Part 2: COST CONCEPTS AND COST BEHAVIOR ANALYSIS

Equation “Y = a + bX”

Y = total costs (dependent variable)

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

Illustration: Variable, Fixed and Mixed Costs

Problem I:

Cleveland Manufacturing Company has the following information available regarding costs at various levels of monthly
production:

Production Volume
14,000 units 20,000 units
Direct materials P 70,000 P 100,000
Direct labor 56,000 80,000
Indirect materials 21,000 30,000
Supervisor’s salaries 12,000 12,000
Depreciation on plant assets 10,000 10,000
Maintenance 32,000 44,000
Utilities 15,000 21,000
Insurance on plant assets 1,600 1,600
Property taxes on plant assets 2,000 2,000
Totals P 219,600 P 300,600

Required:
1. Identify each cost as being variable, fixed or mixed cost.
2. Determine the variable cost per unit and the fixed cost per month.
3. Predict the total cost for a monthly production volume of 16,000 units. 2)
VC per unit:
DM P 5.00
DL 4.00
IM 1.50
Maintenance 2.00
Utilities 1.00
Total P13.50

Total FC:
Sup Sal. P 12,000
Dep on PA 10,000
Ins on PA 1,600
Prop taxes 2,000
Maintenance 4,000
Utilities 1,000
Total P 30,600

VC per unit – Maint.: = P44,000 – P32,000

20,000 – 14,000
= P12,000
P6,000
= P2

TFC – Maintenance = P32,000 – (P2 x 14,000)

= P4,000

VC per unit – Utilities = P21,000 – P15,000

20,000 – 14,000
= P1

TFC – Utilities = P21,000 – (P1 x 20,000)

= P1,000
OUTLIER – abnormally low or high cost driver

Problem II:

Chicago Co. manufactures 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 and sold each year is given below:

Units produced and sold

60 80 100
Total costs:
Variable P120 P 160 P 200
Fixed 600 600 600
Total P 720 P 760 P 800
Cost per unit:
Variable P2 P2 P2
Fixed P 10 P 7.5 P6
Total P 12 P 8.5 P8

Required: Based on the above data,

1. Complete the schedule on total and unit costs (Fill in the blanks).
2. Identify two specific costs that remain constant over the relevant range. TFC and VC per unit
3. Identify two specific costs that are directly related with unit production. TVC and TC
4. Identify the two specific costs that are inversely related with unit production. FC per unit and TC per unit
5. Express the cost formula based on the line equation for “Y = a + bX”. Y = P600 + P2x
6. If the company produces 90 units, then the total cost is expected to be P .

Y = P600 + P2(90)
= P780

Y = bx
Y = Total VC

Y=a
Y = Total FC

Cost Estimation: Segregation of Mixed Costs into Fixed and Variable Elements
1. High-Low Method 4. Engineering Method
2. Least-Squares Method 5. Account Analysis Method
3. Scattergraph (Scatter Diagram) Method 6. Conference Method

High-Low Method
The fixed and variable elements of the mixed costs are computed from two sampled data points – the highest and
lowest points as to activity level or cost driver. For analysis purposes, the high-low method usually produces a reasonable,
not precise estimate. However, this method is criticized because it ignores much of the available data by concentrating on
only the extreme points.

Illustration: Separation of the Fixed and Variable Components of Mixed Costs

Problem I:

Machine hours and electricity costs for Indiana Industries for 2014 were as follows:

Month Machine Hours Utility Costs

January 2,500 P 36,800
February 2,900 42,000
March LP 1,900 27,000
April 3,100 46,000
May 3,800 56,500
June 3,300 44,000
July 4,100 49,500
August 3,500 45,500
September 2,000 31,000
October 3,700 52,000
November HP 4,700 62,000
December 4,200 55,500
Required: Using the high-low method;
1. Compute for the variable cost per machine hour. P12.50
2. Compute the total variable cost at the highest and lowest level of activity.
3. Determine the fixed cost at each level of activity. P3,250
4. Develop an equation to determine the total cost at any level of activity. y = P3,250 + P12.5x

STEP 1: Determine the highest and lowest levels as to activity driver.

STEP 2: Compute for the variable cost per MH.

VC per MH = TC @ HP – TC @ LP (Change in TC)

HP – LP (Change in Driver)

= P62,000 – P27,000
4,700 – 1,900

= P35,000 (Change in TVC)

2,800 (Change in Driver)

= P12.5/MH

Y = a + bx
Y = a + P12.5x

a=?

STEP 3: Determine the total FC.

TC = TFC + (VC/MH x MH)

TFC = TC – (VC/MH x MH)

TFC @ HP = P62,000 – (P12.5 x 4,700)

= P62,000 – P58,750
= P3,250

TFC @ LP = P27,000 – (P12.5 x 1,900)

= P27,000 – P23,750
= P3,250