Objectives, Role and Scope of Managerial Accounting

Lesson Objectives:

At the end of this module, you should be able to:

1. Identify differences between management, cost and financial accounting; controller &
treasurer; line & staff functions.

2. Gain an understanding on the role of a CMA.

Management accounting – is the process of identifying, measuring, analyzing, interpreting,

and communicating information in pursuit of an organization’s goals.

Management Functions

In pursuing its goals, an organization acquires resources, hires people, and then engages in an
organized set of activities. The day-to-day work of the management team comprises four
activities:

1. Planning – This step involves mapping out exactly how to achieve a particular goal.
Say, for example, that the organization's goal is to improve company sales. The
manager first needs to decide which steps are necessary to accomplish that goal. These
steps may include increasing advertising, inventory, and sales staff. These necessary
steps are developed into a plan. When the plan is in place, the manager can follow it to
accomplish the goal of improving company sales.

2. Organizing – After a plan is in place, a manager needs to organize his team and
materials according to his plan. Assigning work and granting authority are two important
elements of organizing.

3. Directing / Leading – A manager needs to do more than just plan and organize to
achieve a goal. He/she must also lead. Leading involves motivating, communicating,
guiding, and encouraging. It requires the manager to coach, assist, and problem solve
with employees.

4. Controlling / Evaluating – After the other elements are in place, a manager's job is
not finished. He needs to continuously check results against goals and take any
corrective actions necessary to make sure that his area's plans remain on track.

Management Accounting vs Financial Accounting vs Cost Accounting

Management Financial
Accounting Accounting

Cost Accounting

Management accounting – focus on internal reporting for decision making of managers in

fulfilling organization’s goals.
Financial Accounting – focus on external reporting for decision making of those outside the
organization

Cost accounting – serves as the database for both management and financial accounting
because it provides information relating to cost of acquiring and utilizing resources.

For further comparison of management accounting and financial accounting, let’s read the next
table:
Management Accounting Financial Accounting
1. Users Internal External
2. Accounting Principles Not governed by GAAP GAAP
3. Reports Optional Mandatory
4. Frequency of reporting Management discretion On a regular basis
5. Non-monetary
Considered Not considered
information
Current figures, estimates,
6. Data Presented historical data if useful in Mostly historical data
future estimates
Timeliness and relevance are
7. Precision More or less precise
more important than precision
Compressed and simplified
More extensive and detailed without sacrificing full
8. Amount of detail
for better analysis and control disclosure of relevant
information
Not only from accounting
Drawn heavily from company's
9. Source of Data system. Also considers
accounting records
economics, statistics, etc.
 Planning, organizing, staffing, To produce financial
10. Purpose
directing, and controlling statement
11. Focus Various segments of an entity Entity as a whole

Controller vs Treasurer
Controller / Comptroller – is the head accountant of the company. They supervise other
accountants and oversee the preparation of financial reports, such as income statements and
balance sheets. In large organizations, the controller reports to the chief financial officer (CFO).
In smaller entities, however, the controller might be assigned as the head of the finance
department. Aside from preparing reports and overseeing the accounting and auditing functions
of a business, the controller job description entails monitoring internal controls to lessen risks
and create value within the organization. The controller also takes part in analyzing financial
data, as well as preparing budgets. They are also in charge of your tax compliance and see to it
that deadlines and regulations are strictly followed.

Treasurer – the protector of a company’s value and finances from financial risks that arises
from business activities. The duties of a treasurer include interacting with shareholders,
bankers, and current and potential investors. They are primarily responsible for obtaining
investment capital and managing the cash flow of the business. They are in charge of obtaining
loans and credit from outside sources. They build and maintain healthy business relationships
with banks and raise equity capital. They are responsible for investing company funds and
communicating with shareholders. Treasury functions in a company generally involve cash
management and making sure that financial goals are met.

Functions of: Controller Treasurer

1. Planning for control 1. Provision of capital
2. Financial reporting and interpretation 2. Investor relations
3. Management audit 3. Short-term financing
4. Internal audit 4. Banking and custody of
funds
5. Tax administration 5. Credit and collections
6. Government reporting 6. Investments
7. Economic appraisal 7. Insurance

Line vs Staff Position

Line position – directly involved in the day-to-day operations of the organization, such as
producing or selling a product or service. Line personnel carry out the primary activities of a
business and are considered essential to the basic functioning of the organization. Line function
includes production, sales, and marketing.

Staff position – serve the organization by indirectly supporting line functions. Staff personnel
use their technical expertise to assist line personnel and aid top management in various
business activities. Staff personnel also provide support, advice, and knowledge to other
individuals in the chain of command. Staff function includes human resource, accounting, public
relations, and legal departments.
Example of an organization chart that emphasizes line and staff functions:

Lesson Objective 2

Certified Management Accountant (CMA) is a certification in financial accounting and

strategic management. Furthermore, unlike other accounting certifications, CMA is a globally
recognized credential with a special focus on corporate finance and management accounting.
Consequently, it may be useful to get a brief perspective of CMA before we dive into how it can
enrich your career. This professional certification is offered by the Institute of Management
Accountants (IMA). Institute of Certified Management Accountants (ICMA) is a division within
IMA which awards CMA certification. Also, IMA is headquartered in New Jersey and has a
reach in over 140 countries.

Certified Management Accountant Function

CMAs work in accounting, corporate finance and strategy teams in an organization. CMAs
analyze and parse data from multiple sources to inform performance improvement. Additionally,
they not only crunch numbers for internal review and budget analysis, but also contribute to
strategic business decisions by providing insights into the financial condition of the company.
Furthermore, they coordinate with other performance managers to propose improvements
regarding the financial strength of the company. Certified Management Accountants typically
work as cost accountants, risk managers, budgeters, corporate accountants, management
accountants, financial strategists, and executive decision makers.
Duties of Certified Management Accountants
CMA are certified professionals qualified to areas of financial analysis and financial planning
such as budgeting and forecasting, internal control, reporting, and professional ethics. Hence,
the typical CMA work experience can be broadly summarized as follows:
● Identify opportunities for investment management
● Act as a mentor and supervise lower level accountants
● Prepare financial statement – income statements, balance sheets, and cash flow
statements
● Make presentations to senior management
● Create strategies to improve and manage various internal and external risks
● Arrange funding and financing options
● Monitor and administer compliance

Ethical Principles of a CMA

Members of ICMA shall behave ethically. A commitment to ethical professional practice
includes: overarching principles that express a CMA’s values, and the standards that guide a
CMA’s conduct.

Principles
ICMA’s overarching ethical principles include: Honesty, Fairness, Objectivity, and
Responsibility. All CMAs shall act in accordance with these principles and shall encourage
others within their organizations to adhere to them.

Standards
A CMA’s failure to comply with the following standards may result in disciplinary action including
disbarment from membership.

Competence
Each member has a responsibility to:
1. Maintain an appropriate level of professional expertise by continually developing
knowledge and skills.
2. Perform professional duties in accordance with relevant laws, regulations and technical
standards.
3. Provide decision support and business analysis information and recommendations that
are accurate, clear, concise, and timely.
4. Recognize and communicate professional limitations or other constraints that would
preclude responsible judgment or successful performance of an activity.

Confidentiality
Each member has a responsibility to:
1. Keep information confidential except when disclosure is authorized or legally required.
2. Inform all relevant parties regarding appropriate use of confidential information.
3. Monitor subordinates’ activities to ensure compliance.
4. Refrain from using confidential information for unethical or illegal advantage.
Integrity
Each member has a responsibility to:
1. Mitigate actual conflicts of interest.
2. Regularly communicate with business associates to avoid apparent conflicts of interest.
3. Advise all parties of any potential conflicts.
4. Refrain from engaging in any conduct that would prejudice carrying out duties ethically.
5. Abstain from engaging in or supporting any activity that might discredit the profession.

Credibility
Each member has a responsibility to:
1. Communicate information fairly and objectively.
2. Disclose ah relevant information that could reasonably be expected to influence an
intended user’s understanding of the reports, analyses or recommendations.
3. Disclose delays or deficiencies in information, timeliness, processing, or internal controls
in conformance with organization policy and/or applicable law.

Resolution of Ethical Conflict

In applying the Standards of Ethical Professional Practice, you may encounter problems
identifying unethical behavior or resolving an ethical conflict. When faced with ethical issues you
should follow your organization’s established policies on the resolution of such conflict. If these
policies do not resolve the ethical conflict, you should consider the following courses of action:
1. Discuss the issue with your immediate supervisor except when it appears that the
supervisor is involved. In that case, present the issue to the next level.
2. If you cannot achieve a satisfactory resolution, submit the issue to the next management
level. If your immediate superior is the chief executive officer or equivalent, the
acceptable reviewing authority may be a group such as the audit committee, executive
committee, board of directors, board of trustees, or owners. Contact with levels above
the immediate supervisor should be initiated only with your superior’s knowledge,
assuming he or she is not involved. Communication of such problems to authorities or
individuals not employed or engaged by the organization is not considered appropriate,
unless you believe there is a clear violation of the law.
3. Clarify relevant ethical issues by initiating a confidential discussion with an ICMA Ethics
Committee Representative or other impartial advisor to obtain a better understanding of
possible courses of action.
4. Consult your own attorney as to legal obligations and rights concerning the ethical
conflict.

Determine whether the Statements are most closely associated with financial accounting or
managerial accounting. Write F for financial accounting and M for managerial accounting.
1. Is heavily involved with the recordkeeping and reporting of assets, liabilities, and
stockholders’ equity.
2. Focuses on planning, control, decision making, and performance evaluation.
3. Is heavily regulated.
4. A field that is becoming more "cross-functional" in nature.
5. Much of the field is based on costs and benefits.
6. Is involved almost exclusively with past transactions and events.
7. Much of the information provided is directed toward stockholders, financial
analysts, creditors, and other external parties.
 8. Tends to focus more on subunits within an entity rather than the organization as
a whole.
9. May become involved with measures of customer satisfaction, and the amount of
actual cost incurred vs. budgeted targets.

Introduction to Cost Terms and Concepts

Lesson Objectives:
At the end of this module, you should be able to:
1. Identify cost terminologies.
2. Track the flow of costs for the different types of industries.

Cost – monetary amount that must be paid to acquire goods and services or resource sacrificed
or forgone to achieve a specific objective
Cost object – anything for which a separate measurement of costs is needed/desired

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 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.

Different Types of Costs per Category

I. According to Management Function

a. Manufacturing costs – costs incurred to convert raw materials into finished goods.
These include cost of raw materials used (direct materials), direct labor, and factory
overhead.

Classifications of Manufacturing Costs

1. Direct material costs – raw materials in stock and awaiting use in the manufacturing
process
2. Direct labor costs – cost of salaries, wages, and fringe benefits for personnel who work
directly on the manufactured products
3. Manufacturing overhead / Factory overhead costs – all other costs of manufacturing
which includes three types of costs: indirect materials, indirect labor and other
manufacturing costs

Note: Direct materials + direct labor = prime cost

Factory overhead + direct labor = conversion cost

b. Non-manufacturing costs – all costs that are not part of manufacturing costs. These
include selling expenses (such as advertising costs, delivery expense, and salaries of
salesmen) and administrative expenses (such as salaries of executives and legal
 expenses).

Sales xx
Cost of sales (xx)
Manufacturing cost Direct materials, Direct Labor, Manufacturing overhead
Gross profit xx
Operating expenses (xx)
Non-manufacturing
Operating income cost xx
II. According to Timing of Charge Against Revenue Selling and Administrative expenses

a. Product costs / Inventoriable costs – These costs are used to value inventory of
manufactured goods or merchandise until the goods are sold. In the period of sale, the
manufacturing costs are recognized as expense called the cost of goods sold. All
manufacturing costs are product costs.

b. Period costs – These costs are identified with the period of time in which they are
incurred rather than with units purchased or produced. Period costs are recognized as
expenses during the period in which are incurred. All non-manufacturing costs are period
costs.

Sales xx
Cost of sales (xx)
Product cost DM, DL, MOH
Gross profit xx
Operating expenses (xx)
Operating income xx
Period cost Selling and Administrative expenses
III. According to Traceability

a. Direct costs – those that can be traced directly to a particular cost object such as a
product, department, or branch. These include materials and labor. Some operating
expenses can also be classified as direct costs, such as advertising cost for a particular
product.

b. Indirect costs – those that are not directly traceable to a particular cost object. They are
also called common costs or joint costs. Indirect costs include factory overhead and
operating costs that benefit more than one product, department, or branch.

IV. According to Behavior

a. Variable costs – vary in total in direct proportion to changes in activity level. However,
variable cost per unit remains the same as activity level changes. Examples include
direct materials, direct labor, and sales commission based on sales.

b. Fixed costs – costs that remain constant in total regardless of changes in activity level.
However, per unit fixed cost declines as the level of activity changes. Examples include
rent, insurance, and depreciation using the straight-line method.

c. Mixed costs / Semi-variable costs – costs that vary in total but not in proportion to
change in activity level. It basically includes a fixed and a variable portion. An example
 would be electricity expense that has a minimum charge on a fixed amount plus variable
charges based on additional usage.

Sales xx Variable product cost DM, DL, Variable MOH

Cost of sales (xx)
Fixed product cost Fixed MOH
Gross profit xx Variable period cost Variable S&A expense
Operating expenses (xx)
Operating income xx

V. According to Controllability

a. Controllable costs – refer to costs that can be influenced by the managers.

b. Uncontrollable costs – refer to costs that cannot be influenced by the managers.

Fixed period cost Fixed S&A expense

VI. According to Relevance to Decision Making

a. Relevant cost – cost that will differ among alternative courses and will affect the future.

b. Standard cost – predetermined cost based on some reasonable bases such as

experiences, budgeted amounts, industry standards, etc. The actual costs incurred are
compared to standard costs.

c. Opportunity cost – benefit forgone or given up when an alternative is chosen over the
other/s. Example: If a business chooses to use its building rather than rent it out to
tenants. The opportunity cost would be the rent income that would have been earned
had the business chose to rent it out.

d. Sunk cost – historical costs or costs that are incurred in the past and will not make any
difference in making a decision. Example is money spent last year to buy a machinery.

e. Out-of-pocket costs – those that require the payment of cash or other asset as a result
of their incurrence.

f. Differential cost – the amount by which the costs differ under alternative actions.
Example: The difference in the cost of two vehicles.

g. Marginal cost – extra cost incurred when one additional unit is produced.

h. Incremental cost – total additional cost associated with the decision to expand output or
to add a new variety of product etc.

i. Avoidable cost – cost that is not incurred if the activity is not performed. For example,
supply expenses are avoidable costs. You can simply decide to not buy the supplies,
and no expense will be incurred.

j. Unavoidable cost – cost that is still incurred even if the activity is not performed. For
example, if a manufacturing plant shuts down, it still needs to incur depreciation for for
idle equipment, property taxes, lease payments, etc.
 k. Committed cost – costs that result from an organization’s ownership or use of facilities
and its basic organization structure. Example: property taxes and depreciation of
building and equipment

l. Discretionary cost – arises as a result of management decision to spend particular

amount of money for some purpose. Examples are

m. Average cost per unit – total cost, for whatever quantity is manufactured, divided by
the number of units manufactured. Example: advertising, research and development

Lesson Objective 2
Flow of Costs

Manufacturing

The flow of costs in a manufacturing company starts with the purchase of raw materials. The
flow of costs then moves to work-in-process inventory, where direct labor and overhead costs
are added to the cost of the raw materials. Once the production process is complete, the costs
move to the finished goods inventory classification, where the goods are stored prior to sale.
When the goods are eventually sold, the costs move to the cost of goods sold. During this
process flow, the costs are initially recorded in the balance sheet as assets. Unused raw
materials are recorded as raw materials inventory, unfinished products are recorded as work-in-
process inventory, and unsold finished products are recorded as finished goods inventory.
Costs are eventually treated as expense at the point of sale and shifted to the cost of goods
sold section of the income statement. Other costs such as selling and administrative expenses
are expensed immediately when incurred.

Merchandising
The flow of costs of a merchandising company is quite simple because a merchandising
company purchases finished products form suppliers and resells them to customers at a
markup. The remaining unsold products at the end of the period will form part of asset as
merchandise inventory. Other costs such as selling and administrative expenses are expensed
immediately when incurred.
Service

Cost of
Direc Labor Services

Period
Other costs
Costs

The flow of costs concept is less applicable in a services firm, where most costs are incurred
and charged to expense at the same time. Most service-oriented firms do not incur raw material
and does not have inventory accounts

Exercise 1
Eastside Manufacturing produces small electric engines. Identify the following costs as direct
materials (DM), direct labor (DL), manufacturing overhead (MOH), or a period cost (PC). Also
indicate whether the cost is variable (V) or fixed (F) with respect to behavior.
A. Commissions paid to salespeople
B. Straight-line depreciation on the factory building
C. Salary of the plant supervisor
D. Wages of the assembly-line workers
E. Machine lubricant used in production activities
F. Engine casings used in production activities
G. Advertising placed in trade journals
H. Lease payments for the president's automobile
I. Property taxes paid on the factory facilities

Exercise 2
The selected amounts that follow were taken from Kentucky Corporation's accounting records:

Raw material used ₱ 27,000

Direct labor 35,000
Total manufacturing costs 104,000
Work-in-process inventory, 1/1 19,000
Cost of goods manufactured 100,000
Cost of goods available for sale 175,000
Finished-goods inventory, 12/31 60,000
Sales revenue 300,000
Selling and administrative expenses 125,000
Income tax expense 18,000

Required:
Compute the following:
A. Manufacturing overhead. E. Conversion cost.
B. Work-in-process inventory, 12/31. F. Cost of goods sold.
C. Finished-goods inventory, 1/1. G. Gross margin.
D. Prime cost. H. Net income after tax.

Splitting Mixed Cost – High-Low Method

Lesson Objectives:
At the end of this module, you should be able to:
1. Analyze the behavior of costs.
2. Separate fixed and variable components of a mixed costs using high-low method.

Analysis of Cost Behavior

1. Variable costs – vary in total in direct proportion to changes in activity level. However,
variable cost per unit remains the same as activity level changes. Examples include direct
materials, direct labor, and sales commission based on sales.
Illustration:
No. of Units Produced Cost of DM per Unit Total Cost
10,000 ₱ 5.00 ₱ 50,000.00
20,000 ₱ 5.00 ₱ 100,000.00
30,000 ₱ 5.00 ₱ 150,000.00

The table shows the behavior of a variable cost in response to a cost driver. The cost driver is
the number of units produced. As the number of units increases, the total amount of variable
also increases but the cost per unit remains the same.

2. Fixed costs – costs that remain constant in total regardless of changes in activity level.
However, per unit fixed cost declines as the level of activity changes. Examples include rent,
insurance, and depreciation using the straight-line method.

Illustration:
No. of Units Produced Rent per month Cost per unit
5,000 ₱ 30,000.00 ₱ 6.00
10,000 ₱ 30,000.00 ₱ 3.00
15,000 ₱ 30,000.00 ₱ 2.00

The table shows the behavior of a fixed cost in response to a cost driver. The cost driver is the
number of units produced. As the number of units increases, the total amount of fixed cost
remains the while the per unit fixed cost decreases because more units will absorb the amount
of fixed cost.

Graph of Fixed and Variable Costs

3. Mixed costs / Semi-variable costs – costs that vary in total but not in proportion to change
in activity level. It basically includes a fixed and a variable portion. An example would be
electricity expense that has a minimum charge on a fixed amount plus variable charges based
on additional usage.

Graph of a Mixed Cost

What are step costs?

Step cost refers to the behavior of the total cost of an activity at various levels of the activity.
When a step cost is plotted on a graph (with the total cost represented by the y-axis and the
quantity of the activity represented by the x-axis) the lines will appear as steps or stairs rising
from left to right.

1. Step variable cost – a cost that generally varies with the level of activity, but which tends to
be incurred at certain discrete points and to involve large changes in amounts when such a
point is reached. Conversely, a truly variable cost will vary continually and directly in concert
with the level of activity.

An example of a step variable cost is the compensation of a quality assurance (QA) worker in
the assembly area of a production department. Each QA worker is capable of reviewing a
certain number of parts per day. Once the production process exceeds that volume level,
another quality assurance worker must be hired. Thus, the cost of the QA person generally
varies with the level of activity, but only changes at discrete points - when the existing QA staff
can no longer handle the work load, forcing another person to be hired.

Graph of step variable cost

2. Step fixed cost – cost that does not change within certain high and low thresholds of activity,
but which will change when these thresholds are breached. When the cost changes as a result
of a threshold breach, a new set of high and low activity thresholds will then apply, within which
the fixed cost will not change appreciably. The concept is useful when deciding whether to
invest in capital projects.
Examples of step fixed costs include:
a. The cost of starting up a new production shift, which includes utilities and the salaries of shift
supervisors.
b. The cost of a new production facility, which includes depreciation on the equipment and the
salaries of the production line supervisors.
c. The cost of rolling out an entirely new sales region, which may include the cost of a
warehouse distribution system.

Graph of step fixed cost

Lesson Objective 2
Methods of Segregating Fixed and Variable Element 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 Scatter Graph 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 squared
deviations of each actual plotted point from the point directly above or below it on the regression
line is at minimum.

Note: Only High-low method will be tackled in this module. Scatter graph method and
regression analysis will be tackled in the next module.

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.

Remember: This cost function will be used to calculate the total cost of a product at a certain
level of activity or cost driver:
 y-intercept Slope

y=a+bx
Where:
y = total costs Dependent variable Independent variable
a = fixed cost
b = variable cost per unit
x = cost driver or level of activity

High-Low Method

Total cost of highest activity −Total cost of lowest activity

Variable cost per unit=
Highest activity unit−Lowest activity unit

Illustration:
The table below depicts the activity for a cake bakery for each of the 12 months of a given year.
Month Cakes Baked (units) Total Cost (₱)
January 115 ₱5,000
February 80 ₱4,250
March 90 ₱4,650
April 95 ₱4,600
May 75 ₱3,675
June 5 ₱230
July 85 ₱4,400
August 70 ₱3,750
September 115 ₱5,100
October 130 ₱5,550
November 110 ₱5,100
December 125 ₱5,700
Requirements: Solve for:
a. Variable cost per unit b. Fixed cost c. Total cost at 120
units.
Step 1: Identify the highest and lowest volume of activity together with their corresponding cost.
Highest = October Lowest = August
Units 130 Units 70
Cost 5,550 Cost 3,750

Notice that we did not get June as lowest volume of activity even though it had the lowest
production of cakes with 5 units. This is because of the relevant range assumption. The
production of cakes in June is considered outside the relevant range because it was very
unusual compared to production in other months. This unusual volume of activity or volume of
activity outside the relevant range is called outlier.
Note: The corresponding costs of the highest and lowest volume of activity will be used in high-
low method, not the highest and lowest cost. For the problem above, ₱5,550 and ₱3,750 will be
used because it is the corresponding cost of the highest and lowest volume of activity. We will
not use ₱5,700 and ₱3,675 even though they are the highest and lowest cost respectively.

Step 2: Substitute the identified highest and lowest volume of activity together with their
corresponding cost to the formula to compute for the variable cost per unit.
Total cost of highest activity −Total cost of lowest activity
Variable cost per unit=
Highest activity unit−Lowest activity unit
5,550−3,750
Variable cost per unit=
130−70
1,800
Variable cost per unit=
60
Variable cost per unit=30

Step 3: Use the cost function “y = a + bx” to compute for fixed cost. You can plug in the units
and cost of either the highest or lowest volume of activity in the cost function to compute for
fixed cost.

First, let us use the highest units and its cost to compute for fixed cost:

y=a+bx
5,550=a+30(130)
5,550=a+3,900
5,550−3,900=a
a=1,650
Now, let us use the lowest units and its cost to compute for fixed cost:

y=a+bx
3,750=a+30(70)
3,750=a+2,100
3,750−2,100=a
a=1,650

Note: Sometimes the computed fixed cost using the highest point and the computed fixed cost
using the lowest point might have a slight difference due to rounding off of decimal points. The
difference is immaterial.

Step 4: With the computed variable cost per unit and fixed cost, write the cost function for the
problem above. The cost function of the problem would be:

y=1,650+ 30 x
We can solve the cost of any volume of activity within the relevant range with the cost function
above. Let us try to compute the cost of 120 units.

y=1,650+ 30 x
y=1,650+ 30(120)
y=1,650+ 3,600
y=5,250

Advantage of High-Low Method

The main advantage of high-low method is its ease of calculation. The separation between
variable and fixed cost will not require any complex data or calculation. We only need the total
production and total mixed cost.

Disadvantage of High-Low Method

The high-low method only takes into account the highest and lowest figure and ignore the whole
year data. The variable and fixed cost may not fit together when we apply to the rest of the year.

Exercise 1
Ang-bang Co., doing business in the province of La Union, reports the following total costs at
two levels of production:
Cost Item 2,000 units 5,000 units Classification
Direct labor P 12,000 P 30,000 ______________________
Indirect labor 4,000 15,000 ______________________

Property taxes 20,000 20,000 ______________________

Maintenance 7,000 16,000 ______________________
Depreciation 24,000 24,000 ______________________
Utilities 8,000 19,000 ______________________
Direct materials 16,000 40,000 ______________________

REQUIRED: Classify each cost as variable, fixed, or mixed.

Exercise 2
Jimmy P. is a highly successful farmer who has formed his own company to produce and
package banana chips. The recently hired controller for the firm is about to apply the high- low
method in estimating the company's energy cost behavior. The following costs were incurred
during the past 12 months:

Month Kilos of Banana Chips Produced Energy Costs

January 105,000 P70,200
February 63,000 66,300
March 66,000 66,000
April 72,000 67,350
May 90,000 68,700
June 96,000 70,050
July 2,000 12,500
August 90,000 68,400
September 90,000 69,000
 October 84,000 68,100
November 123,000 72,300
December 117,000 74,850

REQUIRED:
1. Use the high-low method to estimate the company's energy cost behavior and express it in
equation form.
2. Predict the energy cost for a month in which 78,000 kilos of banana chips are produced.

Exercise 3
Mighty Muffler, Inc. operates an automobile service facility that specializes in replacing mufflers
on compact cars. The following table shows the costs incurred during a month when 700
mufflers were replaced.
Muffler replacements 600 700 800
Total costs:
Fixed costs a P56,000 b
Variable costs c 28,000 d
Total costs e P84,000 f
Cost per muffler replacement:
Fixed cost g h i
Variable cost j k l
Total cost per muffler replacement m n o
Required:
a. Fill in the missing amounts, labeled ( a) through ( o), in the table.
b. Compute income, assuming that the service fee per muffler replacement is P120, and that the
company made 730 muffler replacements during the period.