MPA 602: Cost and Managerial

Accounting
Cost Behavior Analysis and
Uses
Cost Object
• A cost object is a broad term that can include activities, projects,
organizations, intangible assets, and many other resources.
• Cost object is a term used in budgeting, planning, and accounting,
referring simply to any item associated with a cost figure of its own.
• The term can be applied a very wide range of items whose
costs maybe found by estimation, by direct measurement, or by
allocation or apportionment. Cost object items may include, for instance:
• Services (e.g., consulting services with a specified cost).
• Goods (e.g., raw materials for product production).
• Products (e.g., a product whose cost of design, development, and production is
specified).
• Projects(e.g., a product design project).
• Customers (e.g., a customer for whom the cost of selling or the cost of service
delivery is specified).
• Contracts (e.g., a warranty support contract, whose cost of creation and delivery
is specified).
• Resources (e.g., fuel used to operate vehicles, with a specified cost).
• Activities (e.g., Using a vehicle to deliver goods, at a specific cost).
 Understand how fixed and
variable costs behave and how
to use them to predict costs.
 1-6

Cost Classifications for Predicting Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
The Activity Base
Units
Units Machine
Machine
produced
produced hours
hours

AAmeasure
measureofofwhat
what
causes
causesthe
theincurrence
incurrence
of
ofaavariable
variablecost.
cost.

Miles
Miles Labor
Labor
driven
driven hours
hours
Cost Estimation
Cost Estimation studies involve an attempt
to find predictable relationships between an
activity component (known as cost driver
which affect costs) and costs. Managers are
interested in estimating cost behavior
function because these estimates can help
them make more accurate cost predictions
about future costs.
General issues in Estimating Cost
Functions
• Cost function is the mathematical expression
describing how a cost changes with changes in
the level of an activity.
• - cost behavior is adequately approximated by a
linear cost function within the relevant range.
Cost behavior / classification
Fixed and Variable costs
* Choice of cost object
* Time horizon
* Relevant range

Cost Function
 Straight-line equation:
Y = a + bX
where
Y = Total activity cost
a (F) = Fixed cost component
b (V)= Variable cost per unit
X = Measure of activity output
12
Cost Estimation Approaches

Cost-benefit analysis often dictates which methods are

applied:
1. Industrial engineering method
2. Conference method
3. Account analysis method
4. Quantitative analysis method
Industrial Engineering Method

The industrial engineering method or work-

management method, estimates cost functions
by analyzing the relationship between inputs
and outputs in physical terms. The focus is on
what the cost should be to produce a finished
product using co.’s production facilities in the
most efficient method of operations.
Conference Method
The conference method estimates cost functions
on the basis of analysis and opinions about costs
and their drivers gathered from various
departments of an organization. The conference
method encourages interdepartmental
cooperation. The pooling of expert knowledge
from each value chain function gives this
method credibility
 Account Analysis Method
The account analysis method estimates cost
functions by classifying cost accounts in the
ledger as variable, fixed or mixed with respect
to the identified level of activity. Managers use
qualitative rather than quantitative analysis
when making these cost-classification
decisions.
Quantitative Analysis method

1. Scatter graph
2. High-low technique
3. Regression analysis
Steps in estimating a cost function using quantitative
analysis
1. Choose the dependent variable
2. Identify the independent variables or cost drivers
3. Collect data on the dependent variable and the cost
drivers
4. Plot the data
5. Estimate the cost function
6. Evaluate the cost driver
Scatter graph/ Visual fit method

• A method in which the cost analyst visually fits a

straight line through a plot of all available data.
The Scattergraph Method
Plot
Plot the
the data
data points
points on
on aa graph
graph (total
(total
Y cost
cost vs.
vs. activity).
activity).
20
Maintenance Cost

* ** *
1,000’s of Dollars

* *
**
10 * *

0 X
0 1 2 3 4
Patient-days in 1,000’s
The Scattergraph Method
Draw
Draw aa line
line
through
through the the
Y
data
data points
points
20
Maintenance Cost

* ** *
1,000’s of Dollars
with
with about
about anan
* * equal
equal number
number
**
10 * * of
of points
above
points
above andand
below
below thethe
line.
line.
0 X
0 1 2 3 4
Patient-days in 1,000’s
The Scattergraph Method
Use one
Y data point
Total maintenance cost = $11,000
20 to estimate
Maintenance Cost

* ** *
1,000’s of Dollars
the total
* *
** level of
10 * * activity and
Intercept = Fixed cost: $10,000 the total
0 X
cost.
0 1 2 3 4
Patient-days in 1,000’s
Patient days = 800
The Scattergraph Method
Make a quick estimate of variable cost per
unit and determine the cost equation.
Total maintenance at 800 patients $ 11,000
Less: Fixed cost 10,000
Estimated total variable cost for 800 patients $ 1,000

$1,000
Variable cost per unit = = $1.25/patient-day
800

Y = $10,000 + $1.25X

Total maintenance cost

cost Number
Number of patient
patient days
High – Low method
• A simple method for measuring a linear-cost
function from past cost data, focusing on the
highest activity and lowest activity points and
fitting a line through these two points.
High-Low Method
Materials Number of
Month Handling Cost Moves
January $2,000 100
February 3,090 125
March 2,780 175
April 1,990 200
May 7,500 500
June 5,300 300
July 4,300 250
August 6,300 400
September 5,600 475
October 6,240 425

Step 1: Solve for variable cost (V)

V = Change in cost ÷ Change in activity
25
High-Low Method
Materials Number of
Month Handling Cost Moves
January $2,000 100 Low Activity
February 3,090 125
March 2,780 175
April 1,990 200
May 7,500 500 High Activity
June 5,300 300
July 4,300 250
August 6,300 400
September 5,600 475
October 6,240 425

$7,500 - $2,000
Step1: V   $13.75
500 - 100 26
High-Low Method
Step 1: Solve for variable cost (V)
V = Change in cost ÷ Change in activity
$7,500 - $2,000
V   $13.75
500 - 100
Step 2: Using either the high cost or low cost, solve for
the total fixed costs F

Y  F V(X )
Low cost $2,000  F  $13.75(100)
$625  F
Y  F V(X )
High cost $7,500  F  $13.75(500)
$625  F 27
 Regression Analysis
• Regression analysis can be used to measure the
average amount of change in a dependent
variable that is associated with increase in the
amounts of one or more independent variables.
• The method of least-squares is the most used
regression analysis for estimating the functional
relationship between an independent variable
and the dependent variable.
Least-Squares Regression Method
AA method
method used to analyze total
total costs
costs ifif aa scattergraph
scattergraph
plot
plot reveals
reveals an
an approximately linear
linear relationship
relationship
between the
the XX and
and YY variables.
variables.

This method uses all of the

data points to estimate
the fixed and variable
cost components of a The goal of this method is
mixed cost. to fit a straight line to the
data that minimizes the
sum of the squared errors.
 Least-Squares Regression Method
• Software 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.
Comparing Results From the Three Methods

The
The three
three methods
methods just
just discussed
discussed provide
provide slightly
slightly
different
different estimates
estimates of
of the
the fixed
fixed and
and variable
variable cost
cost
components
components of of the
the mixed
mixed cost.
cost.
This
This is
is to
to be
be expected
expected because
because each
each method
method uses
uses
different
different amounts
amounts of
of the
the data
data points
points to
to provide
provide
estimates.
estimates.
Least-squares
Least-squares regression
regression provides
provides the
the most
most accurate
accurate
estimate
estimate because
because itit uses
uses all
all of
of the
the data
data points.
points.
Cost Determination
 Cost Statement / Cost Sheet
• A cost sheet is a report which accumulated all of the costs
associated with a product or production job.
• Used to compile the margin earned on a product or job
• Form the basis for setting of prices on similar products in
future
• Used as a basis for cost control measures
• Used it as a basis for a quote to customer for customized
product

A statement which provides for the assembly of the detailed

cost of a centre or cost unit.