COST ACCOUNTING AND CONTROL

COST CONCEPTS AND ANALYSIS

MANAGEMENT ADVISORY SERVICES – refers to that area of accounting work concerned with providing advice
and technical assistance to help clients improve the use of their resources to achieve their goals.

MANAGEMENT CONSULTANT – a person who is qualified by education, experience, technical ability, and
temperament to advise or assist businessmen on a professional basis in identifying, defining, and solving specific
management problems involving the organization, planning, direction, control, and operation of the firm.

CHARACTERISTICS OF MAS

1. Services are rendered for the management rather than for third parties
2. Involves problem solving
3. Relates to the future
4. Broad in scope
5. Involves varied assignments
6. Engagements are usually non-recurring
7. Engagements require highly qualified staff
8. Human relations play a vital role in each engagement.

COST 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 – is the relationship between cost and activity – as to how costs react to changes in an activity like
production.

TYPES OF COSTS AS TO BEHAVIOR:

COSTS TOTAL amount PER UNIT amount

Decreases as production increases
1. FIXED Constant (i.e., inverse relationship)
Increases as production increases
2. VARIABLE (i.e., direct relationship) Constant
3. MIXED Increases less proportionately (vs. total Decreases less proportionately (vs. unit
(semi variable) variable costs) as production increases fixed costs) as production increases

MIXED COST FORMULA: Y = a +bx

Where: [Y] – the total costs (dependent variable)

[a] – the total fixed costs (vertical/y-axis intercept)
[b] – the variable cost per unit (slope of the line)
[X] – the activity or cost driver (independent variable)
[bX] – the total variable costs

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COST BEHAVIOR ASSUMPTIONS AND LIMITATIONS

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.
3. Linearity Assumption
The cost is assumed to manifest a linear relationship over a relevant range despite its tendency
to show otherwise over the long run.

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 the low periods as to activity level or cost driver.

Change in Costs (Yh - Yl)

Variable cost per unit (b) =
Change in Activity (Xh - Xl)

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.
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 square 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∑a + b∑x2

CORRELATION ANALYSIS

CORRELATION ANALYSIS is used to measure the strength of linear relationship between two or more variables.
The correlation between two variables can be seen by drawing a scatter diagram:
• If the points seem to form a straight line, there is a high correlation.
• If the points form a random pattern, there is a low correlation or no correlation at all.

COEFFICIENT OF CORRELATION (r) - measures the relative strength of linear relationship between two (2)
variables. Its value ranges from -1.0 to +1.0:
"r" Linear Relationship Scatter Diagram
-1.0 Inverse Downward Sloping Line
0 None No Apparent Patern (Random points)
+1.0 Direct Upward Sloping Line

COEFFICIENT OF DETERMINATION (r2) is the proportion of the total variation in Y that is accounted for by the
regression equation, regardless of whether the relationship between X and Y is direct or inverse. It is a measure of
‘goodness of fit’ in the regression. The higher the r2, the more confidence one can have in the estimated cost
formula.

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COST ACCOUNTING AND CONTROL

EXERCISES: COST BEHAVIOR AND ANALYSIS

1. VARIABLE COSTS vs. FIXED COSTS

Adriel Company manufacture and sells a single product. A partially completed schedule of the company’s
total and per unit costs over a relevant range of 60 to 100 units produced each year is given below:

UNITS PRODUCED
(I) 60 (I) 80 (I) 100
TOTAL COSTS:
(A) VARIABLE COSTS P120 P 160 P200
(B) FIXED COSTS 600 600 600
(C) TOTAL COSTS 720 760 800
PER UNIT COSTS:
(D) VARIABLE COSTS P2.00 P2.00 P2.00
(E) FIXED COSTS P10.00 P7.50 P6.00

REQUIRED:

1. Determine the correct amount of those with (?) mark.

2. Which two (2) specific costs remain constant over the relevant range?
3. Which two (2) specific costs are directly related with production?
4. Which specific cost is inversely related with production?
5. Express the cost formula based on the line equation form “Y = a + bx”
6. If the company produces 90 units, then how much is the expected total costs? P780

2. HIGH – LOW METHOD

The controller of SUREDEAD Hospital would like to come up with a cost formula that links Admitting
Department cost to the number of patients admitted during a month. The Admitting Department’s costs
and the number of patients admitted during the past nine months follow:
NUMBER OF ADMITTING DEPARTMENT'S
MONTH PATIENTS COST
APRIL 18 ₱ 15,600.00
MAY 19 15,200.00
JUNE 17 13,700.00
JULY 15 14,600.00
AUGUST 15 14,300.00
SEPTEMBER 11 13,200.00
OCTOBER 11 12,800.00
NOVEMBER 48 72,500.00
DECEMBER 16 14,000.00
REQUIRED: Using High-low Method, determine:
1. Variable cost per unit P300
2. Annual Fixed Costs P114,000
3. Monthly Cost Function Y = 9500 + 300(x)
4. Department’s estimated cost assuming 14 patients will be admitted next month. P13,700

3. CORRELATION ANALYSIS

(3a) The closeness of the linear relationship between the cost and the activity is known as
a) Variation c) Deviation
b) Correlation d) Standard error

(3b) Looking at the following scatter diagram, we can conclude that:

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COST ACCOUNTING AND CONTROL

a) Cost A will be easier to predict than cost B.

b) Cost B will be easier to predict that cost A.
c) Cost B has no variable component
d) Cost A is out of control.

(3c) Which of these correlation coefficients represents strongest relationship between two variables?
a) +0.50 c) -0.05
b) -0.80 d) +1.05

4. LEAST-SQUARES REGRESSION METHOD

Sydney Company’s total overhead costs at various levels of activity are presented below:
MONTH MACHINE HOURS TOTAL OVERHEAD COSTS
MARCH 500 ₱ 970.00
APRIL 400 851.00
MAY 600 1,089.00
JUNE 700 1,208.00

The breakdown of the overhead costs in April at 400 machine-hour level of activity is as follows:

Supplies (Variable) ₱ 260.00

Salaries (Fixed) 300.00
Utilities (Mixed) 291.00
Total ₱ 851.00

REQUIRED:
1. How much of June’s overhead cost of P1,208 consisted of utilities cost? P453
2. Using high-low method, determine the cost function for utilities cost Y = 75 + 0.54x
3. Using high-low method, determine the cost function for total overhead cost.
Y = 375 + 1.19x
4. Using least-squares method, determine the cost function for total overhead costs
Y = 375 + 1.19x
5. What would be the total overhead costs if operating level is at 200 machine hours? P613

WRAP UP EXERCISES
1. Consider the following graphic representation of certain costs:

Which of the following costs are most likely represented by the above graph?
a) Total fixed costs, total variable costs
b) Dependent Variable
c) Slope of the line
d) Y-axis intercept

2. In cost analysis using the line equation Y = a + bX, the total fixed cost (a) is regarded as the
a) Independent Variable

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COST ACCOUNTING AND CONTROL

b) Dependent Variable
c) Slope of the line
d) Y-axis Intercept

3. A company has developed a production cost equation for its lone product: Y = 100 + 2X, where X is
based on the number of labor hours. Assuming a relevant range of 10 to 20 labor hours, what is the
estimated production cost at zero (0) labor hour?
a) P100
b) P120
c) P140
d) The exact amount cannot be determined without additional information

4. If the coefficient of correlation (r) between two variables is + 1, then a scatter diagram will appear to
be a regression line that
a) Slopes upward to the left
b) Slopes upward to the right
c) Slopes downward to the right
d) Appears to be horizontal or vertical

5. A data point that falls far away from other data points in a scatter diagram is called a (an)
a) Outlier
b) Margin of Error
c) Standard Deviation
d) Coefficient of Determination

6. Ana Company is interested in the relationship between sales (dependent variable) and occurrence of
rain (independent variable). Using the proper formula, the coefficient of correlation (r) is computed as
-0.99. What conclusion about the sales and rain occurrence could one make?
a) An increase in sales causes an increase in rain occurrence
b) An increase in sales causes a decrease in rain occurrence
c) An increase in rain occurrence causes a decrease in sales
d) An increase in rain occurrence causes an increase in sales

7. What is the appropriate range for the coefficient of determination (r 2)?

a) 0 to +1
b) 0 to -1
c) -1 to 0
d) -1 to +1

8. Using statistical normal relationships, the least squares method used which of the following
equations?
a) Y = a +bx & ∑Y = na + b∑x
b) Y = a +bx & ∑xy = ∑xa + b∑x2
c) Y = a +bx & ∑xy = ∑xa + b∑x
d) ∑Y = na + b∑x & ∑xy = ∑xa + b∑x2

9. What cost segregation technique gives the most mathematically precise cost estimate?
a) Scatter diagram method
b) Least-Squares Method
c) High-Low Method
d) Calendar Method

10. Under the Cost-Volume-Profit (CVP) Analysis, a mixed cost should be:
a) Disregarded
b) Treated as a fixed cost
c) Treated as a variable cost
d) Separated into fixed and variable components

This material is exclusive to the University of Caloocan City. Any unauthorized distribution of this material is
prohibited.