Chapter 5

Cost Behavior

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
 Cost Behavior Patterns

Cost behavior describes the way total cost behaves,

or changes, when some measure of activity changes.

The range of activity within

which
assumptions about cost
behavior hold true is the
relevant range.
Unit variable costs Total fixed costs
remain unchanged. remain unchanged

5- 3
Learning Objective 5-1

Identify costs as variable,

fixed, step, or mixed.

5- 4
Variable Costs

Total variable costs Variable cost per unit

increase as is
activity increases. constant as
activity increases.
5- 5
Fixed Costs

Total fixed costs Cost per cup

remain constant declines as
as activity activity increases.
increases.
5- 6
 Cost Behavior Summary

Cost In Total Per Unit

Changes proportionately Remains constant for each
with changes in activity additional unit as long as
Variable
within the relevant range. activity is in the relevant
range.
Remains the same even The per unit amount
when activity changes changes each time the
Fixed within the relevant range. level of activity changes
due to the fixed nature of
the related costs.

5- 7
Step Costs

Step-variable costs Step-fixed costs are

rise in multiple steps fixed over a fairly
across the relevant wide range of
range. activities.
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Mixed Costs

Mixed costs contain a fixed portion that is incurred

even when the facility is unused, and a variable
portion that increases with
usage. Utilities typically behave in this manner.

st
Total Utility

d co
ix e
m
Cost

l
ta
To Variable
Cost per
KW
Fixed
Activity (Kilowatt
Monthly
Hours)
Utility 5- 9
Mixed Costs

Total mixed costs Per unit mixed costs

increase as decrease as
activity increases. activity increases.
5- 10
 Linear Approaches to Analyzing Mixed Costs

y = total cost, which is plotted on the

vertical

y = Total Costs
axis, and is called the dependent
a = total fixed cost, an amount that will e
variable. op
be Sl
incurred regardless of the activity b=
level,
b = the slope of the line, the unit
and is
variable called the intercept or the
cost, a =
constant.
which tells us how much the total Intercept
cost (y) activity
x = the will that causes total cost
increase for each unit increase in
(y) to
activity (x). Activity (x) is also called x=
change.
Activity
the cost
driver, or the independent variable. 5- 11
 Linear Approaches to Analyzing Mixed Costs

There are three different methods to analyze mixed costs,

all using the linear assumption as a base.
1.Scattergraph: A graph that provides a visual
representation of the relationship between total cost (y)
and activity level (x). A scattergraph is a useful first step
in analyzing cost behavior because it helps determine
the nature of the relationship and whether the linearity
assumption is valid.
2.High-low method: A simple approach that uses the two
most extreme data points to determine the slope of the
line (variable cost per unit) and the intercept (total fixed
cost).
3.Least-squares regression: A statistical technique for
finding the best fitting line based on historical data.
The slope of the line provides an estimate of the 5- 12
Learning Objective 5-2

Prepare a scattergraph to
illustrate the relationship
between total cost and
activity.

5- 13
Scattergraph
A scattergraph is a graph with total cost
plotted on the vertical (Y) axis and some
measure of activity on the horizontal (X)
axis.

5- 14
 Preparing a Scattergraph
scattergraph can be created by manually plotting data points on
aph-paper, or by using a the following steps in Excel:
Enter the data in Excel, and highlight the data that you want to p
Select the Chart Wizard from the toolbar.
Select XY (Scatter) as the chart type. Be sure total cost is on the
Y axis, with the activity driver on the X axis.
Add a chart title and labels for the X and Y axes.

To apply these steps, Customers Total OH

Served (X) Cost (Y)
consider the following data
January 9,000 $ 15,000
showing the total overhead February 15,000 15,750
cost (Y) March 12,500 16,000
of running our hypothetical April 6,000 12,500
Starbucks location, along May 5,000 13,250
with the number of June 10,000 13,000
customers 5- 15
Preparing a Scattergraph

5- 16
Learning Objective 5-3

Use the high-low method to

analyze mixed costs.

5- 17
High-Low Method

5- 18
 High-Low Method

_
Total Fixed Cost = Total Cost Variable Cost per Unit × Activity
February Estimate
_
Total Fixed Cost = $15,750 $0.25 × 15,000
Total Fixed Cost = $12,000

May Estimate
_
Total Fixed Cost = $13,250 $0.25 × 5,000
Total Fixed Cost = $12,000
5- 19
High-Low Method

5- 20
Learning Objective 5-4

Use least-squares regression

to analyze mixed costs.

5- 21
 Least-Squares Regression Method
A statistical method used to analyze
18,000

16,000
mixed costs.
14,000
} Error
Total Overhead Cost

12,000

10,000

8,000

6,000

4,000

2,000

-
4,000 6,000 8,000 10,000 12,000 14,000 16,000

Customers Served
The goal of this method is to minimize the sum of the
squared errors.
5- 22
Least-Squares Regression Method
 Software such as Excel can
be used to fit a regression
line through the data points.
 The cost analysis objective
is the same:
y = a + bx

The
The output
output from
from the
the regression
regression analysis
analysis
can
can be
be used
used to
to create
create an
an equation
equation that
that
enables
enables you
you to
to estimate
estimate total
total costs
costs at
at
any
any activity
activity level.
level.
5- 23
Least-Squares Regression Method

5- 24
Least-Squares Regression Method
SUMMARY OUTPUT

Regression Statistics R22 tell us how closely we can

Multiple R 0.802489134 explain the relationship
R Square 0.643988811
Adjusted R Square 0.554986013
between our two variables. In
Standard Error 1011.697667 our example, the number of
Observations 6 customers explains about 64%
ANOVA of the overhead costs.
df SS
Regression 1 7405871.321
Residual 3 4094128.679
The intercept and x
Total 4 11500000 coefficient,
respectively, are
Coefficients Standard Error
Intercept 11180.90017 1213.424073
estimated total fixed
Customers Served (X) 0.320253895 0.11905759 cost and variable
cost per unit.
5- 25
Least-Squares Regression Method

Total Total Fixed Total Variable Cost

Cost
= Cost
+ (Variable Cost per Unit × X)

Using our regression output, if Starbucks

expected to serve 8,000 customers in July,
we would estimate total overhead costs as
follows:
$0.32 × 8,000 =
$2,560
+ $11,181 = $13,741

5- 26
Summary of Linear Methods

5- 27
Learning Objective 5-5

Prepare and interpret a

contribution margin income
statement.

5- 28
Contribution Margin Approach

Contribution margin is the difference

between sales revenue and variable
costs.
5- 29
 Contribution Margin Ratio
Contribution Margin Formula
Contributio Sales Variable
n = Revenue ‒ Costs
Margin

Contribution Margin Ratio

Contribution Contribution
Margin Ratio = Margin
Sales Revenue
5- 30
Contribution Margin
Unit
contribution
margin

Contribution margin ratio

5- 31
Contribution Margin

5- 32
 Supplement 5A

Variable Versus Full Absorption Costing

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 5-S1

Compare variable costing to

full absorption costing.

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Variable Versus Full Absorption Costing

5- 35
Reconciling Variable and
Full Absorption Costing

5- 36
Full Absorption Costing
Income Statement

5- 37
Variable Costing Income Statement

Variable costs only.

All fixed manufacturing overhead is

5- 38
 Reconciling Variable and
Full Absorption Costing

Difference between Change in Units in Fixed

Full Absorption and = Ending Inventory × Manufacturing
Variable Costing (Production ‒ Overhead Cost
Income Sales) per Unit
$40,000 = 2,000 units × $20 per unit

5- 39
Effect of Changes in Inventory Under Full
Absorption and Variable Costing
Relationship Relationship between
Effect on
between production variable and
inventory
and sales absorpton income
Inventory Absorption
Production > Sales increases >
Variable
Inventory Absorption
Production < Sales decreases <
Variable
Absorption
Production = Sales No change =
Variable
5- 40
End of Chapter 5

5- 41