COST BEHAVIOR,

ANALYSIS AND USE

 OUTLINE
• Importance of Studying Cost Behavior
• Methods of Cost Estimation
o Account Analysis Method
o Industrial Engineering Method
o Conference Method
o High-Low Method
o Least Squares Method
o Scattergraph or Visual Fit
o Correlation Analysis
o Learning Curve
 IMPORTANCE OF STUDYING COST
BEHAVIOR
• Planning
• Control
• Cost Analysis
METHODS OF COST ESTIMATION
 ACCOUNT ANALYSIS METHOD
• Based on experience of accountants and managers
• Each account is reviewed and classified as either fixed or variable
• Advantage: Extensive study of database
• Disadvantage: Subjective
 INDUSTRIAL ENGINEERING
METHOD
• Analysis of inputs (materials, labor, etc.) to outputs
• Done step by step
• Advantage: Detailed analysis will help determine strength and weaknesses in the process.
• Advantage: Can be used to estimate costs in new activities
• Disadvantage: Costly
 CONFERENCE METHOD
• Each department contributes their opinion.
• Advantage: Quick estimate
• Disadvantage: Dependent on objectivity and reliability of resource persons
 HIGH-LOW METHOD
Data for the past ten months for Kristal Inc. follows:

Direct labor hours Supplies Cost in Pesos

20 50
40 110
60 150
20 70
30 80
40 100
50 150
10 60
30 110
50 120
 HIGH-LOW METHOD
Step 1: Determine the highest level of activity and its cost.
60 DLH with cost of P150

Step 2: Determine the lowest level of activity and its cost.

10 DLH with cost of P60
 HIGH-LOW METHOD
Step 3: Determine the variable rate per activity using the formula:
VOH rate = Cost at highest level – Cost at lowest level
Highest level of activity – Lowest level of activity
(P150 – P60) / (60 DLH – 10 DLH) = P1.80 per DLH

Step 4: Determine the fixed cost using the cost of either the highest activity or the lowest
activity.
P150 = 60 (1.80) + n n = P42
P60 = 10 (P1.80) + n n = P42
 LEAST SQUARES REGRESSION
METHOD
• Statistical technique used to separate mixed costs into fixed and variable
components.
• The equation for the total mixed cost is Y = a + bX
• The values for a and b are obtained by simultaneously solving two
equations:
ΣY =Na + bΣX ΣXY = ΣXa + bΣX2
• We will use the set of data we used in the high low method
 LEAST SQUARES REGRESSION
METHOD
Y = Total cost (dependent variable)
a = Fixed cost
b = Variable cost rate
X = measure of activity (independent variable)
N = number of observations
 LEAST SQUARES REGRESSION
METHOD
20 x 50 = 1,000 Direct labor Supplies Cost
XY X2
hours (X) in Pesos (Y)
202 = 400
20 50 1000 400
40 x 110 = 4,400 40 110 4400 1600
60 150 9000 3600
402 = 1,600 20 70 1400 400
30 80 2400 900
40 100 4000 1600
50 150 7500 2500
10 60 600 100
30 110 3300 900
50 120 6000 2500
350 1000 39600 14500
 LEAST SQUARES REGRESSION
METHOD
Substitution:
Equation 1 ΣY = Na + bΣX 1,000 = 10a + 350b
Equation 2 ΣXY = ΣXa + bΣX2 39,600 = 350a + 14,500b
We multiply Eq 1 by 35 to make the coefficients of a similar so that we could cancel
them. Thus:
Eq 2 39,600 = 350a + 14,500b
Eq 1 35,000 = 350a + 12,250b
4,600 = 2,250b
b = 2.04 This is the variable cost rate
 LEAST SQUARES REGRESSION
METHOD
We substitute the value of b to Eq 1
1,000 = 10a + 350 (2.04)
a = P28.06 This is the fixed cost
 SCATTERGRAPH OR VISUAL FIT
• Plotting the variables on a graph and visually fitting a trend line
• As much as possible, the distance of the points above the line must equal to the distance of
the points below the line,
 SCATTERGRAPH OR VISUAL FIT
Chart Title
160

140

120

100

80

Fixed Cost
60

40

20

0
0 10 20 30 40 50 60 70
 SCATTERGRAPH OR VISUAL FIT
To compute for the variable cost rate, use two points on the trend line and their corresponding
costs.
Variable rate = Difference in costs / Difference in activity levels
Variable rate = (114 – 92) / (40 – 30) = P2.20
 CORRELATION ANALYSIS
• This aims to establish the sensitivity of the dependent variable (the total cost) to changes in
the independent variable (cost driver).
• This is measured using the coefficient of determination (r2).
r2 =1 - (Est. conditional SD based on regression line2/ SD based on ave.2)
r2 = 1 – (SD Reg.2 / SD Ave.2)
SD Reg = ∑(Y – Y)2/n-2 SD Ave. = ∑(Y – Y)2/n
Y = actual data
Y = line of regression cost Y = average cost
n = number of items of data
 CORRELATION ANALYSIS
Using the same set of data, we compute first the estimated conditional SD based on regression
line: Conditional
Direct labor Deviation
√ 1,595.60 / (10 - 2) hours
Actual Cost Expected Ave Deviations
Squared
Cost
14.12 20 50 69.4 -19.4 376.36
40 110 110.2 -0.2 0.04
60 150 151 -1 1
20 70 69.4 0.6 0.36
30 80 89.8 -9.8 96.04
40 100 110.2 -10.2 104.04
50 150 130.6 19.4 376.36
10 60 49 11 121
30 110 89.8 20.2 408.04
50 120 130.6 -10.6 112.36
350 1000 1595.6
 CORRELATION ANALYSIS
• Now we compute the SD based on average cost
√11,000/10 = 33.17 Direct labor
Actual Cost Deviations
Deviation
hours Squared

20 50 -50 2500
40 110 10 100
60 150 50 2500
20 70 -30 900
30 80 -20 400
40 100 0 0
50 150 50 2500
10 60 -40 1600
30 110 10 100
50 120 20 400
350 1000 11000
Average 100
 CORRELATION ANALYSIS
We now solve the coefficient of determination (r2).
r2 = 1 – (SD Reg.2 / SD Ave.2)
r2 = 1 – (14.122/ 33.172)
r2 = 81.88%

Conclusion: The correlation is high but not perfect.

 CORRELATION ANALYSIS
• This method is correlational and not necessarily causal.
A high correlation may mean:
• X may cause Y
• X and Y move together but is caused by another factor Z
• X and Y interact
• Pure co-incidence
 LEARNING CURVE THEORY
• This assumes that workers become more efficient as they repeat the work.
• This leads to reduction in the average amount of resource used per unit.
• Reduction can range from 10% to 40%, with 20% as the most common.
• If the reduction is 20%, the curve is said to be an 80% curve.
 LEARNING CURVE THEORY
Sample: Predicted
Cumulative
Cumulative Total Hrs to
Ave Worker
quantity Perform the
Hrs per unit
Task
1.00 2.00 2.00
2.00 x 80% 2.00 1.60 3.20 1.60 x 2
1.60 x 80% 4.00 1.28 5.12 1.28 x 4
8.00 1.02 8.19
16.00 0.82 13.11
32.00 0.66 20.97
64.00 0.52 33.55