COST BEHAVIOR

BACOSTMX Module 2
Learning Outcomes
The students should be able to:

1. Define and describe fixed, variable and mixed costs.

2. Separate mixed costs into their fixed and variable components using the scatter-graph method, the high-low
method, and the method of least squares.

3. Explain how multiple regression can be used to assess cost behavior

4. Use Regression Program for separating mixed costs

5. Discuss the use of managerial judgement in determining cost behavior.

BACOSTMX Module 2 2
DEFINE AND DESCRIBE FIXED,
VARIABLE AND MIXED COSTS.
Learning Outcome 1

BACOSTMX Module 2 3
Cost behavior
 Used to describe whether a cost changes when the level of
output changes
 Fixed costs do not change as output changes
 Variable costs increase in total with an increase in output and
decrease in total with a decrease in output

BACOSTMX Module 2 4
The Activity Base
(also called a cost driver)
Units Machine
produced hours

A measure of what
causes the
incurrence of a
variable cost

Miles Labor
driven hours
BACOSTMX Module 2 5
Types of Cost Behavior Patterns –
Variable
A variable cost is a cost whose total dollar
amount varies in direct proportion to changes
in the activity level.
Summary of Variable and Fixed Cost Behavior
Cost In Total Per Unit

Variable Total variable cost is Variable cost per unit remains

proportional to the activity
level within the relevant range.
Total fixed cost remains the
same even when the activity
Fixed level changes within the
relevant range.
the same over wide ranges
of activity.
Fixed cost per unit goes
down as activity level goes up.

BACOSTMX Module 2 6
True Variable Cost – An Example
As an example of an activity base, consider
overage charges on a cell phone bill. The activity
base is the number of minutes used above the
allowed minutes in the calling plan.
Charges on Cell
Total Overage

Phone Bill

Minutes Talked
BACOSTMX Module 2 7
Types of Cost Behavior Patterns –
Variable
Variable costs remain constant if expressed on
a per unit basis.

Summary of Variable and Fixed Cost Behavior

Cost In Total Per Unit

Variable Total variable cost is Variable cost per unit remains

proportional to the activity
level within the relevant range.
Total fixed cost remains the
same even when the activity
Fixed level changes within the
relevant range.
the same over wide ranges
of activity.
Fixed cost per unit goes
down as activity level goes up.

BACOSTMX Module 2 8
Variable Cost Per Unit – An Example
Referring to the cell phone example, the cost per overage
minute is constant, for example 45 cents per overage minute.

Overage Charge
Per Minute
Minutes Talked

BACOSTMX Module 2 9
Variable Costs: Illustrative example
 Nooksack Expeditions, a small company that provides daylong whitewater rafting
excursions on rivers in the North Cascade Mountains. The company provides all of the
necessary equipment and experienced guides, and it serves gourmet meals for its
guests. The meals are purchased from an exclusive caterer for $30 a person for a day
long excursion. If we look at the cost of the meals on a per person basis, it remains
constant at $30. This $30 cost per person will not change, regardless of how many
people participate in a daylong excursion. The behavior of this variable cost, on both a
per unit and a total basis, is tabulated as follows:

Number of Guests Cost of Meals per Total Cost of Meals

Guest
250 $30 $7,500
500 $30 $15,000
750 $30 $22,500
1,000 $30 $30,000
BACOSTMX Module 2 10
Examples of Variable Costs
1. Merchandising companies – cost of goods sold.
2. Manufacturing companies – direct materials,
direct labor, and variable overhead.
3. Merchandising and manufacturing companies –
commissions, shipping costs, and clerical costs
such as invoicing.
4. Service companies – supplies, travel, and
clerical.

BACOSTMX Module 2 11
True Variable Costs
The amount of a true variable cost used during the
period varies in direct proportion to the activity level.
The overage charge on a cell phone bill was one
example of a true variable cost.

Direct material is
Cost

another example
of a cost that
behaves in a true
variable pattern.
Volume
BACOSTMX Module 2 12
Step-Variable Costs
A step-variable cost is a resource that is obtainable only
in large chunks (such as maintenance workers) and
whose costs change only in response to fairly wide
changes in activity.
Cost

Volume BACOSTMX Module 2 13

Step-Variable Costs

Small changes in the level of production are not

likely to have any effect on the number of
maintenance workers employed.
Cost

Volume
BACOSTMX Module 2 14
Step-Variable Costs

Only fairly wide changes

in the activity level will
cause a change in the
number of maintenance
Cost

workers employed.

Volume
BACOSTMX Module 2 15
Types of Cost Behavior Patterns –
Fixed
A fixed cost is a cost whose total dollar amount
remains constant as the activity level changes.

Summary of Variable and Fixed Cost Behavior

Cost In Total Per Unit

Variable Total variable cost is Variable cost per unit remains

proportional to the activity
level within the relevant range.
Total fixed costs remain the
same even when the activity
Fixed level changes within the
relevant range.
the same over wide ranges
of activity.
Fixed cost per unit goes
down as activity level goes up.

BACOSTMX Module 2 16
Total Fixed Cost – An Example
For example, your cell phone bill probably includes a fixed
amount related to the total minutes allowed in your calling
plan. The amount does not change when you use more or
less allowed minutes.
Cell Phone Bill
Monthly Basic

Number of Minutes Used

within Monthly Plan
BACOSTMX Module 2 17
Types of Cost Behavior Patterns –
Fixed
Average fixed costs per unit decrease as the
activity level increases.

Cost In Total Per Unit

Variable Total variable cost is Variable cost per unit remains

proportional to the activity
level within the relevant range.
Total fixed costs remain the
same even when the activity
Fixed level changes within the
relevant range.
the same over wide ranges
of activity.
Average fixed costs per unit
decrease as the activity
level increases.

BACOSTMX Module 2 18
Fixed Cost Per Unit Example
For example, the fixed cost per minute used
decreases as more allowed minutes are used.

Cost Per Cell Phone Call

Number of Minutes Used
within Monthly Plan
BACOSTMX Module 2 19
Types of Fixed Costs

Committed Discretionary
Long-term, cannot be May be altered in the
significantly reduced in short-term by current
the short term. managerial decisions

Examples Examples
Depreciation on Buildings Advertising and
and Equipment and Real Research and
Estate Taxes Development
BACOSTMX Module 2 20
Fixed Costs and the Relevant
Range

90
Rent Cost in Thousands
The relevant range
of Dollars
Relevant of activity for a fixed
60 cost is the range of
Range activity over which
the graph of the
cost is flat.
30

0
0 1,000 2,000 3,000
Rented Area (Square Feet)
BACOSTMX Module 2 21
Fixed Costs and the Relevant
Range
For example, assume office space is available at
a rental rate of $30,000 per year in increments of
1,000 square feet.

Fixed costs would increase

in a step fashion at a rate of
$30,000 for each additional
1,000 square feet.

BACOSTMX Module 2 22
Mixed Costs
(also called semivariable costs)

A mixed cost contains both variable and fixed

elements. Consider the example of utility cost.
Y
Total Utility Cost

Variable
Cost per KW

X Fixed Monthly
Activity (Kilowatt Hours) Utility Charge
BACOSTMX Module 2 23
Mixed Costs
The total mixed cost line can be expressed
as an equation: Y = a + bX

Where: Y = The total mixed cost.

a = The total fixed cost (the
Y vertical intercept of the line).
b = The variable cost per unit of
Total Utility Cost

activity (the slope of the line).

X = The level of activity.

Variable
Cost per KW

X Fixed Monthly
Activity (Kilowatt Hours) Utility Charge
BACOSTMX Module 2 24
Mixed Costs – An Example
If your fixed monthly utility charge is $40, your
variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what is
the amount of your utility bill?

Y = a + bX

Y = $40 + ($0.03 × 2,000)

Y = $100
BACOSTMX Module 2 25
SEPARATE MIXED COSTS INTO THEIR FIXED AND
VARIABLE COMPONENTS USING THE SCATTER-GRAPH
METHOD, HIGH-LOW METHOD,, AND METHOD OF LEAST
SQUARES.
Learning Outcome 2

BACOSTMX Module 2 26
Method of Separating Mixed Costs

Least-square
Scatter-graph High-low
regression
method method
method

Account Engineering
analysis approach

BACOSTMX Module 2 27
The Scatter-graph Method
Plot the data points on a graph
(Total Cost Y vs. Activity X).
Y
20
Maintenance Cost

* ** *
1,000’s of Dollars

* *
**
10 * *

0 X
0 1 2 3 4
Patient-days in 1,000’s

BACOSTMX Module 2 28
The Scatter-graph Method
Draw a line through the data points with about an
equal numbers of points above and below the line.
Y
20
Maintenance Cost

* ** *
1,000’s of Dollars

* *
**
10 * *

0 X
0 1 2 3 4
Patient-days in 1,000’s

BACOSTMX Module 2 29
The Scatter-graph Method
Use one data point to estimate the total level of activity
and the total cost.
Y Total maintenance cost = $11,000
20
Maintenance Cost

* ** *
1,000’s of Dollars

* *
**
10 * *
Intercept = Fixed cost: $10,000

0 X
0 1 2 3 4
Patient-days in 1,000’s
Patient days = 800
BACOSTMX Module 2 30
The Scatter-graph Method
Make a quick estimate of variable cost per unit and
determine the cost equation.

Total maintenance at 800 patients $ 11,000

Less: Fixed cost 10,000
Estimated total variable cost for 800 patients $ 1,000

Variable cost per unit = $1,000 = $1.25/patient-day

800
Y = $10,000 + $1.25X

Total maintenance cost Number of patient days

BACOSTMX Module 2 31
Method of Separating Mixed Costs

Least-square
Scatter-graph High-low
regression
method method
method

Account Engineering
analysis approach

BACOSTMX Module 2 32
The High-Low Method – An Example
Assume the following hours
of maintenance work and
the total maintenance costs
for six months.

BACOSTMX Module 2 33
The High-Low Method – An Example
The variable cost
per hour of
maintenance is
equal to the change
in cost divided by
the change in hours.

$2,400
= $6.00/hour
400

BACOSTMX Module 2 34
The High-Low Method – An Example

Total Fixed Cost = Total Cost – Total Variable Cost

Total Fixed Cost = $9,800 – ($6/hour × 850 hours)
Total Fixed Cost = $9,800 – $5,100
Total Fixed Cost = $4,700
BACOSTMX Module 2 35
The High-Low Method – An Example

The Cost Equation for Maintenance

Y = $4,700 + $6.00X
BACOSTMX Module 2 36
References:
 Raiborn and Kinney (2011) Cost
Accounting: Foundations and Evolution
8th edition, Cengage Learning
 Hansen, Don R. and Mowen, Maryanne
M. (2018) Cost Accounting and Control.
Cengage Learning: Boston, USA.
 Garrison, Noreen, and Brewer (2010)
Managerial Accounting and Control 13th
edition, McGraw-Hill

BACOSTMX Module 2 37