3-1

Costs
Segregation
 3-2

Objectives

After reading this

chapter, you should
be able to:

▪ Understanding the limitations of methods of

cost behavior and analysis.
 3-3

Estimated Cost Behavior

Fixed Cost Behavior Variable Cost Behavior

$ $

Activity Activity

Unit Cost Varies with Volume Unit Cost Rate is Constant

 3-4

Estimated Cost Behavior

Mixed Cost

Total Costs
$ Cost

Variable Costs

Fixed amount

Number of Units Produced

Total Costs = Fixed Amount + (Variable Cost Per Unit x Number of Units)
Total Costs = Fixed Costs + Variable Costs
 3-5

Estimating Cost Behavior

✓Account Analysis
✓Engineering Approach
✓Interviews
✓The (High-Low) Two-Point Method
✓Scatter-Diagram Method
✓Regression
✓Least Squares Method
 3-6

Account Analysis
Manager decides how to classify a cost by
looking at its name and then checking this
judgment by scanning the account for that
cost for several periods.
Example: Rent, depreciation, salaries, and
advertising are generally fixed.
Weakness: It only shows what costs have
been, not what they should be.
 3-7

Engineering Approach
Engineers study the material and labor
requirements of products and related
operations, then make per-unit estimates of
the costs that should vary with production.
Advantage: It indicates what costs should
be rather than what they
have been.
 3-8

Interviews
This is a simple tool that has proven useful in
determining what drives many costs, and to
determine what is likely to happen to
particular costs, given specific actions.
Advantage: It does help to identify cost
drivers.
Weakness: Interviewing does not help
determine how much of a
particular cost is fixed or
variable.
 3-9

High-Low (Two-Point) Method

The high-low (two-point) method is a

relatively unsophisticated, yet widely used,
method of estimating the components of a
mixed cost.
Approach: This method uses two past levels
of activity and the amounts of the
cost incurred at those levels;
more specifically, the highest and
lowest levels of activity.
 3-10

High-Low (Two-Point) Method

Variable cost
change in cost
component of =
mixed cost change in activity
Variable cost
$40,800 – $14,800
component of =
mixed cost 18,000 – 5,000

Variable cost
component of = $26,000 $2 per
= machine hour
mixed cost 13,000
 3-11

High-Low (Two-Point) Method

Fixed cost variable
component of = total – volume x
cost cost
mixed cost components
At the high point: 18,000
Fixed cost
component of = $40,800 – (18,000 x $2)
mixed cost
Fixed cost
component of = $4,800
mixed cost
 3-12

High-Low (Two-Point) Method

Fixed cost variable
component of = total – volume x
cost cost
mixed cost components
At the low point: 5,000
Fixed cost
component of = $14,800 – (5,000 x $2)
mixed cost
Fixed cost
component of = $4,800
mixed cost
 3-13

High-Low (Two-Point) Method

An Example
Month Utility Costs Units Produced
January $4,000 400
February 5,000 800
March 9,000 1,200
April 10,000 1,600
May 15,000 2,000

High!
 3-14

High-Low (Two-Point) Method

An Example
Month Utility Costs Units Produced
January $4,000 400
February 5,000 800
March 9,000 1,200
April 10,000 1,600
May 15,000 2,000

Low!
 3-15

High-Low (Two-Point) Method

Variable Cost = ($15,000 – $4,000) / (2,000 – 400)
= $11,000 /1,600
= $6.875 per unit

Fixed Costs = $15,000 – ($6.875 x 2,000)

= $1,250

The cost formula using the high-low method is:

Y = $1,250 + $6.875 (X)

 3-16

Scatter-Diagram Method
The scatter-diagram (or graphical) method
requires cost and volume data from prior
periods, and drives an equation (cost
prediction formula) based on those data.
Weakness: The placement and slope of the
line are matters of judgment;
the manager “eyeballs” the data
and fits the line visually.
 3-17

Scatter-Diagram Method
Utility Cost
$16,000
x

12,000

x
x
8,000 Analyst can fit line
based on his or her
x experience
4,000 x

0
400 800 1,200 1,600 2,000
Units Produced
 3-18

Regression Method
Regression analysis (or just regression) is a
more sophisticated method for estimating the
fixed and variable components of a mixed
cost.
Regression uses cost and volume data from
prior periods to yield an equation of the form
y = a + bx.
 3-19

Problems and Pitfalls in

Cost Behavior Analysis
Historical Data
▪ High-low, scatter-diagram, and regression
methods all use historical information.
▪ Formulas based on historical data can give
useful predictions only if past conditions prevail
in the future.
▪ Outliers should be ignore
 3-20

Least Squares Method

Least squares method extends the analysis of

the basic regression equation by finding the
∑Y and ∑XY. This brings to two more
regression equations, as follows:
Equation 1: Y = a + bx
Equation 2: ∑Y = na + b∑x
Equation 3: ∑XY = ∑xa + b∑x2
 3-21

Least Squares Method

One of the products of Camiling Corporation goes through a
glazing process. For the last six quarters, the cost of the glazing
process was observed in relation with the number of units
produced as tabulated below:
Qtr. Units Produced Total Cost
01 800 P27,000
02 500 P20,000
03 1,000 P31,000
04 400 P19,000
05 600 P24,000
06 900 P29,000
 3-22

Least Squares Method

Required:
1. Using the least squares method, calculate the variable cost
rate and the total fixed costs elements of the glazing process.
2. Express the cost data in “1” above in the form of Y = a +
bx.
3. Assume the company processes 1,120 units in the next
quarter, how much is the expected glazing cost?
 QUESTIONS????
 REACTIONS!!!!!
 3-24

Question 1:
Hungarian Sausage wishes to analyze the fixed and variable components
of the semi-variable cost. The following information is available:
Month Output (units) Costs
Jan. 1,000 P12,000
Feb. 700 P10,000
Mar. 1,100 P14,000
Apr. 800 P11,000
May 1,400 P18,750
June 1,200 P15,000

Using the high-low method, compute the variable and fixed cost.
 3-25

Question 2:
Below is an examination of last year’s financial statements of Mackenzie
Park Co., which manufactures and sells trivets. Labor hours and
production cost for the last 4 months of the years which are representative
of the year were as follows:
Month Labor Hours Total Prod’n Costs
Sept. 2,500 P20,000
Oct. 3,500 P25,000
Nov. 4,500 P30,000
Dec. 3,500 P25,000

Using the least square methods, determine the variable cost and fixed cost.