Managerial Accounting

Sixth Edition

Chapter 6
Cost Behavior

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Learning Objectives
6.1 Describe key characteristics and graphs of various cost
behaviors
6.2 Use cost equations to express and predict costs
6.3 Use account analysis and scatterplots to analyze cost
behavior
6.4 Use the high-low method to analyze cost behavior
6.5 Use regression analysis to analyze cost behavior
6.6 Describe variable costing and prepare a contribution
margin income statement
6.7 Analyze cost behavior and make predictions using data
analytic tools

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Learning Objective 1
Describe key characteristics and graphs of various cost
behaviors

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Cost Behavior
• Cost behavior: how costs change as volume changes
• Most common cost behaviors:
– Variable costs
– Fixed costs
– Mixed costs

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Variable Costs
• Costs that are incurred for every unit of volume.
• Total variable costs change in direct proportion to changes
in volume.
• Graphs always begin at the origin.
• Slope represents the variable cost per unit of activity.

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Variable Costs Graph

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Learning Objective 2
Use cost equations to express and predict costs

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Cost Equation—Variable Costs
• Mathematical equation for a straight line, to express how a
cost behaves
• Variable cost line: y = vx, where
– y = total variable cost
– v = variable cost per unit of activity
– x = volume of activity
• Variable cost per unit remains constant

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Key Characteristics of Variable Costs

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Fixed Costs
• Costs that do not change in total despite changes in
volume
– Property taxes and insurance
– Straight-line depreciation and maintenance
– Lease payments
– Salaries of managers
• Committed fixed costs
• Discretionary fixed costs
• Graph—flat line that intersects y-axis

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Fixed Costs Graph

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Cost Equation—Fixed Costs
• y = f, where
– y = total fixed cost
– f = fixed amount over a period of time
• Fixed cost per unit is inversely proportionate to volume.

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Key Characteristics of Fixed Costs

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Mixed Costs
• Contain both variable and fixed cost components
– Hotel utilities—minimum amount required (common
areas)  fixed
– Hotel utilities—$8 per guest (guest rooms)  variable
• Increases with volume
• Does not start at the origin

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Mixed Costs Graph

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Cost Equation—Mixed Costs
• y = vx + f, where
– y = total mixed costs
– v = variable cost per unit
– x = number of variable units
– f = fixed cost component
• Total mixed costs increase when volume increases, but
not in direct proportion.

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Key Characteristics of Mixed Costs

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Relevant Range
• The band of volume where the following remain constant:
– Total fixed costs
– Variable cost per unit

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Other Cost Behaviors—Step Costs
• Step costs: fixed over a small range of activity and then
jump up to a new fixed level

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Other Cost Behaviors—Curvilinear Costs
• Curvilinear costs: not linear, do not fit into any neat
pattern

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Sustainability and Cost Behavior
• Paperless e-banking and e-billing
– Drives down variable costs
– Drives up fixed costs
– Variable savings > increased fixed costs
– Environmental benefits
– Allows households to embrace greener lifestyles

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Learning Objective 3
Use account analysis and scatterplots to analyze
cost behavior

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Analyzing Cost Behavior
• Four Methods
– Account analysis
– Scatterplots
– High-low method
– Regression analysis

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Account Analysis
Using judgement to classify each general ledger account as
variable, fixed, or mixed

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Scatterplots
• Graphs historical cost data on the y-axis and volume data
on the x-axis
• Helps visualize the relationship between cost and volume
• Linear pattern  strong correlation
• Random pattern  little to no correlation
• Outliers: abnormal data points

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Scatterplot Graph

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Learning Objective 4
Use the high-low method to analyze cost behavior

Copyright © 2021 Pearson Education, Inc. All rights reserved.

High-Low Method
• Fits a mixed cost line through the highest and lowest
volume data points

Copyright © 2021 Pearson Education, Inc. All rights reserved.

High-Low Method—Step 1
• Find the slope of the mixed cost line. The slope is the
variable cost per unit of activity.
• To find slope:

Rise Changein cost y (high)  y (low)

Slope = Variablecost per unit of activity (v)   
Run Changein volume x (high)  x (low)

• EX: Units: Low—January 13,250; High—July 25,200

Costs: Low—January $114,000; High—July $209,600
• ($209,600 – $114,000) ÷ (25,200 – 13,250) = $8 per guest

Copyright © 2021 Pearson Education, Inc. All rights reserved.

High-Low Method—Step 2
• Find the vertical intercept—the place where the line
intersects the y-axis, the fixed cost component.
• E X: Use mixed cost equation:
– y = vx + f
– Insert either high or low data point and solve for f
– $209,600 = ($8 x 25,200) + f
– f = $8,000

Or
– $114,000 = ($8 x 13,250) + f
– f = $8,000

Copyright © 2021 Pearson Education, Inc. All rights reserved.

High-Low Method—Step 3
• Using the amounts solved for in steps 1 and 2, write the
equation representing the costs’ behavior.
• E X: y = $8x + $8,000, where
– y = total monthly utilities cost
– x = number of guests

Copyright © 2021 Pearson Education, Inc. All rights reserved.

High-Low Method Conclusion
• Advantages
– Simple
– Follows familiar y = mx + b
• Disadvantage
– Only uses two data points

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Learning Objective 5
Use regression analysis to analyze cost behavior

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Regression Analysis
• Statistical procedure for determining the line and cost
equation that best fit all of the data points in the data set;
“the line of best fit”
• More accurate than high-low method
• R-square: statistic tells us how well the line fits the data
points; “goodness-of-fit”
• Usually completed in Microsoft Excel or with a graphing
calculator

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Microsoft Excel Regression Analysis

Copyright © 2021 Pearson Education, Inc. All rights reserved.

R-Square
• Higher the R-square, the stronger the relationship between
cost and volume
• Ranges from 0 to 1
• Rule of thumb:
– R-Square > 0.8 indicates very reliable cost equation
– R-Square between 0.5 and 0.8 should be used with
caution
– R-Square < 0.5 indicates equation is not reliable

Copyright © 2021 Pearson Education, Inc. All rights reserved.

R-Square Graphs

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Data Concerns
• Only valid within relevant range
• Seasonality
• Inflation
• Outliers
– May need to remove from data set

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Learning Objective 6
Describe variable costing and prepare a
contribution margin income statement

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Absorption Costing
• All manufacturing-related costs (fixed and variable) are
absorbed into the cost of the product.
• D M, D L, and MO H are treated as product costs.
• Required by GAA P and the I R S.

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Variable Costing
• Only variable manufacturing costs are treated as product
costs.
• Only used for internal management purposes.
• Often leads to better decisions:
– Shows incremental cost of manufacturing each unit.
– Operating income will not be affected by changes in
inventory levels.

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Example Absorption vs. Variable
Costing (1 of 4)

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Example Absorption vs. Variable
Costing (2 of 4)

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Example Absorption vs. Variable
Costing (3 of 4)
• Assume the company decides to produce an extra 5,000
units.
• Variable costing (5,000 units x $50) = $250,000.
• Absorption costing (5,000 units x $75) = $375,000.
• Variable costing is more accurate for internal decision
making.

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Example Absorption vs. Variable
Costing (4 of 4)

Copyright © 2021 Pearson Education, Inc. All rights reserved.

The Traditional Income Statement

Copyright © 2021 Pearson Education, Inc. All rights reserved.

The Contribution Margin Income Statement

Copyright © 2021 Pearson Education, Inc. All rights reserved.

The Contribution Margin Income
Statement Characteristics
• Organized by cost behavior.
• All variable costs are expensed above the contribution
margin line.
• All fixed costs are expensed below the contribution margin
line.
• Contribution margin = sales revenue – variable expenses.
• Operating income is the same in both statements when all
units are produced and sold in same period.
• Service and merchandising companies operating income
will always be the same regardless of format.
• Only for internal use.
Copyright © 2021 Pearson Education, Inc. All rights reserved.
Service and Merchandising
Companies (1 of 2)
• Don’t have MO H  variable and absorption costing do not
apply differently

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Service and Merchandising
Companies (2 of 2)
• Don’t have MO H  variable and absorption costing do not
apply differently

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Comparing Operating Income (1 of 3)
Scenario 1: Inventory Levels Remain Constant
• Both absorption and variable costing result in the same
operating income (lean manufacturers).

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Comparing Operating Income (2 of 3)
Scenario 2: Inventory Levels Increase
• Operating income will be greater under absorption costing
than under variable costing (economic growth).

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Comparing Operating Income (3 of 3)
Scenario 3: Inventory Levels Decrease
• Operating income will be greater under variable costing
than under absorption costing (economic recession).

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Reconciling Operating Income—
Inventory Increase (1 of 2)
Difference in operating income = (Change in inventory
level, in units) x (Fixed MO H per unit)
• E X: 40,000 units produced, 30,000 sold, Fixed M O H is
$25 per unit
• $250,000 = 10,000 units x $25
• Operating income $250,000 lower under variable than
absorption costing

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Reconciling Operating Income—
Inventory Increase (2 of 2)

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Reconciling Operating Income—
Inventory Decrease (1 of 2)
• E X: 45,000 units sold, 40,000 produced in current period,
5,000 produced in previous period, $25 fixed MO H per unit
• $125,000 = 5,000 units x $25
• Operating income $125,000 lower under absorption than
variable costing

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Reconciling Operating Income—
Inventory Decrease (2 of 2)

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Key Points—Variable Costing and the
Contribution Margin Income Statement

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Learning Objective 7
Analyze cost behavior and make predictions using
data analytic tools

Copyright © 2021 Pearson Education, Inc. All rights reserved.

How Can Managers Use Data Analytics
for Making Cost Predictions? (1 of 4)
• Suppose an airline’s management is considering whether to
begin offering a nonstop flight from Atlanta to Tokyo.
• Managers need an accurate prediction of the cost of operating
the flight.
• Management has thousands of data records for the company’s
international flights from the past several years, a sample of
which is Exhibit 6.31

Copyright © 2021 Pearson Education, Inc. All rights reserved.

How Can Managers Use Data Analytics
for Making Cost Predictions? (2 of 4)
• Managers could run a
regression analysis using
nautical miles (x) to predict
cost (y)
• Simple linear regression:
regression analysis that
includes only one x variable
• Managers would filter the data
set to only include transpacific
international flights over the
last month. A scatterplot of the
data is Exhibit 6-32

Copyright © 2021 Pearson Education, Inc. All rights reserved.

How Can Managers Use Data Analytics
for Making Cost Predictions? (3 of 4)

Copyright © 2021 Pearson Education, Inc. All rights reserved.

How Can Managers Use Data Analytics
for Making Cost Predictions? (4 of 4)
Given the nonstop Atlanta-Tokyo flight will be 6,854 nautical
miles and is expected to carry an average of 320 people,
managers can now predict the cost of the flight

y  ($39.67  number of passengers)  ($11.60  number of miles)  $5,170.54

y  ($39.27  320 passengers)  ($11.60  6,854 miles)  $5,170.54
y  $97,371.34

Copyright © 2021 Pearson Education, Inc. All rights reserved.

How to Create a Scatterplot with a
Regression Line, Equation, and R-
Squared Value
1. Start with a data set with the independent variable (x) in
the column to the left of the dependent variable (y).
Select both the x and y columns of data.

Copyright © 2021 Pearson Education, Inc. All rights reserved.

How to Create a Scatterplot with a
Regression Line, Equation, and R-
Squared Value (1 of 2)
2. Choose the Insert tab on the Excel ribbon. Click the scatter icon from
the group of available charts.

3. To add axis labels to the scatterplot, click on Quick Layout and choose
the first option. Type in descriptive titles for your chart or delete the
legend if desired.

Copyright © 2021 Pearson Education, Inc. All rights reserved.

How to Create a Scatterplot with a
Regression Line, Equation, and R-
Squared Value (2 of 2)
4. To add the regression line, equation, and R-squared statistic to the scatterplot,
point your cursor at any data point on the scatterplot and right click. Click on
add trendline. The Format Trendline task pane will appear on the right side of
the screen. Leave the default option: Linear. At the bottom of the task pane,
check the two boxes next to Display equation on chart and Display r-squared
value on chart.

5. The cost equation and R-squared value will now appear on the scatterplot in a
text box. Drag the text box to a different area of the scatterplot or add dollar
signs, if desired.
y  $12.19x  $15,303
R 2  0.8772
Copyright © 2021 Pearson Education, Inc. All rights reserved.
How to Obtain Regression Output for Simple
Linear or Multiple Regression (1 of 3)

1. Start with a data set with the independent variable(s) (x1,

x2, etc.) in the column to the left of the dependent variable
(y)
2. Click on the Data tab on the ribbon. Then click on the
Data analysis icon at the far right on the ribbon.

Copyright © 2021 Pearson Education, Inc. All rights reserved.

How to Obtain Regression Output for Simple
Linear or Multiple Regression (2 of 2)

3. From the list of data analysis tools, select Regression,

then click O K. A dialog box will open.

Copyright © 2021 Pearson Education, Inc. All rights reserved.

How to Obtain Regression Output for Simple
Linear or Multiple Regression (3 of 3)

4. In the dialog box, check the labels box if the first row of
the data set contains the column labels. Next fill in the
data range for the y and x variables by either typing in the
data range or selecting the data with your cursor. Click
O K. The regression output will appear in a new
worksheet.

Copyright © 2021 Pearson Education, Inc. All rights reserved.

Copyright

This work is protected by United States copyright laws and

is provided solely for the use of instructors in teaching their
courses and assessing student learning. Dissemination or
sale of any part of this work (including on the World Wide
Web) will destroy the integrity of the work and is not
permitted. The work and materials from it should never be
made available to students except by instructors using the
accompanying text in their classes. All recipients of this
work are expected to abide by these restrictions and to
honor the intended pedagogical purposes and the needs of
other instructors who rely on these materials.

Copyright © 2021 Pearson Education, Inc. All rights reserved.