Cost

Behavior
Definition of cost behavior
Cost Behavior means how a cost will react a changes take place in the level of
business activity. Managers who understand how cost behave are better able to
predict what cost will be under various operating circumstances. An understanding
of cost behavior under varying conditions are essential to adequate decision
making in the planning and control of firm activity.
Importance of understanding Cost behavior
Planning requires that management make decisions based in part on expectations as to the future.
These expectations should be based on the data relevant to the decision objectives, gathered and analyzed
in competent, unbiased fashion. Failure in this activity could mean displacement costs due to unexpected
events. Control is the process of using feedback information for comparison with expectations and the
implementation of actions on the basis of that comparison.
Cost Analysis is an integral part of the planning and control functions. The key to effective costs
prediction lies in an understanding of cost behavior patterns.

Types of
Cost Behavior patterns
Variable Cost
Are those cost that change in total as the level of activity changes in the short run and within the relevant
range
Fixed Cost
Is a cost that remains constant in total regardless of changes in the level of activity within the relevant range.
Sample Problem: Variable and fixed cost
NDesign Company provides the following costs structure in
product:
Total Fixed Cost P 200,000
Unit Variable Cost P 20
What will happen to fixed cost and variable costs, per total and
per unit, if production levels are zero, 5,000 units, 10,000 units,
and15,000 units.
Mixed Cost
Is one that contains both variable and fixed cost elements.

Step cost

COST
ESTIMATION
Cost Segregation Techniques
Mixed costs should be segregated as to their fixed and
variable components.
There are three (3) popular methods used in separating
fixed from variable costs. All of them have their technical origin
from the field of statistics. They are:

High-Low Method
Scattergraph Method
Least-squares Method
ACCOUNT ANALYSIS
METHOD
INDUSTRIAL ENGINEERING
METHOD
INDUSTRIAL ENGINEERING METHOD
Estimates cost functions by analyzing the relationship between inputs
and outputs in physical forms.
Physical way of examining the relationship between the cost drivers and
costs by analyzing the inputs coming into the company, the outputs that
are created, and the work that goes into the process.
ADVANTAGES OF INDUSTRIAL ENGINEERING
METHOD

It can detail each step required to perform an operation.

It can be used to estimate costs for totally new activities.
EXAMPLE:
Cara is the CFO of a large business that manufactures curtains. The
inputs for these curtains include wood, dye, thread, machine hours, and
labor. The output, of course, is the finished curtain. Her business uses the
industrial engineering method to help estimate costs. Why is this a good
choice for Cara’s organization? What information might it give her?
CONFERENCE
METHOD
THE HIGH-LOW METHOD
THE HIGH-LOW METHOD
The high-low method involves taking the highest level of activity and
the lowest level of activity and comparing the total costs at each level.

It is the traditional method of costs segregation. In statistics, it is called

the "range analysis".
FORMULA:
VCR = ∆ in Costs / ∆ in Units

OR

Variable cost rate or per unit = Cost at highest activity - Cost at

lowest activity / Highest activity - Lowest Activity
TFC = TC – TVC
 Fixed Cost = Total Cost at highest activity - [Variable cost
per unit × Highest activity stated in units] OR
Fixed Cost = Total Cost at lowest activity - [Variable cost per
unit × Lowest activity stated in units]

The total maintenance costs of Silver Company in the last four months
are presented as follows:
Month Machine hours Maintenance Costs
January 7,200 450,000
February 6,800 422,000
March 7,000 440,000
April 6,400 418,000
The company expects to use 7,400 machine hours in May.
SOLUTION:
Highest 7,200 450,000
Lowest 6,400 418,000
Difference 800 32,000

REQUIREMENT #1

32,000/800 machine hours

= 40 per MH

Take note that the total fixed costs remains the same
regardless of level of activity.
EXAMPLE:
Data for the past 10 months were collected for Predictors, Inc. to
estimate the variable and fixed manufacturing overhead.
The following data on supplies cost and direct labor hours from January
to October are available.

Required:

Determine the variable cost rate hour and the fixed cost
portion using the High-Low Method.

SOLUTION:
VCR = 150-60/60-10
= 90/50
= 1.80
at 60-hour level at 10-hour level
FC = 150 - (1.80 × 60) FC = 60 - (1.80 × 10)
= 150 – 108 = 60 - 18
= 42 = 42

What happens when High-Low Method ends up with a

negative amount?
REGRESSION ANALYSIS
METHOD
LEAST-SQUARES METHOD
LEAST-SQUARES METHOD
The least-squares method of cost estimation involves using
mathematical regression techniques to calculate the slope and intercept
of the best-fit line for the costs used in estimation. In order to determine
these estimates, a manager will assemble cost data by cost and level of
production.
A statistical technique which is often used in separating mixed
costs into their fixed and variable components.

The least-squares method is usually credited to Carl Friedrich

Gauss (1795), but it was first published by Adrien-Marie
Legendre.

The equation for the determination of a straight line is:

Y = a + bX

The two linear equations that are used to solve for a and b are:

Equation (1) ∑Y = Na + b∑X

Equation (2) ∑XY = ∑Xa + b∑�𝑿�𝟐�

Determine the variable cost rate and the fixed cost under the
Least-squares regression method.

Equation (1) 1,000 = 10a + 350b

Equation (2) 39,600 = 350a + 14,500b

To eliminate one unknown (a), and solve for b, multiply Equation

1 by 35 (least common denominator) and subtract the new Equation 3
from Equation 2.

Equation (2) 39,600 = 350a + 14,500b

Equation (3)
[Equation 1 × 35] 35 000 = 350a + 12,250b
4,600 = 2,250b
Variable cost rate or b = 2.04

Strengths and Weaknesses of Cost Estimation Methods

HIGH-LOW
METHOD