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" Cost Behavior :Analysis and Use "

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Republic of Iraq
Ministry of Higher Education &Scientific Research
Wasit University
College of Administration & Economics
Accounting Department

" Cost Behavior :Analysis and Use "

Submitted to:

Professor
Dr. Abbas Nawar Khait Al-Musawi

By The Student:

Maryam Shwetti Kitten Al-Zweeni

1440 A.H. Waist 2019 A.D.

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Introduction
Cost behavior refers to the relationship between total costs and activity
level. Based on behavior, costs are categorized as either fixed, variable or
mixed. Fixed costs are constant regardless of activity level, variable costs
change proportionately with output and mixed costs are a combination of
both.

Cost behavior analysis overview

Cost behavior analysis refers to management’s attempt to

understand how operating costs change in relation to a change in
an organization’s level of activity. These costs may include direct
materials, direct labor, and overhead costs that are incurred from
developing a product. Management typically performs cost
behavior analysis through mathematical cost functions.

Cost functions are descriptions of how a cost (e.g., material, labor,

or overhead) changes with changes in the level of activity relating
to that cost. For example, total variable costs will change in relation
to increased activity, while fixed costs will remain the same. Cost
functions may come in various forms
(https://corporatefinanceinstitute.com/resources/knowledge/accounting/cost-behavior-
analysis/)

Define cost behavior, and identify variable, fixed, and mixed

Cost behavior—the way costs respond to changes in volume or activity—
is a factor in almost every decision managers make. Managers commonly
use it to analyze alternative courses of action so they can select the
course that will best generate income for an organization’s owners, use
resources wisely, and maintain liquidity for its creditors when they plan,
perform, evaluate, and communicate.(Needles: 924 :2011)

Variable costs

. The total amount of a variable cost increases in proportion to the

increase in an activity. The total amount of a variable cost will also
decrease in proportion to the decrease in an activity. An example of
a variable cost is the cost of flour for a bakery that produces artisan
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breads. The greater the number of loaves produced, the greater the
total cost of the flour used by the bakery .
https://www.accountingcoach.com/blog/what-is-cost-behavior))

variable cost per unit is constant . For exampleAverage variable cost

https://xplaind.com/552306/cost-behavior

Fixed costs are those which do not change with the level of activity
within the relevant range. These costs will be incurred even if no
units are produced. For example rent expense, straight-line
depreciation expense, etc.

Fixed cost per unit decreases with increase in production. Following

example explains this fact : (https://xplaind.com/552306/cost-behavior)

3
An example of a fixed cost is the depreciation and insurance on the
bakery facility and equipment. Regardless of the quantity of artisan
breads produced in a month, the total amount of depreciation and
insurance cost for the month will remain the same.
(https://www.accountingcoach.com/blog/what-is-cost-behavior)

Relevant Range
In cost behavior analysis, relevant range represents the production
bracket expressed in terms of units within which fixed costs are
indeed fixed.

We define fixed costs as costs which do not change with increase or

decrease in the number of units produced. However, this
proposition is not valid indefinitely, i.e. fixed costs remain fixed
only when production remains within certain minimum and
maximum limit. Such limits constitute relevant range.

Identification of relevant range is important because knowing the

production level at which costs will change is critical for cost
accounting, budgeting and financial planning.
(https://xplaind.com/113534/relevant-range)

(Garrison, Noreen & Brewer 199)

4
Mixed Costs
have both variable and fixed cost components. Part of a mixed cost
changes with volume or usage, and part is fixed over a particular period.
Monthly electricity costs are an example. Such costs include charges per
kilowatt hour used plus a basic monthly service charge. The kilowatt-hour
charges are variable because they depend on the amount of use; the
monthly service charge is a fixed costs .(Gaorsson :253 :2008)

For example:- The annual expense of operating an automobile is a

mixed cost. Some of the expenses are fixed because they do not
change in total as the number of annual miles change. These
include insurance, parking fees, and some depreciation. Some of
the expenses are variable since the total amount will increase when
more miles are driven and will decrease when fewer miles are
driven. The variable expenses include gas, oil, tires, and some
depreciation.
Let's assume that a simple linear regression analysis indicates that
the past annual expense of operating an automobile (y) consisted
of the fixed cost (a) of $5,000 per year and the variable rate (b) was
$0.20. When the number of miles driven during a year (x) are
15,000 miles, the expected total annual expense is the fixed
expense $5,000 + the variable expense of $0.20 X 15,000 = $5,000
+ $3,000 = $8,000. If the miles driven are 10,000 miles, the
expected total annual expense is the fixed expense of $5,000 + the
variable expense of $0.20 X 10,000 = $5,000 + $2,000 = $7,000 .
(https://www.accountingcoach.com/blog/mixed-costs-fixed-costs-variable-costs)

5
(https://xplaind.com/552306/cost-behavior)

There are three ways to separate mixed costs:-

1- High-low method
2- Scatter Graph Method
3- least squares

The above methods can be illustrated as follows:-

1- high-low method:-
From basic geometry, we know that two points are needed to
determine a straight line. If we know two points on a line, then its
equation can be determined. Recall that F, the fixed cost
component, is the intercept of the total cost line, and V, the variable
cost per unit, is the slope of the line. Given two points, the slope and
the intercept can be determined. The high-low method preselects the
two points that will be used to compute the parameters F and V.
Specifically, the method uses the high and low points. The high
point is defined as the point with the highest activity level. The low
point is defined as the point with the lowest activity level (Hansen:59-
60 : 2009)

Letting (X1 , Y1 ) be the low point and (X2 , Y2 ) be the high point,
and fitting these two points in the equation for the straight line, we
have:
Y1 = F + VX1
And
Y2 = F + VX2
Applying some basic algebra and solving for V and F, we obtain:
V = Change in cost/Change in activity
= (Y2 – Y1 )/(X2 – X1 )
F = Total mixed cost – Variable cost
Or
F = Y1 – VX
Notice that the fixed cost component is computed using the total
cost at either (X1 , Y1 ) or (X2 , Y2 ).

6
In cost accounting, the high-low method is a way of attempting to
separate out fixed and variable costs given a limited amount of data. 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.

If the variable cost is a fixed charge per unit and fixed costs remain the
same, it is possible to determine the fixed and variable costs by solving
the system of equations

First, determine the variable cost component

HAUs−Lowest Activity cost

Variable Cost = ---------------------------------------

Units HAC−Lowest Activity

where:
HAC=Highest activity cost

HAUs=Highest activity units

Variable cost is per unit

Next, use the following formula to determine the fixed cost

component:

Fixed Cost=HAC−(Variable Cost × HAUs)

Use the results of the first two formulas to calculate the high-low
cost result using the following formula:

High-Low Cost=Fixed Cost+(Variable Cost × UA)

where:
UA=Unit activity
https://www.investopedia.com/terms/h/high-low-method.asp

2-Statistical Methods
Statistical methods, such as regression analysis, mathematically describe
the relationship between costs and activities and are used to separate

7
mixed costs into variable and fixed components. Because all data
observations are used, the resulting linear equation is more
representative of cost behavior than either the high-low or scatter
diagram methods. Regression analysis can be performed using one or
more activities to predict costs. For example, overhead costs can be
predicted using only machine hours (a simple regression analysis), or they
can be predicted using both machine hours and labor hours (a multiple
regression analysis) because both activities affect overhead. We leave
further description of regression analysis to statistics courses, which
provide detailed coverage of this method . (Needles: 933 : 2011)

3-least squares:-
Up to this point, we have alluded to the concept of a line that best fits
the points shown on a scatter graph. What is meant by a best-fitting
line? Intuitively, it is the line to which the data points are closest. But
what is meant by closest?. The closeness of each point to the line can
be measured by the vertical distance of the point from the line. This
vertical distance is the difference between the actual cost and the cost
predicted by the line. For point , and the deviation is represented. The
deviation is the difference between the actual cost and the predicted
cost.(Hansen: 61 : 2009)

There are two ways to reach the rate of change directly and
indirectly

directly

For Example\\ about The Mixed Costs

When Jerome Company’s monthly costs were $75,000, sales were
$80,000; when its monthly costs were $60,000, sales were $50,000. Use

8
the high-low method to develop a monthly cost formula for Jerome’s
coming year. ( Needles: 951: : 2011 )

The solution\\

Profit = sales – cost

= 80,000 – 75000

= 5000 $

Loss = 50,000 – 60,000 =( 10,000)

Fixed = 5000 – ( 0.5 × 80,000)

=5000 – 40,000

= - 35,000$

Cost Monthly = 75,000 – 35,000

= 40,000$

Summary:-
Cost behavior is the general term for describing how cost changes when
the level of output changes. A cost that does not change as output
changes is a fixed cost. A variable cost, on the other hand, changes in
proportion to changes in output. Output is the result of activities and can
therefore be measured by activity drivers. For example, materials
handling output can be measured by the number of moves, shipping
goods output may be measured by the units sold, and laundering hospital
bedding output may be measured by the pounds of laundry. We now
take a closer look at fixed, variable, and mixed costs. In each case, the
cost is related to only one measure of output.

9
 Sources :-
1- . Financial, and, Managerial Accounting, Belverd E. Needles, Jr., Ph.D.,
C.P.A., C.M.A. DePaul University, 2008, Marian Powers, Ph.D.,
Northwestern University, Susan V. Crosson, M.S. Accounting, C.P.A,
Santa Fe College

2- Managerial Accounting, Belverd E. Needles, Jr., Ph.D., C.P.A., C.M.A.

DePaul University, Eighth Edition , 2011.

3-Cost behavior analysis , Comparing costs and activities

(https://corporatefinanceinstitute.com/resources/knowledge/accounti
ng/cost-behavior-analysis/

4-What is cost behavior

(https://www.accountingcoach.com/blog/whatiscosbehavior)

5-What is cost behavior https://xplaind.com/552306/cost-

behavior

6-What is cost behavior, -

(https://www.accountingcoach.com/blog/what-is-cost-behavior)

7- Relevant Range -( https://xplaind.com/113534/relevant-range)

8-Cost behavior November 23, 2018,

(https://www.accountingcoach.com/blog/mixed-costs-fixed-costs-
variable-costs

9- High-Low Method Definition , Updated Jun 26, 2019,

https://www.investopedia.com/terms/h/high-low-method.asp
01- Cost Management ACCounting , Control , Don R. Hansen
Oklahoma State University, Liming Guan University of Hawaii at Manoa
., 2009 , Sixth Edition

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