference ..................................... 40,000 P 3,040

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* 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

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 Cost Behavior: Analysis and Use Chapter 9

Variable cost element:

Change in cost
= Variable rate
Change in activity
P12,000
Shipping expense: = 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
Shipping expense (@P8) ........................... 36,000
Salaries and commission expense
(@P24) ................................................... 108,000 396,000
Contribution margin ....................................... 234,000

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Chapter 9 Cost Behavior: Analysis and Use

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.

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 Cost Behavior: Analysis and Use Chapter 9

Requirement 2

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
X
P-
0 1 2 3 4 5 6 7 8
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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
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.

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 Cost Behavior: Analysis and Use Chapter 9

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

P90,000

P80,000

P70,000

P60,000
Overhead Costs

P50,000

P40,000

P30,000

P20,000

P10,000

P0
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000
Cost Driver: Labor-Hours

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

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Chapter 9 Cost Behavior: Analysis and Use

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

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- 3,000 4,000 5,000 6,000 7,000 8,000
hours

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.

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

P700,000

P600,000
Total Overhead Costs

P500,000

P400,000

P300,000

P200,000

P100,000

P0
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000
Professional Labor-Hours Billed

IV. Multiple Choice Questions

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

2. D 12. C* 22. D 32. B 42. D
3. B 13. C 23. C 33. A 43. C
4. A 14. A 24. A 34. B
5. B 15. D 25. D 35. A
6. B 16. C 26. B 36. D
7. C 17. D 27. D 37. B
8. D 18. B 28. B 38. C
9. C 19. C 29. A 39. B
10. A 20. 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

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