Separating

Fixed and
Variable Cost
WEEK 2 : Cost Behavior analysis
&
Costs Systems & cost Accumulation
 Cost Behvior
• Cost behavior analysis refers to management's attempt to.
understand how operating costs change in relation to a
change in an organization's level of activity.

• Fixed Cost
• Variable Cost
• Semi- Variable Cost
• Step Cost
 • A fixed cost is that which does not change in
total as business activity increases or
decreased
• Some costs are fixed in appearance all the
costs are variable in the long run

Fixed Costs • Therefore, any kind of expenditure should be

classified as fixed within a limit range of
activity
• Some expenditures are fixed as a result of
management’s decisions.
• Per unit cost decrease with increase in
activity
• DISCRETIONARY OR PROGRAMMED FIXED
COST :the level of advertising or charitable
contribution are determined by
managements decision not directly related
to business activity or sales of units
• COMMITTED FIXED COSTS:
• Expenditures that require a series of
payments over a long-term period of time.
Interest on long term debt or long term
lease rentals
 A variable costs is the one that increase
in proportion to increase in activity and
vice versa

It includes cost of direct materials ,

direct labor some supplies, some
indirect labor ,rework and spoilage .
Variable
costs : The cost per unit remains constant
within the relevant range

Can be easily, accurately and reasonably

assigned to operating departments
 • Defined as the one that shows both a fixed
and variable characteristics
• Often characterized by a fixed dollar amount
below which it will not fall , at all relevant
Semi - levels of output. The variable element,
(above that fixed amount) changes at a
Variable costs constant amount per unit of output within a
relevant range .
• Cost of electricity ,water, gas, fuel, oil,
maintenance, some indirect
labor ,payroll ,taxes
Separating Fixed &
variable Costs
• To plan , analyze, measure ,or evaluate costs at different
levels of activity, fixed and variable costs must be separated.

• Entirely fixed or variable costs and the fixed and variable

components of semi variable costs must be estimated.

• More reliable classifications and cost estimates are obtained

by using the following methods :
1. The high and low points method
2. The scatter graph method
3. The method of least squares
 • WHAT IS THE BASIC DRIVER OF COST?
Question
 The fixed and variable elements of a
cost are computed from two data
points

The data points selected from the

High and low historical data are the period of
highest and lowest activity
points method
High and low are selected because
they represent conditions for the
activity levels that are the farthest
apart
Month Electricity cost $ Direct labor hours
January 640 34,000
February 620 30,000
March 620 34,000
April 590 39,000
May 500 42,000
June 530 32,000
July 500 26,000
August 500 26,000
September 530 31,000
October 550 35,000
November 580 43,000
December 680 48,000
Total 6840 420,000
average 570 35,000
High activity = 48000 hours , lowest activity = 26000
Highest Cost =680 , lowest cost =500

Step 1 : Calculate VC per unit

VC per unit

Step 2 : Calculate Fixed cost

Total cost = Fixed cost + VC per unit (no of
units )

For check
680= 213+287
 • The scatter graph method is a visual technique
for separating the fixed and variable elements of
a semi-variable expense in order to estimate and
budget for future costs.

Scatter graph • A scatter graph has

• a horizontal x-axis that represents
method production activity,
• a vertical y-axis that represents cost,
• data that are plotted as points on the graph,
• and a regression line that runs through the
dots to represent the relationship between the
variables.
• Step 1: Draw scatter graph
• Plot the data on scatter graph. Plot activity level (i.e. number of units, labor hours
etc.) along x-axis and total mixed cost along y-axis.
• Step 2: Draw regression line
• Draw a regression line over the scatter graph by visual inspection and try to
minimize the total vertical distance between the line and all the points. Extend the
line towards y-axis.
• Step 3: Find total fixed cost
• Total fixed is given by the y-intercept of the line. Y-intercept is the point at which the
line cuts y-axis.
• Step 4: Find variable cost per unit
• Variable cost per unit is equal to the slope of the line. Take two points (x1,y1) and
(x2,y2) on the line and calculate variable cost using the following formula:
• 1. take an average of your total cost
• 2.take your average of your total activity
• 570-287= 283 variable component on average
• 283/35000= per unit rate=0.0081
• 17985 cost -10000 =7985 average variable
• 819 /7985
=0.102
 Merchandising and manufacturing
concerns

Cost of flow in manufacturing

Chapter 4 : concerns
cost Control accounts and subsidiary
accumulation accounts

systems Cost of goods sold statement

Different type of costing systems and

technique
• Flow of costs refers to the manner or path in which
costs move through a firm. Typically, the flow of
costs is relevant with manufacturing companies
whereby accountants must quantify what costs are
in raw materials, work in process, finished goods
inventory, and cost of goods sold.
 The process of the flow
of costs begins with
valuing the raw
materials used in
manufacturing.

Following the sale of the

Understanding
The flow of costs then
goods, the flow of costs
moves to the work-in-
finally moves to cost of
process inventory.
goods sold.

Flow of Costs

The flow of costs next The cost of the

moves to the inventory machinery and labor
stage where the finished involved in production
goods are stored until are added as well as any
they're sold. overhead costs.
 Cost system
• A cost accounting system (also called product costing system or
costing system) is a framework used by firms to estimate the cost
of their products for profitability analysis, inventory valuation and
cost control.

• Estimating the accurate cost of products is critical for profitable

operations.

• A costing system helps in estimating the closing value of materials

inventory, work-in-progress and finished goods inventory for the
purpose of financial statement preparation.
Actual cost system(historical ) :

• Cost information is accumulated as cost is incurred

Standard cost system:

• Products, process and operations are costed based on

predetermined prices of those resources.

Absorption costing:

• costs allocated to units of production may include all

manufacturing costs.

Variable costing :

• costs allocated to units of production may include all

variable manufacturing costs
 MANUFACTURING COSTS ELEMENTS ALLOCATED TO PRODUCTION.

COST MEASURED AT : Direct material & direct

Direct Material, Direct Direct Material,Direct
labor, Variable & fixed
labour Labor ,Variable overhead
overhead

(1) (4) (7)

Historical Amounts
Actual Prime costing Actual Direct costing Actual absorbtion costing

Historical Amounts for DM (8)

(2) (5)
& DL predetermined A Hybrid Absorption
A hybrid Prime costing A Hybrid Direct costing
amounts for Overhead costing

(9)
(3) (6)
Predetermined amounts Standard Absorption
Standard Prime costing Standard Direct costing
costing
Prepare :Cost of goods sold statement
• Stroup Manufacturing incurred manufacturing Costs Totaling $110,000 in
July .inventories were as follow(in thousands)

JUNE 30 JULY 31
Finished Goods $150 $120

Work In process 80 90
• ABC company had gathered the following data concerning its may
operation (in thousands)
Required: calculate cost of goods sold for MAY

Work in Process Inventory , Beginning $250

Direct Materials Used 90
Finished Goods Inventory , Beginning
300

Direct Labor 60
Work in Process Inventory Ending
210

Factory Overhead 80
Finished Goods Inventory , Ending 340
Cost accumulation
Cost accumulation involves the use of a
formal cost accounting system to collect cost
information.
By collecting and analyzing cost information,
management can make more informed
decisions about the operations of a business.
Cost accumulation systems fall into two main
categories, which are:
• Job cost system. Accumulates materials,
labor, and overhead costs about individual
jobs.
• Process system. Accumulates costs by
cost center and then assigns average costs to
products.
 • There are two main cost accounting systems: the job
order costing and the process costing.

• Job order costing is a cost accounting system that

accumulates manufacturing costs separately for each
job. It is appropriate for firms that are engaged in
production of unique products and special orders. For
cost example, it is the costing accounting system most
appropriate for an event management company, a niche

accounting furniture producer, a producer of very high cost air

surveillance system, etc.

systems • Process costing is a cost accounting system that

accumulates manufacturing costs separately for each
process. It is appropriate for products whose production
is a process involving different departments and costs
flow from one department to another. For example, it is
the cost accounting system used by oil refineries,
chemical producers, etc