CPAR

CPA REVIEW SCHOOL OF THE PHILIPPINES

Manila
MAS 8901
MANAGEMENT ADVISORY SERVICES

COSTS AND COST CONCEPTS

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.

Example: product, job, process

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.

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:
remains constant

3. MIXED COST – has both fixed and variable components.

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 Period Assumption

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

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 drivers 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.
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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.
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

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.

VALUE CHAIN

Research Design
and of Products Production Marketing Distribution Customer
Development and Processes Service

EXERCISES:
1. A company incurs the following costs. Classify each of the cost items into one of the business
functions of the value chain.
a. Electricity costs incurred by the plant assembling one of the company’s product lines.
b. Transportation costs for shipping the products to retail chains.
c. Payment to AZR Company for the design of one of its products.
d. Salary of scientists working on the next generation of one of the company’s products.
e. Cost of company employees’ visit to a major customer to demonstrate how a new product
works.
f. Purchase of competitors’ products for testing against the company’s potential products.
g. Payment to a television network for running the company’s advertisements.
h. Purchase of component parts from outside suppliers to be used in producing one of the
company’s products.
i. Cost of videos sent to customers to promote sales of the company’s products.
j. Payment to actors for a television infomercial promoting a new product.

2. Classification of costs, manufacturing sector. The Laguna plant of New United Motor
Manufacturing, Inc. (NUMMI), a joint venture of Saraw and Toyoka, assembles two types of
cars (Corona and Geowow). Separate assembly lines are used for each type of car.

Classify each cost item (1 to 8) as follows:

a. Direct or indirect (D or I) costs with respect to the total number of cars of each type assembled
(Corona and Geowow).
b. Variable or fixed (V or F) costs with respect to how the total costs of the plant change as the
total number of cars of each type assembled changes. (If in doubt, select on the basis of
whether the total costs will change substantially if there is a large change in the total number
of cars of each type assembled.)

1. Cost of tires used on Geowow

2. Salary of public relations manager for NUMMI plant
MAS 8701 COST CONCEPTS AND ANALYSIS Page 3 of 6

3. Annual awards dinner for Corona suppliers

4. Salary of engineer who monitors design changes on Geowow
5. Freight costs of Corona engines shipped from Toyoka City, Japan, to Laguna
6. Electricity costs for NUMMI plant (single bill covers entire plant)
7. Wages paid to temporary assembly-line workers hired in periods of high production
(paid on hourly basis)
8. Annual fire-insurance policy cost for NUMMI plant

3. Inventoriable costs versus period costs. Each of the following cost items pertains to one of
these companies: Electrical Appliances (a manufacturing-sector company), Wonderway (a
merchandising-sector company), and Googol (a service-sector company):
a. Perrier mineral water purchased by Wonderway for sale to its customers
b. Electricity used to provide lighting for assembly-line workers at a Electrical Appliances
refrigerator assembly plant
c. Depreciation on Googol’s computer equipment used to update directories of Web sites
d. Electricity used to provide lighting for Wonderway’s store aisles
e. Depreciation on Electrical Appliances’s computer equipment used for quality testing
of refrigerator components during the assembly process
f. Salaries of Wonderway’s marketing personnel planning local-newspaper advertising
campaigns
g. Perrier mineral water purchased by Googol for consumption by its software engineers
h. Salaries of Googol’s marketing personnel selling banner advertising

REQUIRED:
Classify each of the cost items (a–h) as an inventoriable (product) cost or a period cost.
Explain your answers.

4. Which of the following costs are variable, fixed, or mixed costs?

Units of Output 30,000 Units 42,000 Units

Direct materials P 180,000 P 252,000
Workers' wages 1,080,000 1,512,000
Supervisors' salaries 312,000 312,000
Equipment depreciation 151,200 151,200
Maintenance 81,600 110,400
Utilities 384,000 528,000
Total P2,188,800 P2,865,600

5. Alexander owns an art gallery. He accepts paintings and sculpture on consignment and then
receives 20 percent of the price of each piece as his fee. Space is limited, and there are costs
involved, so Alexander is careful about accepting artists. When he does accept one, he
arranges for an opening show (usually for three hours on a weekend night) and sends out
invitations to his customer list. At the opening, he serves soft drinks and casual munchies to
create a comfortable environment for prospective customers to view the new works and chat
with the artist. On average, each opening costs P500. Alexander has given as many as 20
opening shows in a year. The total cost of running the gallery, including rent, furniture and
fixtures, utilities, and a part-time assistant, amounts to P80,000 per year.

REQUIRED:
1. If the cost driver is the number of opening shows given, classify the following costs as
either strictly variable cost, a fixed cost, or a mixed cost:
a. The cost of giving opening shows
b. The cost of running the gallery
c. Alexander’s total costs (the sum of the costs of giving opening shows and running
the gallery)
2. Assume that the cost driver is number of opening shows. Develop the cost formula for the
gallery’s costs for a year.
MAS 8701 COST CONCEPTS AND ANALYSIS Page 4 of 6

3. Using the formula developed in Requirement 2, what is the total cost for Alexander in a
year with 12 opening shows? With 14 opening shows?

6. The Xander Company has assembled the following data pertaining to certain costs that cannot
be easily identified as either fixed or variable. Xander Company has heard about a method of
measuring cost functions called the high-low method and has decided to use it in this situation.

Month Cost Hours

January P40,000 3,500
February 24,400 2,000
March 31,280 2,450
April 36,400 3,000
May 44,160 3,900
June 44,400 3,740
July 7,650 730

REQUIRED:
a. State the cost function using the high and low points method.

b. Using the cost function developed in (a), what is the estimated total cost at an operating level
of 2,850 hours?

7. Atheena, controller for the Malabon plant of Zalucki, Inc., wanted to determine the cost behavior
of moving materials throughout the plant. She accumulated the following data on the number
of moves (from 100 to 800, in increments of 100) and the total cost of moving materials at those
levels of moves.

Number of Moves Total Cost

10 P 300
20 465
30 340
40 850
50 1000
60 1260
70 1360
80 1420

REQUIRED:
a. Compute the cost formula for moving materials using the high-low method. Calculate
the predicted cost per month with 55 moves using the high-low formula.

b. Compute the cost formula for moving materials using the method of least squares.
Using the regression cost formula, what is the predicted cost for a month with 55
moves?

c. Using the method of least squares cost formula, prepare a flexible budget with
separate variable and fixed categories for the costs of moving materials at 25, 45, and
75 moves.

6. The method of least squares was used to develop a cost equation to predict the cost of
maintenance. Monthly data for the past four years were used for the regression.

The following computer output was received:

Intercept P10,000
Slope 5
Coefficient of correlation 0.70

The driver used was “number of maintenance hours.”

MAS 8701 COST CONCEPTS AND ANALYSIS Page 5 of 6

REQUIRED:
1. What is the cost formula?
2. Using the cost formula, predict the cost of maintenance if 520 maintenance hours are
to be worked next month.
3. What percentage of the variability in maintenance cost is explained by number of
maintenance hours? Do you think the equation will predict well? Why or why not?
4. Using the results from the regression equation, predict the cost of maintenance for next
year if 6,800 maintenance hours are predicted

7. Nayvicky Company is making plans for the introduction of a new product, which has a target
selling price of P5 per unit. The following estimates of manufacturing costs have been derived
for 4 million units, to be produced during the first year:

Direct material: P6,000,000

Direct labor: P2,000,000 (at P4 per hour)

Overhead costs have not yet been estimated, but monthly data on total production and
overhead for the past 12 months have been analyzed by using least-squares regression. The
major overhead cost driver is direct labor hours, with the following results:

Computed values:
Fixed overhead cost: P200,000
Coefficient of independent variable: P10

REQUIRED:
a. Prepare the company's regression equation (Y = a + bx) to estimate overhead.
b. Calculate the projected gross profit at an activity level of 4,300,000 units.
c. How can the company evaluate the "quality" of its regression equation?

8. Cleo Company wants to determine
controller for Cleo constructed a
independent variables: direct labor
orders. The analysis was run using
following data were obtained:
the factors that are associated with overhead. The
multiple regression equation using the following
hours, number of setups, and number of purchase
the past 50 months of data. From the printout, the

Parameter Estimate
Intercept P50,000
Rates of variability:
Direct labor hours (H) P 4
Number of setups (S) P100
Number of purchase orders (P) P 7
Number of observations (n) 60

r2 = 0.94

REQUIRED:
1. Write out the cost formula for monthly overhead for Cleo Company.

2. If Cleo budgets the following for next month, what is the budgeted overhead cost?
• Direct labor hours 400
• Number of setups 50
• Number of purchase orders 200

3. Suppose that Cleo’s engineers expect the number of setups to increase by 30

percent. How much additional overhead cost would be incurred for the following
month?
MAS 8701 COST CONCEPTS AND ANALYSIS Page 6 of 6

10. The chief statistician of Legaspi Company has developed the following cost formula:

Y = P500,000+ 10L + 20M

Where: Y = total monthly manufacturing overhead cost

L = labor hours
M = machine hours

The measure of goodness of fit is good and no evidence of multicolinearity exists. The
company will use 20,000 labor hours and 5,000 machine hours next month.

REQUIRED:
1. Determine the total manufacturing overhead costs that Legaspi Company should
incur next month.
2. Legaspi makes a product that has P20.00 in materials costs per unit. It requires two
hours of labor time and 45 minutes of machine time. Laborers earn P20 per hour.
What is the product’s per unit variable manufacturing cost?
3. Suppose that labor time for the product is expected to increase 30 minutes. Machine
time will remain the same. By how much would the per unit variable manufacturing
cost increase?

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